Since childhood, we are brought up with this idea that we should buy our own houses as soon as possible. And for almost everyone, a house is the biggest investment (or expenditure) which one makes during his lifetime. And there is absolutely nothing wrong with that.
But there is something that makes me restless.
Why is it that as soon as we start earning, we should commit ourselves to make the biggest investment of our lives, and tie ourselves for the next 15–25 years of paying EMIs? Are we really supposed to live a life like that?
Don’t get me wrong. I am not saying that one should not buy a house at all. I am just weighing the pros and cons of buying a house early on in one’s career.
A few days back while surfing the internet, I came across something interesting. It was said that in 2005, one of India’s most well-known investors, Rakesh Jhunjhunwala sold some shares of CRISIL for purchasing a house in Mumbai. The amount received on selling the shares was Rs 27 Crores. The house today might be worth Rs 50 to 60 Crores. This means a compounded annual growth of 7% to 9.5%.
Now, what would have happened had he not sold his shares in the company?
I am not sure if he purchased that house for living purposes or for investment. Had it been for living purposes, it’s possible that he would still be staying in a house on rent(!) And assuming he paid a rent of Rs 2 Lac a month, till now he would have paid close to Rs 2.1 crores as rent itself. Seems horrible… right?
But what happened to 27 Crores worth of shares then?
The shares are now worth a whopping Rs 700 Crores!! A growth rate of more than 43% every year!! 🙂
Now we are not experts like Jhunjhunwala or Buffett. We may not be able to find multi-baggers like CRISIL. But we can find good top mutual funds which offer reasonable growths…isn’t it? Any reputed well-diversified equity mutual fund scheme would have given returns in excess of 15% in the last 10 years. And that is more than what real estate offers.
Now does it not make sense that early on in our financial lives, we should invest as much as possible in equities? If not directly, then through mutual funds? Returns are far more than what average real estate offers. And you also don’t have to remain stuck with paying EMIs for decades. Why not stay on rent and invest the remaining amount? I know it sounds controversial but I am just doing loud thinking.
I seriously think that our mindset of buying a house early on in our lives needs a serious rethink.
Note – I know people around us these days, are constantly talking about doubling their real estate investments every 2-3 years. But believe me that this is an exception and not a norm. Trends like these do not continue forever.
Yes, exactly and Robert Kiyosaki does not even consider it an asset as long as you are paying EMI's on it. He puts it under liability in that case.
Who knows what was going on his mind or the circumstances when he sold those shares. But you are right in your observation that equity in long run gives better returns that real estate.
True…one of the very first money related books I read as a kid was Kiyosaki's RDPD. And I was really surprised to find house being treated as a liability. But it does make a lot of sense…at least at some times.
Thats true Rajiv… we still don't know the circumstances of his decision. But just the comparison between equity and real estate stood out prominently and hence I shared it here 🙂
I am not saying that buying real estate is a bad idea. I know that equities can be risky and volatile at times and frankly, its not for everyone. What I am just questioning as a concept is the fascination of buying a house early on in one's career and not investing in equities (or other good and high-return-generating assets) because there is no money left after paying monthly EMIs.
Having said that, buying a house also has emotional value attached to it. And we cannot evaluate such things purely on financial terms.
True 🙂 I like the last statement as it helps in reinforcing the thought, that money should never be the prime motivator for everything.
Thats great 🙂
As narayankpl correctly pointed out, living house is not an investment and shouldn't be viewed as such. As Rajiv stated, your home (where you live) is not your asset. You may consider your second home as your investment. Many people don't get these two points, unfortunately. Important questions to ask are: How certain are you when making the decision on your investments? How much risk are you taking? Just because something worked out this time, doesn't mean it will work out every-time. You may want to read Howard Marks thoughts on risk. Visit: http://www.oaktreecapital.com/memo.aspx
One very valid point which you made is regarding “How certain are you when making the decision on your investments?” …probably as common investors, it makes sense for people to stick with well diversified and established mutual funds, or for that matter, index funds.
Thanks for sharing the link. 🙂
I agree with you Dev. From beginning of my career, i am averse to buy a house or flat considering the bondage of paying EMIs and you cannot take any major decisions and live the life for a decade or so for the sake of paying EMIs.
I was the odd one out in my friends as well as colleagues circle who had not bought a house or flat. People sometimes even ridicules at me but i know where i am and my financial strength and others financial compulsions.
Since i do not have the commitment to pay EMIs, i am able to divert part of income in various investment options including equities and i am proud that i am on the path to financial freedom.
Hi RK
It is indeed tough and stressful to go against the crowd. And when you have free cashflows which you are diverting towards asset classes like equities, and not towards EMIs for that elusive piece of real estate, there is bound to be a lot of social pressure. Still buying a house is something which has to be done at some point in time. Guess we need to be a little more prudent in choosing that 'point-of-time' and not take that decision under social pressure.
I am even averse to the idea of taking a loan during formative years of career….it brings a lot of constraints…
I agree with your view completely….
The entry barrier for investing into real estate is so high that it wipes out your bank balance completely at the onset itself. This means being totally unprepared for any contingencies.
And this is just the beginning. There is a relentless pressure on one to pay the EMIs month after month, year after year. One is chained to one's job, as even a month or two of break due to any issues is unimaginable. If one gets any windfall of even a lakh or so (bonus, pay-raise etc) the wisest thing is to reduce your loan as one is paying heavy interest on it.
At the end of this entire struggle, you are usually stuck with a 15 year old apartment which in hindsight has fetched you a measly 13% growth or so (if at all)… The problem is that once you adjust your input for inflation and the bank interest paid out, you'd be lucky to have even this much appreciation.
