The author is also a law graduate, with
more than twenty-five years of experience in real estate business including
founding and leading a property consulting firm in India. Prior to real estate,
Mr Vakil worked in senior roles at several listed entities and a fortune 500
company.
Over the years, Real Estate has evolved
into a full fledged investment class. In this free flowing article, the author
discusses the realities and myths about investing in real estate.
For individuals, is investment in real
estate still a viable investment option? Or should individuals invest through
REITs? How should an individual evaluate whether to invest in real estate? What
should be the investment strategy? These are some of the issues addressed in
this article. What follows are some important issues, beliefs and myths that
are prevalent in real estate.
1. Returns on Real Estate:
Out of the 10 richest persons in the world,
7 have become rich due to Real Estate. Need I say more!! If you had an option,
to invest in Real Estate say in 1992, when the industry was liberalised by Dr.
Manmohan Singh, the comparison would be somewhat like this:
– Real Estate in south Mumbai
up by at least 100 times
– Investment in BSE Sensex
stocks up approximately 70 times
– Gold, with all its fluctuations,
would have given you 7 fold increase and Silver about the same.
– If you were permitted to
invest in USD, it would have been twice.
The conclusion is
obvious, that in the long run, Real Estate, if chosen wisely and at a good
location, would probably out beat any other asset class.
2. Issue of Sizing and Pricing:
Lesser the size of Real Estate, bigger is
the universe of buyers. Bigger the size of Real Estate and value, the universe
of buyers shrinks and, at time, shrinks disproportionately. For a developer to
be successful and for a buyer to succeed, the mix of size and price has to be
optimum. This is because “the rate per sq.ft.”, will have no meaning beyond the
affordability level. Having said this, the quality of construction plays a very
important role. There is a developer in Bangalore, who provides quality at
competitive price, that is unmatched by any other. He goes to the extent of
rounding off all edges of walls to ensure that children don’t get hurt! The
plug points are at the right place and even in high rise buildings the windows
withstand the onslaught of rain and extreme breeze.
3. Location:
The mantra for Real Estate is: LOCATION,
LOCATION, LOCATION.
It has a double whammy. Exit or
disinvestment is easy and quick and appreciation is almost guaranteed. There is
no other factor that scores over a good location. Do you know that Altamount
Road in Mumbai is the 10th most expensive location in the world?
4. Tax Breaks and Incentives:
Over the years, the Government has done a
lot to encourage investment in Real Estate, both for the investor and a little
bit for the developer. Chartered Accountants will remember section 80-IB
(though not many developers have succeeded in taking advantage) and now section
80-IBA. Affordable housing is a new mantra and the good thing is that it has
reference only to the size (30 sq. Mtrs. for the four metro cities and 60 sq.
Mtrs. for the rest of India). The result is that over 80 percent of the
development would qualify to be included as “affordable housing”, on which the
developer gets full tax break. The end result is that a compact 2 bedroom flat
outside the four metro cities would still qualify as “affordable housing”. I have
seen a number of developments in Chennai recently, which fall into this
category and selling despite recessionary market conditions.
5. Government Levies and Taxes:
Stamp Duty is a State subject and continues
to be high at 5 per cent and more in the metros.
Property taxes in certain metros have
created avoidable litigation and a lot of confusion. The change of basis from
annual lettable value to capital values have yet to fully stabilise. There is a
need to bunch up similar issues and get a ruling, which can apply to most
pending cases, concerning property
taxes.
The major problem for Real Estate is the
Ready Reckoner values or jantri, as known in some States. Over 30 percent of
flats in south Mumbai, are not getting sold because the market value is up to
30 per cent below the Ready Reckoner value. As CAs you know the implication of
this mismatch. It not only results in higher stamp duty, which is levied with
reference to Ready Reckoner value, but there is a deeming provision both for
the seller and the buyer. The difference between the Ready Reckoner value and
the sale value has to be offered for taxes, both by the buyer and seller.
For the developer, there are issues on how
profit is computed on “under construction” projects and for CAs the new Accounting
Standards (Standard 115) offers a major challenge.
GST will take some time to stabilise and
there is no guarantee that the benefit accruing to the developer, will be fully
passed on to the buyers. For under construction property the GST is a huge
additional cost, which in most cases, the developer, under the present
recessionary market, is required to absorb fully or partly.
6. Investible Quantum:
Real Estate as an investible class is for
people with deep pockets. The minimum surplus required is at least Rs.2 crores
for cities like Mumbai and at least Rs.50 lakhs for other locations.
The investor should remember that exit can
be time consuming and expensive. Also Real Estate is incapable of being broken
down or split. In most cases, either you keep the property or sell it, but
selling “in parts”,
is not possible.
7. Titles:
Please do not save on legal fees, at least
when you buy a property. Titles can be really complicated and a legal scrutiny
is a must. The acid test is “can you sell the property at will, without any
possible issues?” One has to be careful about the mortgages, the lock in
periods, combined or joined flats (known as Jodi flats), terraces that have
been sold to prospective buyers, etc. etc.
There is a recent development, which is
really going to help small investors – “a title insurance”. It’s expected that insurance companies will
now also offer “title insurance” in line with what is happening in developed
countries. This is path breaking and
will definitely benefit a buyer/investor.
8. Investment basket:
I would recommend that not more than 30
percent of your investible wealth should be invested in Real Estate, not
counting the house in which you live. It would not be wise to put substantial
amounts of your liquid assets in Real Estate as not only it would be volatile
but exiting would be difficult.
9. REITS:
REITS will not only change the way
investment in Real Estate is done, but make it possible for smaller investors
to invest in Real Estate. Broadly REITs would operate like a Mutual Fund, where
the investments are in commercial Real Estate, earning rental yields. REITs
will make investment decisions broad based and spread over wider geographies.
With the spread of risk, the returns would also marginally come down. The good
thing is it gives an opportunity to a smaller investor to invest into real
estate.
There are certain issues like stamp duty,
capital gains, etc. that are hindering the success. It is expected that
over a period of time, this will be resolved and REITs will become successful.
The day when REITs begin to invest in
residential Real Estate like in the US, we will begin to see real
professionalism and a reach, that we have never seen before.
Investment into commercial properties today
gives a yield of up to 7 percent, whereas residential properties
barely provide yield of 2 percent. However, if the appreciation for the period of investment is
taken into account probably, the residential REITS will fetch more than
commercial REITs.
10. Investment in Real
Estate abroad:
Investors who
have substantial surpluses and who desire to diversify their investment into
Real Estate abroad, will now have an option. Reserve Bank permits remittance of
upto USD 250,000 per person, per year, for investments. If we take 2 or 3
family members together then the investment could exceed USD 1 million, which
is a decent investible amount. Currently, UK, Dubai, Singapore and certain
parts of US are attractive for such investments. Also there are possibilities of investing in
a newer class of investments like students housing, old age or retirement
homes, etc.
For a long period of time, Rupee has
depreciated vis-a-vis the US Dollar. Any investment made abroad will provide
insulation to the investor from such currency depreciation.
11. Conclusion:
Over a 10 to 20 year period, investment in
Real Estate, if done wisely with good titles and at a good location would give
a return that can exceed any other asset class. I have seen this happen in my
career and I am confident of the future. The key word is “patience”. Don’t be
desperate if prices stagnate, don’t be greedy if prices escalate beyond
targeted appreciation. I recommend investing in Real Estate, without borrowing
money, excepting for the primary home you stay in.
The real thing about Real Estate is that it
is tangible, it is real and more certain than other asset classes.
Good luck to you! Jai Ho!
