Mutual Funds Vs Real Estate – Which is better for Investing in India?

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Real Estate or Mutual Funds? This might be one of the most controversial debates I am starting on Stable Investor. But I had to write about it someday. And by the number of mails I receive from readers asking me to answer this question, it seems that there is much more than just financial logic behind this question. Peer pressure, family pressure and just getting done with this big decision in life are some, which I can think of right now.

Note – This post is a combined effort by Ajay (who has previously authored interesting posts like how to invest your surplus money and how he created a corpus of Rs 3.7 Crores in just 10 years) and myself.

But if you expect us to give you a clear answer at the end of this post, then please tone down your expectations. We do not intend to provide a thumb rule or even a judgment for that matter.

This question of whether you should invest in Real Estate (for investment) or Mutual Funds, can only be answered by you and you alone. This article should ideally be read in that spirit.

Property Vs Mutual Funds

So let’s go ahead…

In words of Ajay, a home is a place to live and it should not be linked to one’s investment strategy. There should not be any second thought given about buying your 1st property for self-occupancy whether with or without tax benefits.

My take on this question is not as strong as that of Ajay. But I do agree with him about the power of equities in the long run. As far as my real estate is concerned, I am still weighing my options and am yet to finalize my long-term real estate strategy. As of today, I don’t own any personal property but my family does have a house in our native city.

So why am I delaying this decision unlike many of my friends who are already paying hefty EMIs every month?

I know it might sound odd to those who believe that one should invest in property starting with the very first salary they get. But I am sorry… I don’t belong to that school of thought. I have full faith in the power of compounding and investing in equities. And I will only buy my first piece of real estate when I am comfortable enough to service my EMIs. I don’t want to have myself stuck in years of paying EMIs where I feel burdened at the end of every month. I don’t want to be slave of my EMIs.

But that was about me and my philosophy…. 🙂 So you can ignore it…

And for those who think that instead of paying rent, it’s better to pay EMIs – I have an answer. Paying rent might seem like an expense. But EMI also has a significant component of interest, which even in accounting term is nothing, but Expense. So this argument does not stand completely true.

Once again I repeat that the objective of this article is to highlight the differences in returns earned by investing in mutual funds and those earned by investing in a home funded through a loan, in the name of investment and tax-saving.

We have tried comparing two cases:

One where investment is made in real estate and the other where it is made in mutual funds.

So here it is…

Case 1: Real Estate Investment

Following is the data being used:

Value of Property = Rs 75 Lacs (1500 sq ft @ Rs 5000/sq ft)

Required Initial Down Payment (@20% of Property value) = Rs 15 Lacs

Loan Availed (for remaining 80%) = Rs 60 Lacs

Loan Tenure = 20 Years

Loan Interest Rate = 10.15%

Few more administrative costs are as follows:

Loan Processing Charges & Other Expenses (@2% of Property) = Rs 1.5 Lacs

Registration Fees (@10%) = Rs 7.5 Lacs

 

After doing some calculations which are depicted below, we arrived at quite interesting numbers.

India Real Estate Investing Analysis
Interest Paid over 20 Years = Rs 80.30 Lacs

And as you can see in the last column in the table above, this property has also been able to generate post-tax and expense adjusted rental income. We used a few assumptions for rental income and expense which are as follows:

  • Rentals increase by 5% every year
  • Rental income from the property is taxed at 20%
  • Maintenance expenses are recurring every 5 years: Rs 1 Lac (5th year), Rs 1.5 Lac (10th year), Rs 2 Lacs (15th year) and Rs 2 Lacs (20thyear)

All in all, these result in an amount of Rs 24.67 Lacs being generated from the property over a period of 20 years.

This means, that effectively the property costs about Rs 1.39 Crores as depicted in the table below:

India Real Estate Profit 2015

Now as per general perception (at somewhat backed by data too), the properties are known to appreciate in price. But here, we are not talking about property prices doubling every 2-3 years. We are talking about much sensible returns ranging from 9% to 12%.

Let’s see what this part of the calculation leads us to:

We will evaluate 3 scenarios where property appreciation is taken as 9%, 10% and 12% continuously for 20 years. And this evaluation is depicted in the table below:

India Real Estate Investing
To summarize the above calculations, this property initially cost Rs 75 Lacs. But since the loan was taken and it also generated rental income, the total landed cost was Rs 1.39 Crores.

Now when 3 different scenarios are considered where this property appreciates by 12%, 10% and 9%, the expected net gains are Rs 5.1 Cr, Rs 3.4 Cr and Rs 2.75 Cr respectively.

Agreed that these are some really big numbers.

But before you start putting your hands on your mouth after reading them, let’s check out the second case where we evaluate similar investments in mutual funds.

