Many people have been screaming about real estate as an investment. Well I have nothing against it, except that I do not understand it. Given limited brain power, I would rather not do it, instead of making a mess of the same

Let me share one real estate transaction that I saw from close quarters:

India Bulls has a property in Panvel (a suburb of a suburb of Mumbai!!).

Cost / buying price for the customer in Sep 2010        : Rs. 2200

brokerage                                                                                                       50

total cost say Rs          2250

the price at which one can be reasonably sure of selling : Rs. 4000 (the builder says 4400)

BUILDER’S transfer charges: Rs. 400

brokerage (assumed)               Rs.     80

Net cash that you will get (over a 16 month period) :              Rs. 3520

Capital Gains 3520-2250 = Rs. 1270

Cap gains tax @ 25% (short term cap gains, so you will pay at max marginal rate): 320 (rounded off)

so net gains: 3200 (cash) on an investment of Rs. 2250 over a 16 month period.

Net gains: 1270 – 320 = 950….

Not bad at all.

Right? Sure, you took the risk, made the investment and the broker still decides to take Rs. 400 – which is greater than the Capital Gains that the government of India charges…

So is realty a good investment…?

Well if you did invest cash, or if you leveraged (after all you did not have the money to do the deal)..and you made money…yes.

Did I do this transaction? NO.

I have done transactions where I have got about 10%p.a.  return over the past 3 years. Not cribbing.

I have seen / done a funding transaction with a builder @ 28% p.a. – secured.

I have seen / done a funding transaction with a builder @ 24%p.a. unsecured….

but my debt transactions are rarely worth talking about – I take too much risks.

Capital gains tax (short term cap gains so assuming 25% tax)

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Why do I find so many attractive targets to write about?

Just found an article on Rediff.com saying ‘Six reasons why property prices WILL NOT FALL in your city’.

Let us look at it reason by reason?

“Property prices across the country are unlikely to see significant price corrections of more than 10 per cent in the coming few years.”

YOU NEED GUTS TO MAKE SUCH A COMMENT…RAW GUTS.(my comment!)

Reasons given in the article:

1. Because it is a cash haven for BLACK MONEY: come on Indians know that now you pay 30% Income tax and 10% short term capital gains tax. Long Term cap gains is 0% – much easier to convert and invest wherever you wish. Even in cities like Mumbai, only some locations can you do a 70:30 (Cheque: Cash) transaction. Much, much easier to do small transactions in gold.

2. Investors are willing to pay the high interest rates: Complete nonsense. Seen a deal where a builder borrowed Rs. 200 million @ 28% p.a. for 2 years. This builder would have happily given a 35% discount on his rack rate – but needed a big committment from the buyer. As it was not forthcoming, it got converted to a secured loan at 28%.

3. Inflation: I did not understand this as a reason, pardon me.

4. Wages have gone up, thanks to NREGA – so labor is not available….

I think the author means that because of inflation and non availability of labor prices cannot come down. Funny, prices of existing housing stock will fall – because the builder may be going out of business!!

5. Contrary to popular belief only a few builders are leveraged: Do not have enough audited figures to dispute this, but take a look at the balance sheets of listed companies – there is surely some leverage, and further loans are JUST NOT AVAILABLE for builders…

6. You are likely to get about 18% p.a. return: Did this working over the last 25, 30, 35 years…did not find any location where property prices doubled in 4 years…feedback welcome. And I am not even talking about interest cost, borrowing costs, term insurance, maintenance, ….etc.

the bold print is in the article – the normal print is my view. Sorry rediff, find it difficult to agree…

Now I know a bunch of people who have LOST money in real estate transactions – bad builder, bad timing, …many reasons and in many locations too! Pune, Chennai, Bengaluru, Mumbai, Navi Mumbai…..will do specific stories…not sure when!!

here is the link

http://www.rediff.com/getahead/slide-show/slide-show-1-money-six-reasons-why-property-prices-will-not-fall-in-your-city/20111121.htm

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It may also be some kind of a protection for people investing only in India. You can look at condos at US $ 50,000 – at such prices the real estate agent in Mumbai and Delhi will not even look at you. Given Indian prices and terrible rental yields, it may be worthwhile to invest in US and UK.

Most of us are today sure that it is India and China are the only growth stories and all US and Europe is doomed. Please understand it takes a couple of world wars to dethrone those in power. US and Europe will not give up the domination very easily – this means the real estate investment cannot be too bad.

