Real Estate – Stable Investor

Mutual Funds Vs Real Estate – Which is better for Investing in India? (2019 Follow up post)

by Dev AshishJune 24, 2019 5 Comments

Note – This is a guest post by Ajay. He has previously written on this topic here. Since a few years had passed, he was kind enough to share his views again (with a useful real-life example). Ajay has also authored other interest posts here like How He created a corpus of Rs 3.7 Crore in just 10 years. So over to Ajay for this post…

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A few years back, I had written on a controversial topic – Investing in Mutual Funds Vs Real Estate in India. I wanted to do a follow-up post on the topic as with each passing year, a new set of people begin asking the same questions:

Are mutual funds better than real estate for investing in India?
Can investing in real estate be better than investing in equity funds?
Mutual Funds Vs Real Estate – which is better
And similar versions asking the same things…

So let me try and address this again…

I once again reiterate that there will be many reasons for investing (or let’s say putting money) in real estate – such as peer pressure, family pressure, social status etc. and I am not debating the same. This question of whether you should invest in Real Estate (for investment) or Mutual Funds, can only be answered by you and you alone.

And therefore, this article should ideally be read in that spirit.

The intention of this post is to present facts based on the actual data, from both real estate and mutual funds from an investor’s perspective and ofcourse, my opinion on the same. 🙂

Also, as stated in the earlier post:

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 about buying your 1^st property for self-occupancy whether with or without tax benefits.
I am aware and acknowledge the fact that being Equity and Equity Funds oriented investor, my views will tend to be biased towards Equity investments than Real Estate investments.
The experience and the actual investment returns of Real Estate investors vary from location to location. And therefore, many of you may not agree with the conclusion or findings of this post. Nevertheless, through this article, I have analyzed the actual data from the Real estate and mutual fund investments in India.

So let’s go ahead…

Real Estate Investment

In August-2010, a friend of mine decided to buy a 1200 Square feet (Sq.ft). Flat in the outskirts of Bangalore (@ Rs 2290 per Sq.ft.) through a housing loan. The details are as follows:

Cost of Flat (including Car parking, Utilities, Legal costs, Deposits etc.): Rs 31,39,500
VAT, Registration & Stamp paper: Rs 3,02,566

Total Cost of Flat (all Inclusive): Rs 34,42,066

To fund this purchase, he used:

His own money (Rs 12,42,066) and
Took a home loan for Rs 22,00,000 from a bank.

The loan EMI was Rs.21,343.

As like many of you committed individuals, he paid all the loan EMI on or before the due dates, and also increased the EMI amounts as his salary increased during the loan tenure. He also made part payments many times to accelerate the loan closure and to settle the loan as early as possible. He also put this house on monthly rental as he had to live in another city for professional reasons.

Kind of an ideal way of managing a home loan you can say.

Now let’s look at the numbers below (if you are interested in the actual loan cashflow data):

Now the loan ended recently (in May-2019).

So I sat with my friend and re-calculated the actual cost of his flat:

Total Cost (Flat in Hand) – Rs 34.4 lac

Downpayment – Rs 12.42 lac

Loan – Rs 22.00 lac

Total EMI Paid – Rs 25.73 lac

Total Initial Downpayment & Prepayments – Rs 18.67 lac

Actual Cost of Flat (excl. rent)- Rs 44.40 lac

Rent Received – Rs 11.36 lac

Net Amount Paid for Flat – Rs 33.04 lac

These are real numbers. Real actual numbers.

Let’s move further.

With the loan completed in almost 9 years time, and with the general assumption of property appreciation, we expected the property to fetch at least double the investment (value) of net amount paid for the flat.

So we expected Rs 66 lac from the sale of the property.

However, we did not find a single buyer even at Rs 55 lac!!

From the local brokers and available market information, we got to know that the property could be sold immediately for Rs 40 to 42 lac and if we were lucky, it can be sold for a stretched value of Rs 45-48 lac (let’s say max Rs 50 lac). Also, there will be capital gains tax on the profit amount.

