Skip to main content

Should you tie up your hard earned money in Real Estate???

Your House is not just Property?

One should buy a house for no purpose other than to live in it. Property or Real estate makes for a poor financial investment because the ticket size is huge, and liquidity is poor. This combination is highly risky for placing a bet using a huge chunk of your money. In addition the entire investment has to be sold at one go. You cannot dream of deleveraging your investment by hiving off a part of your investment at a later date. 

Though the popular wisdom seems to indicate that you can't go wrong with property, the fact is that you may or may not be able to sell when you want to--in a slump, entire markets disappear for long periods. God Forbid, if you need money in a hurry, then you are trapped in a buyers' market. Add to this, the myriad hidden charges like Annual maintenance, Repairs, Taxes and Fees, Registration charges, Stamp Duty, Brokerage, and you begin to wonder about the "real" gains.

When you acquire your first house for staying in it for a fairly long time, it is for the purpose of enriching your life. Hence such incidental charges and fees become necessary evils and need not be the sole deciding factor in calculating whether you are getting a good deal. You should be looking at liveability of the locality, proximity to schools and hospitals, availability of parks and other open spaces, pollution levels, distance to work, etc. 

On the other hand, if you are investing with an aim to earn income or capital gains, the weightage of these factors becomes way more important. As can be seen from the chart below, assuming 4% CAGR for real estate prices, and 9% CAGR for rent, 6 years is the break event point for the rent-v/s-buy decision.

Buy or Rent - Value v/s Time

Gains: Legendary or Mythical?

Coming back to real estate as "investment", many "wise" people point to the huge gains that were made by "certain" property owners in the past. The myth of real estate being a great investment is mostly due to the math behind compounding being a little counter-intuitive.
Compound interest is the eighth wonder of the world. -Einstein.
If you hear that a piece of property is worth 50 or 100 times its value after 40-50 years, it seems impossible to find another asset that can achieve the same ROI. It simply sounds legendary, but once you sit down with pen and paper you realise that it is actually nothing special. It is slightly better than what an FD may have achieved.

Another influencing factor is the large ticket sizes involved. Humans tend to interpret large sums as huge without paying too much attention to the actual percentage gain involved.

To put things in perspective,  a gain of 100 times over 50 years comes to a CAGR of 9.6 % p.a -- good, but not exceptional after adjusting for inflation. Compared to this the BSE Sensex has managed to achieve 300x its value in 38 years.

Why real estate appreciates?

Historically the gains from real estate can be attributed to five sources:-
  1. The original change in usage from agricultural or barren land to residential or commercial. Leads to value unlocking. Similar to the difference between wholesale and retail. The increase in valuation is somewhat on real (actual) terms.
  2. The development of physical infrastructure which makes this land usable for the new purpose. This is value addition mainly through construction of a shelter and amenities and creates additional value and consequently increases the price of the property. The increase in valuation is still rooted in real (actual) terms (construction), but some part of it is future valuation discounting.
  3. The improvement in livability or commercial viability as the area gets populated more and more. This is urbanisation of the locality and improves the apparent valuation due to increased rental income. At this stage, the increase in valuation comes mostly from future valuation discounting.
  4. The periodic booms and busts that afflict real estate. This is mostly speculative and sentiment driver. The increase in valuation is completely in the realm of future valuation discounting and fluctuates.
  5. The general inflation of the economy that becomes part of the visible change in the property's price. This is because rentals are closely tied to the prices of goods and commodities. This is also the reason gold is believed to hold its value over time.
If you give a little free reign to your imagination, you should be able to see the economic similarity between Steps 1->5 above, to the increase in price of an agricultural commodity as it moves from the farmer(#1) to the end consumer(#5). In between, it moves through a supply chain involving value adders and middlemen.

If you look closely, most of the gain happens before Step#3.

Real Estate: A good investment?

If you acquire real estate at an early stage, all the gains from the second to the fifth point above will accrue over the next two to three decades. But this involves the risk and hassles of buying land in faraway places, with no infrastructure and amenities.

Things are very different now. We typically buy an apartment from a real estate developer. In this new model, all gains from stage one to three accrue completely to the developer and whoever came before the developer.

Not just that--and this is the worst part--the developer also tries and often succeeds, in discounting much of the future value potential and capturing much of the value of the later stages in advance from the buyer.

