The math does not add up. The real estate refugees from the builder excesses of the past are now stuck between a rock and a hard place. These are the people lucky enough to actually have a finished flat with possession and not a legal case with absconding builders. These are the people who bought the Delhi suburban dream thinking they were getting in on the ground floor to the next Gurgaon. These are the people who live in Delhi, on rent or in own homes, and bought for investment in the greater NCR region, particularly in Greater Noida. These are the people who don’t know if they should sell and take a loss on their investment or keep funding it and hope prices recover.
Also read: Real estate lessons from the ghost societies of Greater Noida
A typical story goes like this: you bought a 3-BHK flat with a fancy foreign sounding name with a pool, community center, Italian tiles and more bells and whistles for ₹ 60 lakh. Took a loan of ₹ 40 lakh that costs about ₹ 35,000 a month in EMI. Rent where you live in Delhi is ₹ 30,000 a month. Rent from your Noida flat is ₹ 8,000 a month. Amount of loan left is ₹ 30 lakh. Current market price of flat if you can find a buyer— ₹ 50 lakh.
Let’s do some math. At a rent of ₹ 8,000 a month, your rent from your ₹ 60 lakh real estate investment is giving you a yield of 1.6%. Look at some alternative investments. The 5-year fixed deposit interest rate is at 6.75%, an ultra short-term debt fund (these funds are good for a holding period of up to 2 years) has given an average of almost 8.2% return over the past 5 years, a conservative hybrid mutual fund (this has a maximum of 25% equity and the rest is debt) has an average 5-year return of 9.2%. Purely on logic and math, what should you do? Sell your non-performing asset (real estate) and invest elsewhere.
For the story above, the math looks like this: sell the non-performing asset for ₹ 50 lakh, take the hit in the drop on prices. Pay back your loan and be left with ₹ 20 lakh. Invest in a conservative hybrid mutual fund at an assumed return of 8%, this can be higher depending on what fund you pick, but I’m staying conservative here. This gets you an annual income of ₹ 1.6 lakh. You have saved ₹ 35,000 of EMI but lost ₹ 8,000 of rent from your real estate investment. Count in the income from your mutual fund and your rent outflow for Delhi goes down by ₹ 13,000 a month, giving you a net gain of ₹ 40,000 a month. The math will differ from person to person because of the price of the flat, the loan amount taken, the loan amount left, the rental coming in, the rental going out and the ability to choose and invest in mutual funds. A rough rule of thumb is this: if the rent from your own flat is less than 60% of your EMI, your money equation does not add up. At ₹ 8,000 rent when the EMI is ₹ 35,000, less than one-fourth of the EMI is getting covered.
Also see: In Photos: The ghost societies of Greater Noida
What about capital appreciation—we’re not taking that into account? Don’t real estate prices go up in the long run? Will a Gurgaon or a Dwarka happen to the Delhi suburbs? Maybe, but this is really about the number of years you are willing to wait for the big price catch up to happen—5 years, 10 years or more? What is the opportunity cost of this investment and the double strain of sustaining an EMI and rent? You need to ask the question: what is it that this money can do in the interim and is there an investment that will give you a regular return along with some capital appreciation?
While true of Delhi and its suburbs, this story finds an echo in many other parts of the country with unsold stock, large inventories but sticky prices. Each micro-market is different and faces different growth paths making it hard to predict which area will be the new Gurgaon. But it is not hard to predict that real estate in India will find it difficult to go back to the huge returns on investments seen in the years 2003 to 2009. Take a hard look at the numbers and then take a call on whether to keep or sell. There is a personal comfort in having a physical property but the financial math just does not add up. I’d sell right away and get into mutual funds. It is a big leap of faith to move from a real asset to a financial asset and you should work with a good financial planner to make this transition. But remember, if the math does not add up, it is time to sell your own non-performing asset.
Monika Halan is Consulting Editor at Mint and writes on household finance, policy and regulation