All you need to know before investing in Real Estate
Here’s All you need to know before investing in Real Estate:
Real estate has been there for a long time as the preferred investment haven among Indians. Such kind of behaviour is surprising in spite of the mediocre returns given by this asset class.
You might not believe it!
You think that you have earned humongous returns. But in reality, that’s not the case. Why it seems so big is because of the huge quantum of funds involved.
The NHB Residex data provides concrete evidence to bust this myth.
The table shows that real estate has given a moderate CAGR in all the metro cities. Delhi stands at the bottom with CAGR of just 0.74%. Mumbai has given the highest annualised return at 6.69% which can be earned even from a simple Fixed Deposit.
Let’s take another example.
Bought in 1970 for Rs 3.5 lakh, actor Rajesh Khanna’s bungalow in Mumbai got sold for Rs 90 crores in 2014. The property grew by 2571 times in 44 years. But the annualised returns delivered were just 19.54% (Here we have ignored the parameters like indexation, interest cost, brokerage, registration charges, maintenance charges and other incidental expenses). Considering the long-term capital gain tax rate to be 20%, post-tax returns are even lesser at 15.63%.
You must understand that it is case of a premium property located in a metro city. You cannot expect properties situated in other cities to deliver exorbitant returns like that.
If you compare it with the performance of the Sensex, beginning from 1979 till 2017, Sensex has given annualised post-tax returns of 15.60%. Equity Mutual funds are within everyone’s reach because it involves small ticket size unlike real estate.
So, now it becomes necessary to find out what makes real estate so irresistible?
The physical nature of real estate gives you a sense of ownership. Such kind of satisfaction can’t be derived from stocks due to its intangible nature. You are favourably biased towards real estate because you took that legacy from your previous generations.
Additionally, you can access stock market figures in real time. So, there’s a constant insecurity to exit the investment as soon as possible. In the case of real estate, you don’t get to see real-time data. Hence, you keep holding it for as long as 40 years or even more.
If you had done the same thing with equities as well, you would have been in a better position. The short-term volatilities get smoothened out over the longer time horizon. To accumulate wealth, you need to understand the Power of equity.
Meanwhile, let’s look into the risks that you might face while investing in real estate.
Risks in Real Estate
Now and then you come across news of launching of real estate projects. In these ads, the developer offers amenities unheard before. Some of these may also propose sky-high returns in a short span of time. Others may offer premium properties at throw away prices. When you have got ready cash in hand, such proposals may seem a favourable investment opportunity.
Owing to no entry barriers, lots of developers have entered the real estate scenarios. Some of them might be fraud as well. But whenever a lucrative opportunity strikes, you want to just go for it. You might regard the background check as unnecessary.
Many innocent investors have fallen prey to such unscrupulous offers. After investing money, they confront the harsh reality. The developer may use the booking amount to buy more land. He may also sell the same property to multiple investors. Or in the worst scenario, he may vanish from the scene leaving you high and dry.
Anything can happen. So, just be careful.
India faces a tricky situation as regards title to the property. You cannot be sure, prima facie, whether the property which is being sold to you has got no title issues.
The root of this problem can be found in property registration system. Only sales-related transactions can be found in the registrar’s records. But the other stories related to that property remains hidden. You cannot ascertain details of partition, mortgage, court orders just by looking into the registered papers.
Moreover, unlike the developed nations, the government here doesn’t guarantee land titles. You won’t even find any land records in digitised form. Additionally, there can be uncertainty concerning land dimensions; as regards extent of the boundary, inheritance sub-divisions and financial encumbrances.
Delay in Project Completion
You may face unreasonable delays in moving-in to your dream home. The developer may have promised delivery period of 3.5 years. But the project may be still under-construction. Such issues have been noticed extensively in metro cities like Delhi-NCR, Chennai, Mumbai, etc.
In some cases, such delays may be attributed to the dealer facing a cash-flow crisis. In a construction-linked payment, the buyers may stop payments in the midst. It happens if they find project not reaching the promised stage of completion.