The intense marketing hype around real estate projects is intended to convince you that one day in the imminent future, the property you are buying will be among the most desirable in your part of the country. The artificial sense of scarcity that is projected through limited offers and time bound deals easily pressures you into taking an emotional decision due to FOMO, and you end up with an acquisition price that is a high multiple of a value that will supposedly be attained in the far future. This future value is directly proportional to the hype that the developer manages to create.

I personally make it a rule to walk away from deals that needed me to pay the booking amount immediately in exchange for a lower rate without allowing me time to verify the facts, or sleep on it. Beware of FOMO, whatever may be the apparent "possible" loss of opportunity. We need to be aware that, to our minds fear of missing a possible gain (opportunity) is akin to real physical pain, and this deeply influences us.


The price of a property in South Mumbai or South Delhi may have become 50x over the 50 years. However, the flat on the outskirts of these cities that someone developer is pretending is worth Rs 5 crore today is not going to be saleable for Rs 250 crore come 2070.

The reason is not that compounding is going to fail in the future, but that much of the future value is already included in that Rs 5 crore that the developer wants today. All the marrow has been sucked out by the developer.

So before you take the plunge and decide to acquire additional real estate "investments", take a deep breath and consider the following:-
  • Put your FOMO to rest.
  • Don't get dazzled by the large ticket sizes.
  • Convert gains to % CAGR, before deciding how much the actual gain is.
  • Factor in the illiquid nature of the asset (Illiquidity is directly proportional to ticket size)
Therefore, it's only logical that savers buy only one house, the one in which they are going to live in. If your lifestyle and family need many houses, then that's fine but don't consider it as a financial investment.
Post a Comment

Popular posts from this blog

What is OOP? In Layman terms...

What is OOP? OOP stands for Object Oriented Programming. It is not just a programming language, but a paradigm (An example or model used to explain a concept or theory). OOP does not tell you how to program, rather it tells you how to go about designing your software. There are many languages that implement/help you in implementing OOP. C++ is one of them. When you are developing Object-oriented programs/software the emphasis is more on how you think about and design the software rather that on actually implementing(coding) it. Why ‘Object-Oriented’?       What should you do to make sure your program is object oriented? Simple, you stop thinking in terms of Bits, Bytes, Pointers, unions, structures, et al. Instead you think in terms of objects and the interactions between them. It is actually more natural for humans to think Object-oriented than to think in terms of memory and variables, etc.       Simply put, OO is nothing but defining the behavior of software as a collecti…

BLACK...Hindi Cinema's Coming of Age Movie....

Went to See BLACK this Saturday with my Friends.... It was a really unforgettable Experience...BLACK is Unlike any HIndi Movie ever-made. It is Stark, Thought Provoking, Rough, Beautiful, Poetic, Gossamer, and Tough at the same time. Very Few Movie-Makers are able to attain this level of Movie Making. Hats off to Sanjay Leela Bhansali. Black stars Amitabh Bachchan and Rani Mukerji. Bacchan, in one of his best roles, plays the TEACHER and Portrays both Unsurmountable Weakness and Indomitable Strength with equal Ease. Rani(the Girl Next Door) portrays the role of a Deaf and Blind Girl with such conviction, that the viewer cannot help but get affected with her plight. Ayesha Kapur plays the young Rani -- a blind, deaf and hence mute girl -- to perfection. One can just wonder at the performance by a 10 year old little girl. Frustrated by her inability to comprehend the world around her, little Michelle McNally is an untamed 'animal'. Her Father keeps a distance, her mother is to…

Shridharacharya: Solving Quadratic equations in the 9th Century.

SridharAcharya (c. 870, India – c. 930 India) was an Indianmathematician, Sanskrit pundit andphilosopher. He was born in Bhurishresti (Bhurisristi or Bhurshut) village in South Radha (at present Hughli) in the 10th Century AD.He was known for two treatises: Trisatika(sometimes called the Patiganitasara) and thePatiganita. His major work Patiganitasara was named Trisatika because it was written in three hundred slokas. The book discusses counting of numbers, measures, natural number, multiplication, division, zero, squares, cubes, fraction, rule of three, interest-calculation, joint business or partnership and mensuration.He was one of the first to give a formula for solving quadratic equations.He found the formula :- (Multiply by 4a)
Proof of the Sridhar Acharya Formula,let us consider,Multipling both sides by 4a,Substracting  from both sides,Then adding  to both sides,We know that,