Case 2: Mutual Fund Investment

We are using the following data for this case:

Initial lumpsum investment in MF schemes of Rs 24 Lacs. This amount is equal to the sum of Initial Property Down Payment (Rs 15 Lacs), Registration Charges (Rs 7.5 Lacs) and Loan Processing fees (Rs 1.5 Lacs).

Now the EMI amount in the earlier case was Rs 58,459. This amount, in this case, can be used as a monthly SIP. But we also need to consider the tax benefit of Rs 1 Lac availed on house loan investment – which is to be equated monthly. That amounts to Rs 8333 and the resultant amount available for monthly SIP is Rs 50,126.

So here is the calculation sheet for two types of investment scenarios.

First one is where returns from MF move from the initial 12% to 7% in later years. These are conservative numbers when compared to returns given by really good MFs.

Conservative Mutual Fund Investor

The second one is a slightly aggressive returns assumption based analysis. Here the returns move from 15% initially to 7% in later years. But even then the returns of 15% are not that rare and have been achieved by quite a few funds in India for decades.

Aggressive Mutual Fund Investor

Now, what happens when these funds are sold after 20 years? There won’t be any tax as long term capital gains are not taxed in India for stock market returns (till March-2018).

So for an investment of Rs 1.44 Crores (lump sum + SIP of 20 years), a corpus of Rs 10.28 Crs and Rs 7.06 Crs has been achieved. And mind you, this return has been achieved despite having paid the additional tax @ 8333/- per month for 20 years. And these numbers are substantially higher than the real estate investment even after tax saving.

This means a net expected gain ranging from Rs 5.61 Crs to Rs 8.84 Crs.

Compare these numbers with those of Real Estate case and you will understand what this article is trying to point you towards.

Why do People Invest in Real Estate?

We have tried to list down a few reasons which we thought people have for investing in real estate. And here were are not talking about the 1st House but about the 2nd property, which is treated as an investment:

  1. There is mental comfort in buying a hard asset that you can see and feel (also applicable to gold).
  2. It is an asset that can be funded largely through long-term debt (75% Funded by banks). No other asset provides such a benefit.
  3. It is a big asset, which you can acquire and then comfortably pay back via monthly payments (EMIs) over a very long period of time. Once again, no other asset provides this benefit.
  4. The comfort we get by doing mental accounting about tax savings in real estate investments. One always feels happier when one is told that they don’t need to pay tax or no money would be deducted from salary, because of tax savings due to loan-funded real estate investment.
  5. Second income from spouse, which can be used to get additional tax benefits (by being a 1sthome loan for the spouse) by taking a home loan.
  6. The comfort of getting a stream of rental income. An income, which you get without working for – passive income. But most of the times, people forget about the linked expenses.
  7. The general opinion that it is a hedge against inflation.
  8. Mental fix that there is Zero Risk in real estate purchases (in reality, there are more risks than most other investments like gold and mutual funds).
  9. The justification that it is an investment for the next generation(s).
  10. High return expectations due to the recent past records (say last 15 Years).
  11. Black money at work!!
  12. Pride of owning multiple real estate investment and being known as the ‘Landlord’.
  13. As there is no daily ticker, the daily mental valuation of the asset does not take place.
  14. Mental satisfaction and happiness when disclosing to others that you own multiple properties.
  15. The perception that since everyone is investing in real estate and profiting from it, even I should do the same and make easy money.
  16. You always hear the story from neighbours that they bought a flat for Rs 900 / sq ft 15 years ago and now it is worth Rs 5000 / sq ft. Here mental maths comes into the picture. Mentally you might think that this 900 to 5000 appreciation is more than 5 times and a very profitable one. But neighbours comfortably forget to tell you about the expenses they incurred in these 15 years or in repaying loans. Actual returns are always calculated net of expenses. It’s neighbour’s envy and owner’s pride (copied from an old Onida TV advertisement). For those who want to turn Rs 900 to Rs 5000 in 15 years, it’s not that tough. You can do it at 12.1% per year.

Why Don’t People Invest in Mutual Funds?

Since you are reading Stable Investor, chances are high that you would be a mutual fund investor. But there are many who avoid mutual funds to invest in real estate. Let’s see what are the possible reasons for them to do so:

