Risks and Returns in Real Estate
I regularly get calls from people wanting to invest in Real Estate. Some of these callers are perfectly good investors, understand IRR, risks, returns, etc. HOWEVER they ALSO get blinded when they hear something.
So how does this conversation go (normally) is as follows:
‘Subra I wish to buy a house in XXXXXXXXX .
Me: Why XXXXXXXXX ?
Sir my aunt bought there in 2002 and now it has gone up almost 3 times from the original price.
Me: Have you calculated the return?
No sir..something like Rs. 9 lakhs was the buying price, now it is almost 25 lakhs, not bad na?
Me: Sure will you please use excel or Pattu’s calculator and calculate the IRR on the investment? And by the way please also tell me how much money was borrowed, and what is the net PROFIT that your aunt makes now.
Suddenly the answer is so subdued that one cannot believe it.
“Darling the IRR on this is about 8.89%, and I am assuming that Rs. 7L was borrowed at about 12% p.a. from Hdfc (oh I am so happy for myself, thank you), your aunt took a term insurance of about Rs. 10L – as a single premium (the worst way to buy term insurance from an expensive provider like Hdfc life), paid brokerage, stamp duty, paid municipal taxes, spent on maintenance, etc.”
And here are the risks that she took in that period:
1. She did not need any money ‘urgently’ and therefore did not need to sell it in a distress.
2. The builder really built, and gave possession without needing any legal screaming.
3. She had her job, her husbands job, and is CONTINUING to pay the EMI – and that is not hurting at all.
4. She could give it on rent, BUT ON AN AVERAGE she received 8 months rent in a year for the past 4 years.
5. Her tenant did not do anything stupid (allowing a terrorist to stay), or store drugs or commit suicide there.
6. Her tenants have been good and paid rents regularly.
Do you realize that when it comes to investing in equities people worry about all kinds of non existent risks ALSO but while investing in RE (a show off asset) the word risk is forgotten.
So when somebody talks of brilliant returns, chuckle and check out the calculators. Or even just an excel sheet and find out the IRR.
Then also remember ” past performance is not a guarantee of future performance”….
Karthikraja
Subra ji,
Are you against Real Estate as Investment? or are you recommending Equity is better investment than Real Estate?
People buy land/house based on that even during recession we are left with some ownership. but in case of equity, company is just gone and our capital can become zero.
subra
i can only write. Understanding is optional.
Karthikraja
I understand Subra ji because there is no Fixed formula for wealth creation. Your posts are really eye opener in many ways to me. I learnt a lot from your blog and still learning ( one of the recent example is responsibility of Independent director – simply sooperb).
Whether we can get sea profit if we follow Buffet method now as he made.
Mohan
There is nothing like a best investment.
We need all in correct proportions.
Real Estate is not less riskier and more profitable than equities.
One sure thing is Real estate prices can never go beyond affordability limit of the buyers, hence in long term, they are not likely to give inflation beating returns.
You can’t sell a house if no buyer can afford it. So there is always an upper limit. This problem does not exist in equities.