What to consider when investing in real estate
When dealing dispassionately with real estate as an investment, a few aspects need deliberation.
The fundamental premise of real estate investing has to be that you are in it for the long term and that you are looking at an effective hedge against inflation. The fundamental fallacy to avoid when looking at real estate investing is that you can trade it at will and liquidate and hence it is alright to not provide for the entire value of the purchase but just enough to hold and trade. Real estate is a high value commitment and unfortunately not divisible into smaller units.
Before I embark on a soliloquy on investing, I want to make it clear that nothing that I say below applies to the home you live in or will live in. A house to stay, a roof above your head is not investment: it is emotional security for your family. It may appear that prices have hit the roof and selling his sole house and investing that money in a bank fixed deposit (FD) will leave him with a surplus above the rentals he may need to pay. On all such matters of grave repercussion, my humble advice would be to hang on to your property.
When dealing dispassionately with real estate as an investment, a few aspects need deliberation.
Project delivery and delay
“This project will never get delivered,” this is an often abused, rather callous statement we tend to use to justify not buying an absolutely even priced good piece of real estate. Remember that developers are as rational about money as we all should be and often times more, and if it could not have been possible to build, they possibly would not have imagined building it. Construction technology, architectural prowess, workmanship, these all are globally interconnected and commercially available talents and barring some delays, that 100-storey tower or that 100-acre township will more often be a reality.
I imagine the next concern would be delays. “This project will not be ready in the next 10 years” is common. This needs addressing from different aspects. First your developer has no interest in delaying delivery. He sells you the goods at a predetermined price today and the longer it takes to deliver, the higher is the risk of cost escalation while at the same time postponing milestone-linked cash flows and ultimately profit gratification.
For a moment, let us consider that the project still does get delayed. Well, by the virtue of milestone-linked payments, your investment is proportionately postponed as well. It is true that till the property is not ready, the money already invested is stuck, but then when was the last time an under-construction property did not get sold? Or it got sold at a steep discount to the market? In my limited experience, delay has never resulted in price discounts as much as developer’s reputation has been. Often time’s value diminution in under-construction property is a function of a developer’s reputation or his financial well-being. The issue in these cases is not so much of delays but the ability to complete. This is an obvious risk and a potent one.
Developer’s track record
Indeed, this risk required maximum attention when making the buying decision and the basis of such decision cannot be casual living room chats and gossip or even our perception of how we think a developer’s financial and moral health should be. This question’s answer is in research, track records and past deliveries of the developer, his goodwill among his contractors and other shareholders, personal interaction with his organization and a cold and calculated analysis of tell-tale signs that present themselves about the project. For instance, just because a developer has multiple projects launched does not mean he is stretched. Just because we think he may have bought land expensive does not mean he will go belly up. Just because we think his product is overpriced does not mean he will not find buyers.
Real estate like any other business follows fundamental laws of demand, supply and affordability. It is worthwhile to bear in mind that if it is being built, it is most certainly being sold as well.
Practical matters
Payment plan: The biggest virtue in buying property is the staggered completion-linked payment plan. This is the only effective lever one has to control one’s investment. This cannot be sacrificed for upfront cash discounts or lures of discount to convert it into a pure time-linked payment mechanism. A little extra paid over time will eventually be more satiating than the grief of delays if one has paid it all upfront.
Snob value: We often get carried away by distant locations and cheaper product offerings in faraway lands. To my mind, real estate has a value attached to land brick and mortar. And then, it has a snob value. This snob value is the biggest multiplier in value accretion and unfortunately it does not come in faraway lands.
It is quite simple. If you will not go the distance, others like you will also possibly not. And the lower you go in the affordability chain, the more inelastic the pricing becomes because affordability plays a much larger role and is a lot more limited as you go down the value chain. It does good to remember that cheap real estate is an outcome of either poor demand or poor affordability. Snob value is primarily a function of the location or address as we call it. But a location that has been developed into a destination, a project offering better amenities and community living, these are other aspects that add to the aspirational value of real estate, thereby enhancing its value in the medium to long run.
Infrastructure issues: Lastly, overloaded infrastructure cannot be construed as non-existent infrastructure. In a thriving city, the city centre often has the poorest infrastructure and the highest prices. A thriving business district or a prime residential location with traffic snarls often tends to fetch a premium compared with locations on the outskirts with ambient motorways.
I will end with a quote by Franklin D. Roosevelt: “Real estate cannot be lost or stolen, nor can it be carried away. Purchased with common sense, paid for in full, and managed with reasonable care, it is about the safest investment in the world.”
Jasmeet Chhabra is an independent real estate private equity professional.
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First Published:24 Sep 2012, 09:15 PM IST
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