I am neither saying ‘buy’ or ‘sell’ – just read this article by Deepa Venkatraghvan – in Economic Times – and take your own decision..Please remember US is an extremely ‘agent’ oriented country – so while taking a buying decision remember Estate management fee, taxes, currency risk, brokerage and commissions while taking a decision…and as usual have at least ONE BUSINESS CYCLE – 7 years view…shorter views could kill you or maim you at the least.

http://economictimes.indiatimes.com/news/nri/nri-investments/us-real-estate-smart-diversification-option-for-hnis/articleshow/10728864.cms?curpg=2

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This statement is then followed by the following:

1. See over the last 30 years what fantastic returns I have got!

2. Real estate NEVER goes down unlike share markets.

3. God does not make them anymore

4. Mumbai, it suburbs, Delhi, Bengaluru, NCR, …are all places where property prices can NEVER FALL.

………and many more.

Frankly I am not against or for investing in real estate. I feel people should understand things like job uncertainty, interest rates fluctuations, etc. and also see what is happening in real estate – around the world. Like the Economist article at the end of this page…

http://www.economist.com/node/21536592?fsrc=scn/tw/te/ar/risingfromtheruins

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I have a difficult time explaining to editors in their 20s why there is a gap between what I say in my columns, what I do and what others do.

The origins of this article can be traced to a meet with 5 television editors (to be fair, their boss was on my side) who were shocked when I mathematically proved it is better to hire, than to buy. This is true of cars, vacations, or homes! Here we are talking homes.

So let us see what I do which worries, surprises, shocks, my editor friends.

Even though I do write articles on portfolio planning, portfolio construction and occasionally even stock picking, my own money is with a portfolio manager – and he is urging me to index! It took me a long time to understand that ego of stock picking need not interfere in the more important task of wealth creation.

So the stock picking happens as a hobby and the money gets managed by an extremely competent and diligent portfolio manager – and to use today’s modern language he is “just a broker”. He has been handling our family portfolio for the past 30 years.

We attended each other’s wedding, and now his daughter is ready for marriage. No I do not call him my “relation-ship manager”.

I rent an apartment, despite having enough money to buy a house. I plan to keep renting for as long as I can. I’m not just holding out for better prices. Renting will make me richer. Businesses are great investments while houses are poor ones, so I’d rather rent the latter and own the former.

Shares of businesses return 7% a year over long time periods. I’m subtracting for inflation – gradual price increases for everything from a loaf of bread to a root canal surgery. (After-inflation or “real” returns are the only ones that matter.

The point of increasing wealth is to increase buying power, not numbers on an account statement. Shares have been remarkably consistent over the past two centuries in their 7% real returns.

In Jeremy Siegel’s book, “Stocks for the Long Term,” he finds that real returns averaged 7.0% over nearly seven decades ending 1870, then 6.6% through 1925 and then 6.9% through 2004.

The average real return for houses over long time periods might surprise you. It’s zero. Shares return 7% a year after inflation because that’s how fast companies tend to increase their profits. Houses have their own version of profits: rents.

Tenant-occupied houses generate actual rents while owner-occupied houses generate ones that are implied but no less real: the rents their owners don’t have to pay each year. House prices and rents have been closely linked throughout history – except for bouts of bull / bear runs- and related to inflation.

A house, after all, is an ordinary good. It can’t think up ways to drive profits like a company’s managers can. If land, cement, steel, and money are all commodities, how can a combination of all these not be a commodity?

Robert Shiller, a Yale economist and author of “Irrational Exuberance,” which predicted the stock price collapse in 2000, has recently turned his eye to house prices.

Between 1890 and 2004 he finds that real house returns would have been zero if not for two brief periods: one immediately following World War II and another since about 2000.

Even if we include these periods houses returned just 0.4% a year, he says.

The average pundit, planner, lender or broker making the case for ownership doesn’t look at returns over long periods of time – it is embarrassing to say the least! Sometimes they reduce the matter to maxims about “building equity” and “paying yourself” instead of “throwing money down the drain.” If they do look at returns they focus on recent ones. Those tell a different story!
Related Articles:

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If you are in the 30% tax bracket each Rupee you pay interest on is only going to save you 30 paise. That means you are still spending 70 paise to save 30 paise. My family believes that I choose to become a CA over IIT because I am weak in mathematics. Even to my dumb head, this sounds like bad mathematics, correct?

This is actually the classic difference between a deduction and an expense write-off. Can you convince a businessman that an expense is good, just because it can be claimed as deduction? I doubt it.

The other question that I ask in all my classes “Is a car an asset?“  Thanks to `Rich Dad Poor Dad`; many people having read that, say no. Then I ask them “Is a house an asset?“ In spite of reading “Rich Dad Poor Dad“, people are still confused.

And you`re so happy with this so-called tax break you aren`t thinking clearly about what is really happening. In the first few years of a mortgage the majority of your payment goes toward paying your interest on the loan, not the principal. And homeowners think that`s fine; it means a bigger tax deduction. But if you can bring some logic to this you would realize you`re not building up any equity because of your payments.

You may be building up equity yes, but that is because real estate prices are going up.

The question has to be asked, what happens if they ever start to go down. But let`s just look at why the mortgage companies really have you pay the majority of the interest up front.

