Opinion | Why real estate makes a poor emergency fund | Mint
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Business News/ Money / Personal Finance/  Opinion | Why real estate makes a poor emergency fund

Opinion | Why real estate makes a poor emergency fund

We tend to ignore the costs associated with entry, exit and the speed of the transaction

Long-term capital gains take away another one-fifth of the profit, after indexing for inflation, and this really bites if the value growth has been exponential in the investment (Photo: Mint)Premium
Long-term capital gains take away another one-fifth of the profit, after indexing for inflation, and this really bites if the value growth has been exponential in the investment (Photo: Mint)

A friend who runs a small business was hit by a series of events post the North Atlantic financial crisis of 2008. The crisis wiped out a large chunk of the overseas market, hitting his business badly. Next, a series of poor business decisions and external events prevented him from recovering in the next few years. Just as he was getting it back together, GST (goods and services tax) compliance and bribes for refunds dealt the next blow. Thinking that the end was around the next quarter for many years, he got into a debt trap with unpaid dues to banks, suppliers, family and friends. The only way out of this tight financial corner was to sell some land bought more than a decade ago, the price of which had gone up exponentially, with lakhs now worth crores. The sale will more than clear the debt and then leave some capital for restarting the business or just retiring. But one year later, he remains in the market looking to liquidate the land. This story is a text-book example of why real estate is such a clunky, and sometimes dangerous, asset to own, maintain and dispose, and why it is a poor asset for an emergency bail-out situation.

First, the speed of transaction can be really slow when it comes to selling land. When compared to financial assets or even gold, selling a patch of land or a flat is time consuming. If the market smells “distress", the price begins to crash—you are left holding your multi-bagger without an exit. A reasonable sale can take anything from a few months to a few years depending on how sticky the seller is to his selling price and how the buyers perceive the urgency to sell. The more urgent the need, the lower price you can expect. When you compare this difficult transaction to the ease of breaking a fixed deposit or selling stocks and funds, the process of selling real estate looks difficult. We forget to include the lack of liquidity and the time taken for the deal as the costs that real estate investments impose.

Second, land deals still have a cash component in India and that imposes all kinds of other costs. Post demonetization, many people got scared off cash deals in real estate and are now insisting on a full cheque payment. But the other part of the market that deals in cash has seen the cash component actually go up to higher than half the value of the deal. Imagine a multi-crore deal with more than half in currency notes. For people who have not dealt in cash, the trauma of thinking about what to do with the cash and how to convert it into white to pay off the dues is terrible.

Third, the problem of taxes. Long-term capital gains take away another one-fifth of the profit, after indexing for inflation, and this really bites if the value growth has been exponential in the investment. Most people at this stage try and avoid the tax, but then circle back to the black money sump and all the problems associated with cash. When the investment moves from real estate to real estate, cash is less of a problem, but if the real estate investment is your hedge against uncertainty and for future emergencies or to pay back bank loans—you will come up against the problem of turning cash to legit funds. That’s a cost most people forget to add to the cost of investing in real estate.

Fourth, the land mafia can demand its price. Small and middle town India is still like Gangs of Wasseypur in many ways—specially when there are land deals in the air. Dealing with the land mafia is not what everybody can do and if the deal does not happen quickly without the news getting out in the open, the local land mafia tends to get involved. They usually want a certain amount per square foot sold for basically letting the deal go through without bloodshed. This then takes out another big chunk of the return.

Fifth, the costs of services associated with a land deal add up. A difficult real estate deal will need the use of accountants, lawyers and other professionals to sort through the issues and all of them get paid either by the hour or a flat fee that can run into lakhs. Most people forget to include these costs when they look at point-to-point returns.

Investing in land is a habit. It is a habit of the past when investment options were few. The real estate mindset we need to correct is the unwillingness to look at all the other parts of the investment equation other than just a point-to-point return. The costs we tend to ignore are those associated with entry and exit and the speed of the transaction. Then there is the fear of kabza or illegal encroachment to the property or the fear that a tenant will not vacate the property. Include the problem of cash in land deals and what it would cost to turn this cash into funds that can go back into the formal system. When we think of a few lakhs that morphed into a few crores from land deals, we simply don’t think through the entire equation in the deal. There are some people who have a nose for real estate and the temperament to deal with issues around the asset, but most people don’t have the skill, time or the temperament. My friend has sworn off this asset class for the future. It is going to be financial assets all the way.

Monika Halan is consulting editor at Mint and writes on household finance, policy and regulation

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Published: 10 Sep 2019, 09:52 PM IST
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