While it is concerning that there was no value appreciation despite the area is connected and having all the basic amenities in the near vicinity, I decided to take this as a case study to see an alternative scenario – where investments had been made in Mutual Funds. I wanted to know what would have been the outcome.

Mutual Fund Investment

I chose 3 funds to feed the investment data in MF (same amount invested as EMI, downpayment and prepayment on the same date as the loan payments were made).

The choice of funds were as follows:

1 decent performing fund (Franklin India Equity),
1 market performer (UTI Nifty 50 Index Fund), and
1 worst performing fund (LIC Multi-Cap Fund)

Since the direct plans weren’t available in 2010, regular plan (i.e. ones with higher fee and lower returns) were chosen for data crunching. So here are the details below (or you can skip and go straight to the summary just after the table):

Summary of the above investment table is as follows:

Conclusion:

From the table above, it is clearly evident that if instead of buying the flat, the investment was rather made in the worst performing mutual fund, it would still have given returns of Rs 55.5 lac against Rs 40-48 lac current market value of the flat.

Investment in the index fund would have fetched a much better Rs 67.94 lac. And if you luckily had invested in a very good fund, then it would have given you about Rs 78+ lac.

Not bad. Right?

I know what many of you might be thinking…

While we can debate the time of entry in mutual funds, time of entry or locality or high cost paid for the property etc., I still find merit in investing in Mutual Funds instead of Real Estate flats as an investment. And I very well know that irrespective of the above data favouring MFs, many will still argue in favour of the real estate. I leave the decision to you.

An important point that shouldn’t be missed in this Mutual fund vs real estate debate is the importance of selecting a good fund (or avoiding bad ones) for investment. And if we stretch this topic a little, it opens up another separate debate on the Active versus Passive Funds which I guess is best left for another post.

Note: In the calculation of Real Estate, the cost for Home Insurance, Home Maintenance, etc. was not included. Also, the Rs 2 Lac tax savings during this tenure was not considered as there will be a capital gain tax on property investment too. Equity investment until March-2018 were are tax-free and therefore, the tax implication would be negligible in case of equity investment in the above case study’s tenure.

Concluding Thoughts

As stated in the previous post on the debate of real estate vs mutual funds, I once again have the same concluding thoughts.

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

However, based on the comparative analysis done above, one should think twice (or even ten times…) before buying a home for investment purpose. One should carefully weigh all the available data (Or as much reliable information you have) and then take a wise call.

Just because your friend or family members are investing in real estate does not mean that you should also do it.

Diversification aspect should also be looked at. But you should not avoid evaluating your own financial goals. This is extremely critical. And don’t just evaluate and feel helpless about it. Find out how you can plan to achieve them and then decide whether you actually need (or want) to ‘invest’ in real estate or not. Different people will get different answers.

Without doubt, a physical asset (like a house) will always give 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 in many cases, chokes the person’s ability to save and invest for other goals in right instruments.

In my opinion (and it is mine so you can choose to ignore it), after the purchase of the 1^st 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 just because it’s what everyone else around you is doing.

And please, investing in real estate for the sake of saving taxes may not necessarily be the best thing to do. If need be, do not hesitate in taking financial advice to put in place a solid investment plan for your life.

As stated at the beginning of this article too, this is one hell of a controversial debate.

And there is no one straight-forward or logical answer to it. There are no thumb rules either. You and you alone can answer the question of Real Estate Vs Mutual Funds.

In this article (and in the earlier one), all I have tried is to attempt to clear the myth that “Real estate investing is the only best Investment Option” available for everyone. As you might have noticed (if you have spent some time reading the tables above), that all calculations have been done by estimating the returns net of expenses. We just cannot ignore expenses like those many who just tell you the number of times their property has appreciated in value. It’s not correct.