First, the stats show that homeowners tend to buy a second house in six or seven years. So that means when you go to sell you`ve only paid interest on your mortgage; you haven`t really paid down any of your principal which means that the lender has been getting interest on almost all of the money they originally lent you which in the long run helps them make more money but at your expense. At this stage the nice middle class homeowner go back to the lender, pay off the loan and take a fresh loan, and the interest payment cycle continues.

Thank God for my shareholding in India`s biggest mortgage company! They surely got their maths correct, and so did I!

Let me come to my favorite topic of compound interest. Why do people feel happy about real estate?

I think it is simple mental heuristics. People do not understand the importance of the compounding formula (Future value = present value * (1+ r) ^ n).

That is why they come up with “My father bought a house in Santa Cruz (an up market suburb of Mumbai) for Rs 30,000, now it is worth Rs 30,00,000. We see it as a great 100 bagger! Great.“

However if you see that the purchase was made in the year 1964 and do an IRR it comes to “only“ 11% p.a. If you factor in the interest cost, maintenance, and society charges, it does not sound too great, does it? This was over a period when inflation was hovering between 9 and 19% in India, and when for many years cost of funds was in excess of 12%.

Also this person was earning a princely sum of Rs 900 in 1964 – which meant he was paying 33 times his monthly salary for a house. However at a CTC of Rs 18L p.a. I am paying only 20 month`s salary. Thus the house, expressed in terms of inflation adjusted return may not be worth it.

Now while I know most people need a mortgage in order to purchase a home, there will come a time in your life when it will make sense to get rid of your mortgage. So I don`t want you to just keep paying a mortgage under the guise that it is your only tax write-off.

Very few seriously rich people have a mortgage. They simply write a cheque. Its simple guys, “its better to receive interest rather than pay interest“.

Did you know that only since the Second World War the mass psychology changed from “use value“ to “ownership value“. Earlier, people like my Grand dad (decision circa 1919) was happy to rent 2 houses in Central Mumbai location and pay a rent for the rest of his life. One more thing I cannot understand is how come we treat different assets differently?

Do you think you and your husband will do a 2nd job to support a Porshce, or a Mercedes? Sounds irrational, correct?

Do you say “Invested in a car?“ Well, I have not heard that ever. How come you cannot invest in steel but can invest in steel and cement?

It beats me, but thankfully the home loan interest deduction is gone after all!! (direct tax code!)

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If you have seen 3 scams (big ones) and bribing (rampant) bribing in PSU banks all your life, this so called scam should not come as a shock (or surprise) at all. Once in a while such transactions erupt and the news channels have something to scream about.

See the Minister’s comments to Economic Times:
“It’s an individual case of bribery. There is no large-scale scam. Banking system is sound,” Minister of State for Finance Namo Narain Meena told reporters here.

To a query over tanking of banking stocks today, he said markets are governed by many factors, including global cues.

Now if you give millions or rupees to bank executives who do not have to attend the annual general meetings, have no worry about being caught (probability of something like this current scam happening is so low, you can ignore it) such failures or scams are bound to happen.

Apart from Nair, those arrested are Naresh K Chopra, Secretary (Investment), LIC, R N Tayal, General Manager of Bank of India (Delhi), Maninder Singh Johar, Director (Chartered Accountant) of Central Bank of India, Venkoba Gujjal and Dy General Manager of Punjab National Bank (Delhi).

Rajesh Sharma, CMD of Mumbai-based firm Money Matters Ltd and two of its employees — Suresh Gattani and Sanjay Sharma– were among those arrested.

Well as long as bureaucrats have control over the full banking system – and the government can throw favors – why will it let things change?

A good way out would be to force companies to float debentures, have them listed and allow banks or organisations like LIC housing finance to buy them. This will ensure a decent price discovery mechanism, have 2 people appraising the same project…and that will help.

A few months ago Ajit Dayal had written a nice piece on why realty prices are high. He had hinted about this. He had said how we keep our money in banks – banks give money to real estate companies – real estate companies jack up the prices (in connivance with the large housing finance companies as revealed by the scam) – so we borrow more to buy the same houses, which we funded

I have also been screaming about the difference between the real estate prices (sticky) in big places like Mumbai…but the price earning ratio of the real estate companies not reflecting that ..NOW YOU KNOW WHY.

The market knows something which we do not. So all the real estate “talking up” by so called experts on television did not help. One kid from the television channel spoke to me…and asked ‘why are real estate companies quoting at such a low p/e given the prices of real estate..and I explained how the two markets are different. Not sure what she did with the explanation

HOWEVER, if she is reading this, remember the market collectively knows much more than what we know individually.

So one more scam…and one more Chartered Accountant …had to take this dig!

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That may not be the right argument.

