Real estate is a poor investment option, for multiple reasons
Real estate has its faithful believers. In the past 10 years or so, I doubt if we have seen any visible price change of properties in most cities where large developments were planned. Many projects planned before the 2008 crisis, still remain partly completed or unsold. In those areas, prices have not moved. If you invested during the boom time, there is also a high probability that you may not have got delivery of the apartment or got it very late. That has the twin effect of pushing up your costs and reducing your income (assuming you could rent out the apartment).
Check out this link: http://www.nhb.org.in/Residex/Data&Graphs.php. This is an index of residential real estate prices as compiled by the National Housing Bank (NHB). I do not know about other cities; but about Chennai, I can say, with confidence, that the NHB numbers are not in line with the ground situation. Between 2007 and now, outer Chennai, where the big developments are happening, prices are more or less the same as they were then. Projects launched during those times are still not fully sold. And, inside the old city, prices are a meaningless indicator, because the supply of apartments is abysmally low, given that most plots are 2,400sq ft to 7,200sq ft, and no fresh supply of land is available. So, if you had bought a flat in Mylapore, it is likely that you would have made a return as good as on your savings bank account. In 10 years, if NHB Residex has doubled, it just means a compounded annual rate of around 7.2% and that too pre-tax. Do not get carried away by money doubling over 10 years. That index shows the sorry returns on real estate.
In relation to our per capita income, prices of land have gone up beyond reason. Which means that the per unit cost of a house has reached levels where fewer and fewer people can afford to buy a house. If jobs are in urban India, the person wants a house in urban India. If a crore of rupees is the price for a 1BHK (bedroom-hall-kitchen) apartment in Mumbai, how many can afford it? Even if we generously take five years’ current annual net earnings as an indicator of affordability, a Rs1 crore apartment-buyer should have an annual income of Rs20 lakh, that too take-home pay)!
On the other hand, if an ‘affordable’ home in Mumbai costs a crore of rupees, the interest on a crore of rupees invested in a government bond can give you around Rs8 lakh per annum as pre-tax income. It could be Rs10 lakh in a corporate fixed deposit (FD). I wonder whether you need to spend so much on rent. Even if you were to spend Rs25,000 per month on rentals, you can afford to be on rental (with annual escalation of 5%) for at least 20 years, before the rentals will cross the interest earning on government bonds! And, for 19 years, you would have had a big surplus.
Take out a calculator; do different permutations and combinations. You will be surprised.
Of course, you can say that real estate prices will only go up. That is true, up to the point of affordability. Beyond that, it will only be paper quotations and no transactions. Even if you assume per capita income to keep increasing at 10%—check out what kind of increments you got in the past 10 years of your job—not everyone will be able to afford it. More than half of the population will not get that kind of salary increase.
So, what should you do? If you want to be practical, you may like to stay on rent in the city where you work and buy a home in a city that is affordable, so that you can go there when you retire. Of course, our ambitions are without borders. We want an urban house so that we can ‘provide’ for our children. I have seen people buying three to four houses—one for my son; one for my daughter; one for me; and one for rental income. If the same amounts were to be put away in shares of any bank/company, the results, after 20 years, would tell you that the real estate investment is a loser.
Unfortunately, when it comes to choosing investments, the Indian middle-class psyche is so emotionally tilted towards owning a house that cold calculations never come into play. If you take all the money you have spent on a house, the interest cost of the house, the repairs & maintenance, brokerage, stamp duty, etc, you will realise your folly. But, no. We will not do it.
My father bought the house for Rs12,000 and now it is quoting at Rs1 crore. After 40 years. Forty years? If you get the same return in the next 40 years, the house you buy today for Rs1 crore, should be worth Rs85 crore. And your salary, to be able to afford it, should be Rs17 crore per annum.
One important thing to consider is that the final cost of our house includes the interest we pay to the finance company. Over a 15-year period, you will pay close to the price of one more house as interest alone! Even after some tax-breaks, the real cost of your house is not the list price, but much higher. So, if you take this as the total cost and then work out your ‘notional’ gains and losses, you might be a loser, actually. And, if you do make any nominal gains, you will also pay capital gains tax. And the ‘cost’ of your house for income-tax purpose will not include all the interest you paid on your home loan. So, the tax rules are the final nail on the coffin of miserable returns from property.
The fear we all have, that pushes us to destroying wealth by buying a house, is the fact that the rental markets are not very developed. A combination of poor legal framework (working in favour of tenants) and the absence of large-ticket financing, have restricted the supply of rental properties. Today, the legal framework has definitely improved and the rentals market has opened up.
We also have large private equity funds and the impending arrival of real estate investment trusts (REITs) that will help money flow into this sector and create more supply.
Looking back, we have seen the maximum escalation in real estate prices in two phases. The first time was between 1993 and 1996 and the second was between 2006 and 2009. If you think this will keep recurring, just do your numbers on affordability also. If affordability is not an issue, just look at the supply of unsold stocks around you. That should tell you something.
We also do not put a number on the costs of owning a house. The maintenance, the property taxes, the repairs, etc can cost quite a packet. Even after all this, do you want to buy a house? Sure. Go ahead. It is a question of your heart versus your mind. And, in matters of the heart, logic can take a break!