When it comes to investing in realty, the focus is on returns, and scant attention is paid to risk
We have all heard the adage: higher the returns, higher the risk. We know this all too well when we try and make a quick buck from equity investing; we have even burnt our fingers trying to get an extra couple of percentage points from investing in a company fixed deposit. However, when it comes to investing in real estate, the focus shifts only to returns, and scant attention is paid to risk—It does not seem to exist at all.
Let me share with you stories of three of my clients. The objective is not to scare you away from real estate investment, but to ensure that you keep your eyes open when investing in this asset class.
The first tale is of a reputed builder making its entry into a smaller city. A premium project in two cities was announced. The rates offered were significantly lower in the new (smaller) city. The track record of the builder was impeccable and the expectation was that the three-year project would be completed with a few months to spare. Some investors were even tempted to take the additional discount to make 100% payment up front as there seemed to be no question of any delay.
The deadline is well past its time, and the project is at a standstill. It appears that there were some approvals that were not in hand, and do not look like coming in any time soon, if at all. The 15-storey project apparently does not have height clearance beyond the 10th floor, causing my client (who has booked a ninth floor flat) to remark: “Either I will have a penthouse, or no flat at all."
The second story is that of investment in land. To ensure that the title risks were mitigated, a group of three friends invested in a gated community many years ago. One of them needed funds about four years after they had invested in the project and he exited from it. A year later, the second one wanted to sell; but the markets had fallen, and liquidity was limited. The land remained on the market for the next three years. In the meanwhile, the third friend was served a notice as one of the grandchildren of the original landowner, who had transferred the land to the developer, staked a claim on the property. The case has been in court for the past year, and is making extremely slow progress.
The final tale is of a person who invested in a residential project in the mid-1990’s. Soon after making the investment, property prices fell, but since this was an investment in a self-occupied property, it did not matter. After a few years, prices picked up again, crossed the purchase price, and headed upwards. A couple of years ago, the investor sold the property at over three times the original cost—a cool 200% appreciation in 15 years. Apart from the gains, the investor also saved on rent. It did seem like a good deal.
When I calculated the return on investment, this worked out to just over 7.5% per annum over the tenor; whereas during the same period, the S&P BSE Sensex gave a return of nearly 12% per annum—from a level of around 3,200, the Sensex had risen to 18,000 levels during this same period. Even if I gave credit for a rental yield of 4% per annum, which the property owner saved on rental, I found that the equity market index gave a higher return. (Equity mutual funds outperformed the Sensex during the 15-year period, so that would increase the difference in returns even more.)
What are the lessons to be learnt?
One, be extra careful of investing in projects which are launched at “attractive" rates before all, yes, all approvals are in place. There could be many a slip between cup and the lip, especially if the outlay is large, liquidity is required for other goals or you are investing with borrowed money. After all, the equated monthly instalment meter will be ticking even if the project reaches a standstill.
Two, think very deeply before investing in land, especially if you are likely to keep the land barren, and treat it as an investment to be encashed, say, for when your daughter’s education is to be funded. In India, where the accepted method is to acquire small land holdings from farmers, and consolidate them to register, there is a lurking danger that a legal heir, who may not even have been born when the sale happened to the developer, could cite personal law and claim inheritance rights on that land. If you are constructing a house and can claim residential rights, you could be on a slightly better wicket.
Three, remember that five times returns in 15 years equates to 12% per annum. The point I am making is that at times equity markets may be giving you better absolute returns with the added benefit of zero taxes, faster liquidation and a scientific method of valuation.
As any financial planner will tell you, putting all or too many eggs in one basket is a risk that you can ill afford. Proceed with caution and don’t follow the herd without thinking.
Lovaii Navlakhi is founder and chief executive officer, International Money Matters Pvt. Ltd.