It is a person’s migration from one level of strata to the other one which is marked by ‘buying’ a house. He is under tremendous pressure from his own parents, in laws, friends, Hdfc (as a shareholder collecting the recent 1:5 split, I am happy), his employer (an employee committed to an EMI cannot leave, can he?), …so he buys.

It is easy to have a sense of regret…”Oh, only if my father had bought one more flat…” It was available for Rs. 2 lakhs, now it is Rs. 80 lakhs…..” normally you hear this quite often.

My take is if you must feel s…#$%..ed about your dad not buying something it should be equity shares. Your regret should be…”If my dad had just invested Rs. 10,000 (forget Rs. 200,000 maybe he did not have it in 1980) in Wipro (it would have appreciated to Rs. 300 crores), Ranbaxy, Cipla, Larsen And Toubro, Infosys (1992 listing), Sensex, .literally anything..it would have been worth at least about Rs. 2 crores – apart from the dividend with which one could have paid rent….

So first in life, do not regret.

However if you want to regret, regret big! Regret about your dad not understanding the impact of inflation on fixed income securities. Regret that your dad bought land. Or a bank FD. Or put 70,000 in ppf without fail for the past 20 years. Or 40 years. Regret about the ‘gold’ in which they invested – and the Jewelery that will never be sold immaterial of whether gold is in a bull run, bubble run or a bear run. Do not regret that he did not buy some steel, cement, paint, wood, …these are commodities. Instead if he had bought Tisco, Acc, Asian Paints and Hdfc (btw did you notice that a Rs. 50 lakhs house bought with a Rs. 50 lakhs loan costs Rs. 1.1 crore when you multiply the emi * no. of installments?) So Hdfc is also a good proxy for the home that your dad could have bought.

Luckily whenever a friend / cousin / customer asked me for advise re buying a house I made them buy 100 shares of Hdfc. Those who kept the shares (literally most of them) have about 300-400 shares of Hdfc, and 200 shares of the bank.  Not bad considering the interest rates may have been 12-14% p.a. but the share has yielded greater than that…

Ha ha ha….LOL If you get to rent a place @ Rs. 1 Lakh a year, you should buy the place only if it is available at about Rs. 15-17 lakhs according to some researchers in the US. No such no. is available for India…Mumbai is atrociously expensive to buy – it is almost a renter’s paradise in terms of rent: own ratios go. However Mumbai real estate has nothing to do with the kind of income that you can earn @ Mumbai….so read on.

http://online.wsj.com/article/SB10001424052748703561604575282910161870380.html?mod=WSJASIA_newsreel_personalFinance

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Well I am not against gold, and neither against real estate. However what do you call a market which is completely dependent on new investors bringing their fresh money. Well some people call it a Ponzi scheme. I would call it a Madoff scheme.

What drives the gold market is difficult to say – insecurity? Spain? Korean war? – and periods of extremely long price stagnation are scary. Similarly for gold to come down – just shrinking of demand (which is driven by prosperity?) can spook prices.

Real estate again has many myths. ‘Prices in Mumbai do not come down’. Look at the lucky people whose parents bought flats in Santacruz, Ghatkopar, Bandra, Khar…..the list is endless. However this is just 8% return !!

I still insist that you should have gold and real estate in your portfolio – but stop thinking of them as growth assets. They are not. They are Savings assets. You will see some steady appreciation – or a spike – but on a 10 year rolling basis you would have got about 1-2 % of real return.

FOR MOST PEOPLE I KNOW, THIS IS A FANTASTIC RETURN – they let a few million sleep in their savings bank account. So on a comparative basis they are better off doing a SIP in a gold etf – but stop expecting to get 24% return. Just not possible – the market has enough people who will buy put options soon…and there will be enough WRITERS.

Whowever thinks he / she has got good returns in real estate over say 30 years, please put it in an excel sheet..and see the IRR – very likely that you will get a number like 7 or 8% p.a. Not very impressive, no?

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http://www.subramoney.com/book-written-by-me/

Then the myth of ‘you must own your house’ was beautifully spread – and the great middle class dream of being a house owner was started. Over the past few years property prices adjusted to inflation (and interest) have done well. However it could be just part of the asset boom of 2002-7, then the fall in 08, and the rise in09. The Americans (also under the same sales pressure from cement, steel and housing finance companies) have not been so lucky. Most of them have had their pants taken off in the recent crisis. However the learning is not much. Most people anchor to their price, do not know how to calculate the cost of the house, do not know SIP returns (as a benchmark)…this is not my lament, The economist says so…read on

http://www.economist.com/blogs/freeexchange/2010/04/housing_markets_0

and while on the topic, there might be some of you who believe that real estate cannot fail. Or even worse ‘You can NEVER lose money on real estate..well for such people, here is a note

http://money.cnn.com/galleries/2010/real_estate/1004/gallery.commercial_real_estate/index.html

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