On a continuum, the risk of delay is the highest during pre-launch and launch stages. The risk declines as the project near completion.
When it’s about investments, you need to behave rationally. You need to analyse whether there’s value for money in the underlying investment. What it means is that whether you are paying the true value of the property or not. The price of the property should reflect the current market trend and profit-making aspect.
Ascertaining the value of a property is a complicated process. Instead of doing a valuation on your own take help of a professional valuer. Additionally, many financial institutions are involved in property valuation.
The valuation report reflects the true picture of the property. It covers all the aspects including any flaws in the construction. As regards new projects, the report may include a comparative analysis concerning prices and features of existing properties in the location.
Understanding residential properties is easier than commercial properties. It’s because prices of commercial properties are influenced by several macroeconomic factors. Moreover, these are more volatile and require long gestation periods.
Leverage is when you borrow from a financial institution like the bank to purchase an asset like a home. Here, you are trying to own 100% equity in the asset with the help of 20% of your capital.
Let’s understand this with an example.
Suppose you need to buy a home of Rs 30 lakhs. The bank may extend a loan of up to 80% of the property value. It means you could get a loan of Rs 24 lakh and Rs 6 lakh is to be spent from your pocket. By paying only Rs 6 lakh, you are getting to own a property worth five times the value.
Whenever leverage is involved, it comes with its share of risks. It might happen that the value of the property drops to Rs 20 lakh. However, you still need to repay the promised amount of Rs 30 lakh to the bank.
In yet another case, there’s an interest rate risk. If the interest rate on loans rises more than the return available on the investment, then you are in trouble. Similarly, if you borrow more than your repayment capacity, you might land in default.
How to Manage Risks in Real Estate
These are some of the measures which would help you in staying away from deception.
1. Before investing in any real estate offer, you got to analyse it from various angles. The most important aspect relates to reputation and credibility of the real estate developer. In the case of new project launches, check for timely completion of the projects in the past.
2. You may follow a checklist to clarify about the property ownership. Trace prior ownership to avoid any dispute in the future. Verify if the seller is authorised to sell the land and there are no pending taxes. Look for approvals by the city development corporation and other local authorities. Seek information about clearances for further development.
3. Make use of leverage prudently. While seeking home loans, scan the state of interest rate regime. Don’t borrow more than your repayment capacity.
4. While taking investment decisions, keep your financial goals in mind. If you are aiming for high returns, then commercial properties are a better option than residential properties. Commercial properties provide higher yields as compared to residential properties.
5. Residential properties are suitable for individual investors. People tend to invest the single sum of big amount in a single asset class. Their aim is to hold it for the medium to long term.
6. Commercial properties are regarded as more suitable for high net worth and institutional investors. They are capable of taking more risk.
Bringing transparency through RERA
The government launched the Real Estate (Regulation and Development) Act, 2016 on 1 May 2017. It provides the real estate sector with an autonomous regulator. It has been launched to remove the irregularities prevailing in the real estate sector in India. Efforts are being made to include industry practices in line with the global benchmarks.
With the inception of this Act, all the brokers and real estate agents will be required to register themselves. Without registration, they won’t be able to perform property-related transactions.
It aims at protecting interests of the investors and buyers. Now, the developer would have to quote the sticker price based on “carpet area”. Earlier, this was based on “super built up area”. It will give you clarity regarding the space that you are going to buy.
Moreover, the Act will make the developers accountable for the proper management of funds. Additionally, there will be a constant pressure towards the timely delivery of projects.
As a financial goal, the Real estate can become a healthy endowment for your housing needs. To stay protected, ensure that you buy only RERA compliant residential property.
Real estate may be an inferior choice over equity from returns angle as well. Hence, when your goal is wealth accumulation, your portfolio must not be skewed towards real estate. You may look at equity as an investment option. The key to wealth generation lies in efficient asset allocation.