Do Real Estate Investments gives really real Return?

In the emotional aspects of real estate investing, everyone would seek property investment in almost every portfolio. Residential property is the most favorite and common asset class that the people should own. Even while people are in high earning and accumulating phase tend to get carried away and keep buying multiple properties and land in different places.  It usually happens where who moves city to city along with a demanding career across the country. In fact, properties are prone to see as sure-shot investments that will only appreciate but in mirage!

Most people have got entangled into properties in the bull phase for properties which started in 2003 and lasted for about 8-9 years. Prices did shoot up during this time. Real estate prices have now been reached at those levels in the first decade of the 21st century, where has been an actual rupee correction in prices as of 2020, compared to what it was in 2011 or 2012. In some other places, it is a time correction, where prices may be the same or may have slightly gone up; but when the time value is factored, there would be an erosion of values in real terms. Many people do not appreciate the time correction aspect. A large section of people who had heavily invested in all kinds of properties wanted to forget the second decade as the lost decade, looking forward to better days ahead. That hope now seems to have gone up in smoke.

Now we are in post end-covid crisis phase, which has still not receded. It looks like it may take six months to a year for things to come back to normalcy. Currently the property prices have either now been stagnated, gone down in rupee value itself, or have shown small increases. People are still looking to invest in real estate investments and prone to make financially sound decisions. At this juncture, it is imperative to be recognized and dismissed  the real estate myths. In this post, we endeavor to debunk those myths in respect of  property investment. 

Manageability

As already mentioned that since many people having multiple properties and land in different places, its managing across the country is not so easy to all along with a demanding career. It would not be a time when one would want to handle problems like leakages in the flat, electrical problems, maintenance issues in the properties they own etc. But all these have to be contended with, if one has properties. Besides, one needs to deal with brokers, society, tenants for collecting rent etc.  

Amid digital world and non-cash economy, selling the properties are now become tedious work, In fact, it is one of the toughest. There can be a thousand impediments that can come in the way, even developed property may not get sold at the reasonable rate absence of a genuine buyer.

When many people do not find the time to dispose the properties they have due to their time constraints & career obligations, they end up with distress sale and book the permanent loss in lieu of notional gain .  In many places today, one is not able to sell property at all, even if offered at low prices – there are no buyers! One needs to look at properties as investments and need to prune them and invest them in right assets based on liquidity & income needs, simplicity, ease of management of the portfolio and other considerations.

Moving to big properties

Many people who have already just three to four people have 2-to-3-bedroom homes, looking for the current fancy big homes having 3-to-5 bedroom homes. While one is young, it may be somewhat easy to handle. But as one ages, maintaining such homes becomes difficult even with domestic staff, as one needs to be behind them to get work done. People get tired of walking inside such big homes that they start confining themselves to a couple of rooms. That means the whole property does not get used and a couple of rooms just remain closed & unused. The other thing to consider is the maintenance bills, which can be quite high for big sized properties. We know properties where the outgoes can be between Rs.20-40,000 pm now. For very high-end properties, it can run into over a lakh of rupees every month. While maintenance expenses may have been easy to handle while one is working, it becomes a millstone around the neck after retirement.

Hence, due to the difficulties one may face in maintaining big properties and for monetary reasons, one needs to consider right sizing properties one stays in. The key operative word is that it should be manageable

Low Rental-yield

Properties can be rented out.  Yes, but there are two problems. Property rental yields are very low in India.  A residential property costing, say, Rs.1 Crore can be rented for, say, Rs.25,000 – 30,000 a month. After paying society charges, property tax & Income tax, the rental yield comes to just 2% or less. So, If someone wants a good income stream from their investment, property would not be able to offer that. In this situation, property is like a FD that yields 2%!

There are many other hassles in a property. Even this 2% yield will be there only if there is continuous occupancy. However, when one tenant leaves there is invariably a lag to get another tenant. This means that there would be periods in between when there will be no income at all! Also, when one tenant leaves, there will be some repairs / painting to be done. Finding a good tenant would be another challenge. One may have to employ the services of a broker & brokerages would have to be paid, which is an added cost. Over time, one also needs to contribute towards building upkeep & repairs in which the property is situated.  Hence, there are several expenses which come up during the lifetime of a property. 

A simpler way to setup a regular income would have been to invest the money in a financial asset, say even a simple FD, and get much more with a lot less hassles.

Myth about Commercial Property

Since real estate had given very high returns between 2003-2008. Those returns were a one-off aberration & probably not going to be replicated for a long time to come. Many people have now been seeking to invest in commercial property to supersede the notion of low-rental yield in residential property as it does offer better rentals but quantum of investment in commercial property has very high than investing in residential property, loans are also not available at concessional rates and they are prone to even more volatility as compared to residential properties.

The typical return in property ( capital appreciation + rent ) is between 4-9%. That looks still very low. That’s because, we seldom add up the cost of interest we pay on a loan over time, to the cost of the property.  In most cases, the interest paid overtime would be as much, or higher than the loan amount itself.

Let’s take an example. Let us say that one acquires a Rs.2 Crore property (Rs.1.8 Crore is the cost & Rs.20 Lakhs is Registration, Stamp duty & incidentals, which cannot be recovered while selling ) with a Rs.50 Lakh down payment & a loan of Rs.1.5 Crores. If the interest rate is 8.5%, which is one of the lowest seen in India on home loan rates, the interest amount paid over time would be Rs.1.62 Crores, during the loan tenure. If the interest rates were 10%, the interest paid on the loan overtime would be Rs.1.94 Crores. This is a substantial cost, which most ignore and calculate returns based on just the quoted cost of the property.

Also, people spend good amounts in doing-up the home, which cannot be recovered while selling. Repairs and maintenance of property also takes up a good sum, over time. All these costs need to be factored.

Even in case of commercial properties, many of the hassles remain and periods of non-occupancy will very much be there, though rental yields in good properties post all expenses and taxes can be 3-5%. People keep buying the commercial property on notions that the property will appreciate in 3-5 years because a flyover will be built nearby, a metro line would pass through that area, a new arterial road is expected to come up etc. Most people count the chickens before they hatch and feel regret later.

Taxation stuff

Income tax  is an unavoidable expenses. Now seller of the property will receive either short-term or long-term capital gain, which one has to pay short- term capital gain tax on sale of property is 15% plus surcharges, in case one had sold within 2 year from the date of purchase, else will pay long-term tax at the rate of 20% plus surcharge after adjusting inflation index. In later case, there is no scope and provision to save the tax and in former case, one can save the tax to buy another property within 2 years of the date of sale or 1 year before the sale,  which is practically more difficult to reinvest the proceeds at the same price as sometimes need additional money for the same.

Conclusion

Real estate is poised for many changes. If we continue to think that real estate is the only asset that is going to give great returns & want to put money there, caution is suggested. The unreal growth that we saw in the first decade of the 21st century, may probably never be repeated, due to the fundamental changes that are underway.

There is a love affair with real estate, worldwide. But one needs to be sensible and should know what & how much to retain and what to dispose. This is even more true in retirement phase if one values peace and quiet during this time.

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