Hope you found this analysis interesting and useful.

5 People. 1 Story. Reality of the Indian Real Estate

by Dev AshishJuly 18, 2017June 25, 2019 15 Comments

This is a guest post by Shyam Shenoy. A software engineer who is passionate about value investing. He believes that one of the major reasons for the real estate prices reaching unrealistic levels is the Indian IT economy.

You may or may not agree to that, but he has an interesting story to tell you.

So over to Shyam…

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There is absolutely no doubt that Housing is one of the 3 basic needs of life. You need a house. I need a house. And for all practical purposes, we all need a house.

Thousands of articles have already been written about why owning a house makes sense. And even if you don’t read such articles, people around you will try to ‘somehow’ convince you that it does make a lot of sense.

Now housing is a need. And every need… costs.

And for regular people like us, every cost… counts.

Having said that, the cost of a house is probably the single biggest expenditure that a person incurs in his lifetime.

So there needs to be a solid thought process behind the decision to purchase a house.

Now Stable Investor is a site about investments. So here, I am talking from the perspective of prudent money utilization and not from house-is-a-basic-need-so-we-should-buy-it perspective.

In this post, I want to share a story with you. The standard disclaimers apply. 🙂

Disclaimer: Any Resemblance to Actual Persons, Living or Dead, is Purely Coincidental

The Story of 5 People

There were 5 people in a small town:

Ajay an IT engineer
Bob the builder
Charan a corrupt Government Employee
Daniel a banker
Edward who was engaged in small businesses

All of them had close to zero money to start with.

Now a businessman named Peter (who owns a big IT business) comes by and offers Ajay (the IT engineer), a job for Rs 15 Lac per annum.

Immediately, Ajay has levelled up and is going to be rich. And the other four people take notice.

Bob (the builder) now sees an opportunity here.

He approaches Ajay and lets him know that he could build a house for him for a price which he would let him know later. Ajay agrees to it in principle, as he is still not committing anything.

Bob gets down to work. As per his calculations, it would cost him about Rs 30 Lac to construct the house. If he adds his profit of Rs 10 Lac, he can sell this house to Ajay at Rs 40 Lac.

Charan (the corrupt government babu) has years of experience in dealing with approvals and permits. For lack of a better phrase, he can smell money in this transaction too. Being aware of Ajay’s new found income source and about Bob’s construction plans, he tells Bob that he will give approval for his construction project only if he gets his cut. A cut of Rs 20 lac in a suitcase so that he can ‘legalize’ and ‘approve’ this construction.

To sweeten the deal, he assures that he will also bring in Daniel (the banker) and influence him to grant loan for construction.

As you might have guessed, Bob is forced to add Rs 20 Lac more to the selling price. The house will now cost Rs 60 Lac. Adding more for registration costs, stamp duties and other miscellaneous items, the final price for Ajay comes to around Rs 70 Lac.

Bob lets Ajay know that the price of the house would be Rs 70 Lac – ofcourse in a combination of black and white 😉

Daniel (the banker) is ready to offer Home Loan to Ajay at 10% per annum.

Ajay feels that luck is favoring him again with these good deals. After all, it was him who found a job that pays an annual salary of Rs 15 lac whereas other four people still don’t get much.

He accepts Bob’s offer and takes a home loan from Daniel.

If you are aware of the mathematics of home loan, then you would agree that for a long-term home loan of Rs 56 lac (assuming 20% downpayment by Ajay from some other source – may be from his father’s retirement corpus), what Ajay is probably tying himself to is a loan repayment schedule where principal + interest would be around Rs 112 lacs or Rs 1.12 crore (approx.).

But that is Ajay’s headache. 🙂 Let’s move on.

Edward (the 5^th person) sees all this and does his own biddings…. starts a school, hospital, shopping Mall and what not…

So what is the current situation?