  1. Lack of knowledge about mutual funds and equity markets.
  2. Lack of understanding about the power of compounding, the power of equity as an asset class and clear knowledge of wealth building via SIP.
  3. Lack of knowledge about asset allocation.
  4. Risk and loss aversion.
  5. Unable to determine financial goals and estimate the amount required.
  6. They have already utilized all the tax benefits available to them because of home loan. Now they have no tax-incentive to invest in mutual funds. And hence they don’t do it!
  7. Bad past experiences. And these are primarily due to wrong fund selection or wrong time horizon or wrong advice (like combining insurance and investment or wrong thinking that saving and investing are the same).
  8. As daily price movement of MF through NAVs is available, the daily mental valuation of the asset forces one to take frequent buy and sell related decisions. This is driven by a general lack of patience in investors.
  9. Mutual Funds cannot be funded through Black Money.
  10. Unlike real estate, no long-term loans are available for investments in mutual funds.
  11. More people talk about losses made by investing in funds (for whatever reasons) and very few people talk about their success in meeting financial goals through funds.
  12. Mental fixation with recent huge loss events (like 2000, 2009, 2013 etc.)
  13. A major chunk of saved money has already gone into real estate, which leaves almost no money to invest in mutual funds.
  14. And as substantial money is not invested regularly in mutual funds, one does not feel that substantial money can be made through mutual funds.
  15. You don’t get to hear every day that a fund having a NAV of Rs 28 has grown after 15 years to Rs 805 – a return of 25% per year (Check Reliance Growth Fund). Such returns are very high ones and rare and cannot be matched by real estate investment or investments in other asset classes.

Now, let’s test your memory…

Do you remember how much did the petrol cost in the year 2000?

It was around Rs 25. As of today, it is about Rs 66. Now suppose you had invested that Rs 25 in real estate, which grew at 12.1% as mentioned few paragraphs earlier. This would have grown to Rs 139. Enough to buy 2 liters of petrol today. Now if this was invested in a mutual fund, which somehow could manage 25% return, it would have grown to Rs 711. Enough to buy at least 11 liters of petrol.

That is how equities work. That is how compounding works. That is how the value of your money is preserved and increased by investing in the right asset class for long periods of time.

Concluding Thoughts

And this is a repetition of the earlier statement. One should not give any second thought about buying your 1st property for self-occupancy, whether it is with or without tax benefits.

However, based on our comparative analysis above (and estimated returns), one should think twice (or even ten times…) before buying a second home for investment purpose. One should carefully weigh all the available data and then take a wise call. Just because your friend or family member is investing in real estate does not mean that you should also do it. You should evaluate your own financial goals and think about how you plan to achieve it, and then decide whether you want to ‘invest’ in real estate or not.

A hard and physical asset will always give a huge mental comfort and satisfaction over other financial assets like mutual funds. But it is also true that it may not always be the best available investment option. In fact, investing in house funded through a loan, is a huge long-term liability – which chokes the ability of the person to save and invest in other right instruments for the future.

In our opinion (and it is ours and you can ignore it), after the purchase of the 1st property for self-use, if there is any surplus cash left to invest, you should invest it as per your asset allocation (which includes debt, equity, gold & real estate). If the asset allocation permits you to invest in real estate, you may very well do it. But if it doesn’t, then you should refrain from investing in it. Investing in real estate for the sake of saving tax may not be the best thing to do.

As stated at the beginning of this article, this is one hell of a controversial debate. And there is not a straight-forward logical answer to it. There are no thumb rules or any other rules. The question of Real Estate Vs Mutual Funds can only be answered by you and you alone.

We have simply made an attempt to clear the myth that “Real estate investing is the only best Investment Option” available for everyone. We have done all the calculations by estimating the returns net of expenses. We cannot just ignore expenses like those who just tell you the number of times their property has appreciated in value.

Please note that this post may be biased towards Mutual Funds investments.

Do let us know about your thoughts on Real Estate vs. Mutual Fund debate.

Note (Update 2019-20): A new updated real-life case study on Mutual Funds vs Real Estate has been published. You can find it here – Mutual Funds vs Real Estate: Which is better for Investing in India (Follow Up Post 2019 Update)

Disclaimer:

Returns mentioned in this post are only assumptions and not guaranteed ones (for both Mutual Funds and Real Estate). While there is investment return record available for mutual funds, we could not get a credible investment return data for real state (we took NHB data as a guideline). Moreover, the real estate returns vary vastly from location to location.

88 comments

  1. 1. I totally acknowledge two main con's of RE – ticket size and illiquidity. But what I am trying to convey here is if we take out the interest component of the table (meaning self funded), the picture is quite different. 100 rupees earning 10 and 1cr earning 10L, roi is still 10%.

    2. When buffet says equity beats any other form, he is absolutely right because he understands that asset class completely. This statement can't be shown to a grocery shop owner and make him invest in equity MF. The earlier quote of 'invest only in asset classes you understand' seems universal to me and applicable to all.

    3. REITs are now regulated and are required to do full disclosures. Off course reits will take time to earn credibility that MF enjoy these days. But good REIT houses like piramal are already there.

    Disclaimer- I am a big fan of equity.

  2. Totally agree… actually, my supposition of 80 lakhs was on the quite higher side. It was just an example, and I agree that getting that kind of appreciation would be extremely unlikely.

