BackRealty at the cost of other goals
Until as late as last year, the real estate value often appreciated better than other asset classes, certainly more than financial assets
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A lot has been spoken about the imminent burst of the real estate bubble. Various sources, ranging from the Reserve Bank governor to analysts, either believe that prices should come down or that they certainly will. How people make predictions like a 50% fall, I have no idea. There are, however, a few aspects that need to be explored in a little more detail.
Almost all of us either benefited from rising home values over the past decade or know people who did. Until as late as last year, the real estate value often appreciated better than other asset classes, certainly more than financial assets. Apart from the emotional value attached to home ownership, the other under-discussed aspect is that it’s been the only asset you can borrow for at about 10% interest. Therefore, every year, when property prices rose more than 10%, you not only made returns on your money but on borrowed capital as well.
For calendar years 2011-14, the annualised returns on different asset classes, as per a Reserve Bank of India (RBI) report—Recent trends in residential property prices in India: an exploration using housing loan data—are as follows. Real estate gave returns of 12.34% and Sensex 7.61%, while gold slipped into the negative territory with -3.61% returns.
As the numbers suggest, for the most part of the past few years, real estate did just fine in terms of returns. Sure, over a much longer period, these trends might look different, but I use the past few years to illustrate that real estate didn’t fare too badly. However, from last year, cracks have started to appear, and it appears that the going will be rough for some time.
Here are two findings from a study of over 5,000 users of the buy versus rent tool on our website over a period of one year, starting with the latter half of 2014.
• Across the top seven cities in India, between 60% and 80% users expect property prices to rise at less than 10% per annum for the foreseeable future.
• In some cities, a significant proportion of people expect returns between -5% and 5%.
Considering that most home loans come at an annual interest of 10% or more, and given that a large proportion of homes are financed, what then is the financial logic of buying a ready property to live in if this is the expectation of the future? This requires thought, especially when you consider that the same property could possibly be rented for what’s lesser than 3% per annum of its value.
While there are other aspects of the study that show variations in expectations by city, the pertinent question to ask is where do we go from here. This is not about how much prices of the unsold inventory lying with builders will need to drop by or how much lower interest rates will have to get before new buyers come back. The focus is on what happens to the huge number of people (like myself) who are seeing the price of their property, especially those bought with the intention of investment, either remain flat or even drop over the last year, and with fairly grim prospects over the near term?
There are innumerable instances of people who have 80% or more of their net worth tied up in real estate. As Indians we have always attached a lot of pride in ownership of property, and for us more has always been merrier.
Better prospects
Could this be the inflection point that the financial markets have been waiting for? Minuscule retail participation in mutual finds, for example, has always been explained by a much larger cash economy (which the government is chipping away at), or Indians’ preference for physical assets such as property and gold. But with both of these facing less than exciting prospects, might the time for financial assets have finally arrived?
Take an example of a Mumbaikar who is worth 1 crore in all. Of this, 80 lakh is in the form of real estate value. Further, imagine this 80 lakh to be spread between two homes, one primary and the other an investment property worth 20 lakh. While blocking 60 lakh in a property, even in the primary residence, instead of renting the same house makes for an entirely different article, is there much merit in earning a negative return (which is what one would get after accounting for loan repayment instalments at 10% interest) on the 20 lakh invested in the second house and all other goals to be met from the remaining 20 lakh?
Could this money possibly be better invested across financial assets such as debt and equity mutual funds, which have historically indicated inflation-beating returns, and on protection products such as life and health insurance?
These are interesting times when myths that we grew up hearing—“you can never lose on real estate" or “gold is the best protector of value"—are being questioned. And while it’s difficult for us to swallow the fact that our ‘best’ and certainly most highly valued asset isn’t earning us anything, it might force us into taking some tough steps like rebalancing our assets and where our money goes. This might just be a big blessing in disguise for our markets.
Manish Shah, co-founder and chief executive officer, BigDecisions.com
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