Bob certainly makes a profit of Rs 10 Lac. Charan gets his ‘black’ Rs 20 lac. And banker Daniel gets his Rs 56 lac interest on the home loan. There is no real estimate as to what Edward is making. No one except Charan is doing anything illegal (maybe Edward too is doing something as he got huge investments to build those hospitals and schools etc.)

However, Bob, Charan, Daniel and Edward have cleverly exploited the situation.

The money ‘travelled’ from Ajay’s hands to others and Ajay is at maximum risk.

Bob and Charan have already made the money and left. Edward obviously is stinking rich and can afford to sit and wait for things to work out.

Now comes the interesting part…

Try imagining thousands of Ajay(s) and other fours. This becomes the case of an exponentially growing city. Now imagine lacs of such people and it becomes the situation of the entire economy.

Now suppose that Ajay has four friends (colleagues) – Amit, Ashok, Ali and Antony.

They come to know that Ajay has bought a beautiful house. Now, these friends get into the herd mentality. They feel that since Ajay has bought it, it must be good. They too want to buy a house (obviously loan funded).

The opportunities for Bob’s construction business are plenty. So other builders, bankers and establishments also join the party. All are happy. Since people like Charan (the corrupt government official) have very few competitors, more and more people like Ajay and his friends make him richer and richer.

If you see the bigger picture, it’s a clear case of a mad rush to make money at the expense of people like Ajay and his friends.

As more builders enter the fray, Bob is facing stiff competition. He starts making houses out of substandard/inferior raw materials. He also engages real-estate agents and brokers to whom he pays a small cut – to bring more and more unsuspecting buyers to him. Some of the builders like Bob have already started absconding without even completing their projects.

Charan starts approving all the projects blindly. Lands near city dumps, toxic lakes, far away places, agricultural lands, lake beds, flood plains, encroached spaces and lands with no clear titles. Charan is busy signing approval papers and has no interest whatsoever in construction standards, roads or infrastructure.

Daniel is giving out loans like never before. All which can and might turn into NPAs. But he is too busy to see all that. He has undercover and shady links to loan recovery agents.

As for Edward, he starts raising prices of the services he is providing through his schools, hospitals and malls. Prices everywhere are going skywards.

Obviously, this cannot continue forever. The flip side starts showing up slowly but certainly.

Depleting land leads to land mafias. Depleting sand leads to sand mafias. Depleting ground water leads to water mafias. There are no proper waste management systems and nearby rivers are being filled with lakhs of litres of polluted water daily. There are laborers pouring in from all around the city and living in slums with a desire to get employed in this fast growing town.

Can the situation be reversed back?

Almost impossible.

Even if Charan suddenly decides to turn into a good man and stops accepting illegal money. Why would Bob reduce his price from Rs 70 lac to Rs 50 lac all of a sudden? His competitors will not be doing so. No one will quit as long as the party goes on. The houses already constructed cannot be demolished, given the scale of constructions that have taken place.

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So that was the story.

But in spite of me claiming it to be an imaginary one, even you know that it’s not completely fictitious. 😉

Now I am not arguing in favor or against the idea of purchasing of real estate. It all depends and differs from one person to another.

Buying a first house (your primary residence) is sensible. But investing more money into real estate is another question (read this). And remember, you need to consider many other things:

Are you really getting your money’s worth when you are investing in property?
Is the quality of the house reasonably good? Do you know it or you are just assuming it?
Most of you will take a home loan to buy the house. Are you fine being chained to the loan repayment cycle for life (ok not life but a decade or two) and thereby compromising other financial goals to a larger extent?
Have you considered how you would pay EMIs in situations like job loss, health deterioration, etc.?
If it’s an investment, do you feel you will really find a buyer at the price that you wish to dispose of your flat in case of an eventuality?
Now, this is not an easy one to digest. Aren’t you enriching other people with your money by buying houses at exorbitant prices? If so, don’t you think it makes sense to stay in a rental house?

Think about it.