Also, don't forget that since one has ploughed almost their entire savings into this apartment, one has precious little to show other than this flat. How is one to plan for costs related to retirement, health care etc? Sure, one will get by, but unless you've started REALLY early in saving money and investing it, one cannot hope for a great ending. If one doesn't have much else, one might in the end be forced to sell it to make their ends meet.
Now, the question at the end of this tenure is, can you now sell this property ? After 15 years, leakages, repairs, maintenance are the order of the day. Though surely one can find buyers, the final amount realized is not that good since it is not a brand new apartment, but a refurbished one. Sure, the area around the place will be very developed in this time, but the apartment itself will be old.
The scenario I am painting is a worst case scenario, and it is definitely possible to avoid it by taking care of some fundamentals. However, I have seen umpteen cases of people diving into this head on, and now not able to handle the entire situation. In my own office, I have seen so many cases of people who are now living their life, one EMI at a time.
Instead, I feel that one should delay purchase of a house (preferrably an individual plot) as long as possible. Depending upon the average growth in the long term through sensible investments in stock market (shares and mutual funds) will fetch good returns.
Seeing the spiralling costs in housing sector, I feel that there will be at least one crash in this sector in the next 10-15 years. Maybe I'm a hopeless pessimist, but knowing that the general opinion is that real estate will NEVER come down, makes me hopeful.
In short, play the real estate market the same way as the stock market. Buy at a low, not at a high! If it is not low yet, invest in other sectors. The day when it crashes (when, not if), be ready with CASH.
The actual calculation would have to be done against inflation adjusted returns. http://www.financeformulas.net/Real_Rate_of_Return.html
You have calculated the CAGR as 13.9% which is almost equal to 14%…
But if you adjust this for inflation, this comes to 5.6% actual returns.
Real rate of return would be RR = ((1.14/1.08) – 1)*100 = 5.56%
This too would be affected at least a bit by the 10% to 18% interest that would have been paid by your friend (loan rates in 1970 – 1995 were extremely high at maybe 15-18% per annum)… Even if you forget this component, 5.5% is not that great.
RK, It takes a courage and conviction to go against the crowd. I lived in Silicon Valley during the real estate boom. A lot of my friends were purchasing second home during 2001-2007 here in silicon valley and also real estate in India. I didn't buy into either of the idea. I may have lost some opportunities but I followed my conviction and I don't regret a bit. I don't understand real estate market in Indian and I don't mind loosing opportunities in that case. I only do what I know.
Thanks for sharing your experience Dev
As investors, one of our biggest strengths lies in (as you said) 'doing what we know. 🙂
True…It is best not to….But at times we might have to take loans for purposes like education, emergencies, etc which cannot be avoided.
Thanks for sharing your thoughts Bharat. I myself am one which will try to avoid real estate investment for as long as possible 🙂 But what happens in realty is something which, frankly speaking, governed by family and social pressures.
But yes, living one paycheque at a time, and that too for paying EMI, is not the kind of life which I want to live – Even if it means not owning a property worth crores at the end of life 🙂
I prefer doing what I love – write, travel and invest 🙂
But thanks again for sharing your thoughts. I guess I should compile all comments and do a follow up post soon.
Thanks for providing the details Bharat.
#Helpful 🙂
Good point, Bharat.
Having said that that the real rate of return (on stocks) for an average investor will be vastly higher is a debatable issue.
You are right as usual.For historical point of view also ,the time etc being equal ,equity gives better returns than real estate.
Yes, I agree… The returns on stock investments depends on so many factors, that one cannot even start to calculate the returns.
Obviously, you being a reader of Stable Investor means that you are quite knowledgeable about the advantages of stocks. But let me point them out anyway.
1) Entry barrier is extremely low financially. One can purchase even 1rs. worth of stock, unlike a house, for which one has to have at least a few LAKHS of rupees first.
Doesn't mean you should only buy the penny stocks, but you CAN.
When was the last time someone bought a land/flat for even 10,000 Rs? Back in 1970 maybe! 😛
This means that you can start investing when you are a teenager, not when you are having 10 years of job experience. Power of compounding at it's best.
2) With the help of solid books (Intelligent Investor…) and websites (StableInvestor, SafalNiveshak) one can quickly become better at picking safe(r) stocks. One will also learn that the real money is made in the waiting.
3) Variety is the spice of life… Once you buy a house, you'll be lucky if you have any money left to invest ANYWHERE else. Not so in stocks. Diversification, investing into inverse products which do well when stocks don't, ETFs, mutual funds encourage variety.
4)Exit is fast – Though one shouldn't be thinking of exiting (why enter if one wants to exit prematurely?) one CAN exit fast. Ever tried selling a house FAST?
5) If you invest in real estate, you are betting upon the growth of the area in which your house is. If you invest in companies, you are betting on the growth of each and every sector that you invested in. More chances, more success (in theory at least!) 🙂
As I said, the opinion that everyone (well, almost everyone) has is that stock market is risky, and real estate is SAFE.
If I had a rupee for every time I heard the dialog “Real estate will never go down!”, I'd be Warren Buffett!
6) People get easily fooled by numbers, esp. regarding real estate. How many people have you heard say “I bought this flat one year ago for 45 lakhs, and already it is now worth 50 lakhs.” They consider it as being 5 lakhs growth in one year, which they feel is amazing.
Actually, they have just earned 10% interest, which isn't that much more than an FD would have fetched them!
This number distortion increases geometrically as one increases the number of years! As in the case cited by you, on first look 70L from 20K investment looks very impressive, but in reality 5.5% growth has happened over 45 years.