  3. Yes Ajay. It was a big loss for the investing fraternity in India.
    I was lucky to have interacted with him a few times on mails. And apart from being a true-blood investor, he was one of the humble human beings I had ever come across. I was pleasantly surprised when he replied to one of the mails which I sent him the very first time.
    There is so much to learn from him

  4. The way common people have become rich in real estate, I dont think any other business could have done so. Starting a business and making it successful is beyond capabilities of 90% of people because adequate knowledge and contacts are required for that. See the semi-literate villagers around delhi-ncr roaming in luxury cars. Many of them are multi billionaires. Can any other business would have made them multi-billionaire? absolutely no. Real Estate will always remain first choice of indian people and it should be. The proud you will feel in possessing a kothi of 5 crore cannot be given by mutual fund papers of 5 crore.

    1. And once they squander away the money they are on the roads. Easy come easy go. Only a responsible few may invest for security and they could turn out to be clever. They would have sold their ancestral property and hence it would have been easy. Easy come……

  5. Thanks Dev and Ajay for the knowledge. Very useful analysis. I will now venture into MFs et al. RE is more risky than MFs. The best part is liquidity which is needed in times of distress.

  6. Hi Dev.Great article.What if we purchase commercial property?I mean flats get not more than 3-5% in rental yield.However commercial property gets decent yield and capital appreciation.What do you think?

  7. Although I agree with mutual fund part. In real estate investment, the scenario assumes that the buyer is lending the maximum amount of loan possible. And then repaying it over the maximum tenure. Thus increasing the cost of investment to more than double. If the same investment is made without the loan involved, then the returns will be better than shown here.

  8. you have not taken into account land purchase in real estate investment,it sometimes substantially more than a flat

  9. This is a very informative article. But we would have liked to see the comparison of different loan tenures and loan amounts with respective comparable mutual fund plans. Like 15L down payment 60L loan for 15 years; 37.5L upfront and 37.5L loan for 15 years etc. etc. Looking forward to see such comparisons.

  10. It’s a very good comparison.Can similar comparison be done with respect to land purchase.Reason being is investment in land/plot normally gives better returns than flat purchase

  11. @ashish ji your analysis is insightful for second house. Please write an article on purchase of first house for a young professional in 30s.since that is a consumption decision.

  12. Good analysis. I agree with the part of “Mutual Funds”, Instead of investing in Real Estate just by taking the loans, I would prefer Mutual Funds investment due to the low investment with good returns, which can also help us with retirement planning

  13. Hi Ashish, You have provided a good information and it will be really useful for the people who are just confused and I would recommend people to invest in real estate instead of mutual funds!

  14. Hi,

    Good analysis, but I think you missed 1 point while analyzing mutual funds investment which is : the rent paid by mutual fund investor and I think that should be deducted from investment per month.Like in your case the amount invested should be: 50126 – (rent paid).

    In that case also mutual funds will win :).

  15. Really a very nice article.

    2 more points can be added.

    1. Liquidation of mutual fund is very easy compared to sale of property.

    2. We can defer the decision to buy house currently and buy new house as per choice from mutual fund returns of 25 to 30 years in new construction that will last more (compared to house bought 25 to 30 years back from home loan instead of investing more on mutual fnds.)
    Also we will have more money left in hand after 25 to 30 years even after buying same type of house which can be added to retirement fund.

  16. It is definitely a good Article , But I must say that we must understand that 1st property is not an investment it is a basic need , secondly what ever rentals we have shared hv been of residential market which would only be 2.5 to 3 % , However if you invest in Commercial property you will surely get 5 to 6 % which is not bad atall bcz after every 10 years your commercial property would hv 100 % jump. (In most of the locations even more ) Even MF are also very good. Atleast the datas show this only. Now to conclude I would say that an intelligent person would be one who would invest atleast in 4 categories , 1st one should be PPF (of course can be max 1.5 lakhs p.a) 2nd should be SIP , 3rd should be some FD and 4th should be Commercial Property… This is the way I have invested and seen a Corpus growing at a descent level. Like all your needs are not of the same level all investments cannot give same returns but One should plan for all kinds of requirement and should ensure that they get regular income to run House hold , should save for retirement (PPF) should hv some liquid options like FD for immediate unforeseen expenses and some MF to make your money work for you .

  17. Really good one. I took home without prior knowing the SIP and mutual funds. So now at-least i started saving in SIP, My husband pay EMI and I pay in mutual funds. It will good atleast they start 5 years before getting the home loan so some pressure on financial part will be reduced. So from a year i am more interested on SIP rather than other saving like FD

  18. Awesome analysis Dev and stable investor.
    I am in minus of around 70 lakhs today with jobless condition with having no investment on any MF or real estates.
    Really need a serious planning as I am sure of coming back to track of regular income.

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