The actual returns on an asset….
The assets that are easy to understand are those in which you know how much returns you are getting. So you keep a fixed deposit in a bank, the bank tells you that the FD is for 5 years and you will get 9.25% as return.
Ditto for PPF, Kvp, nsc…
However when it comes to Real Estate or Equities, the returns are not so simple to calculate. Recently met a middle aged couple who were very proud / happy with their RE investment in a distant Mumbai Suburb called Kharghar. I AM NOT COMMENTING about the quality of choice of location or investment decision, this is just an explanation of innumeracy.
So I asked them how much are the returns that they had got in that investment. The wife looked towards the husband and he said – ‘clearly about 20% p.a.’. I said during the period 2007 to 2014 I do not think that the return was 20% p.a., but let us take a look.
He had bought the house in 2007 for Rs. 35 lakhs – out of which about Rs. 15 lakhs was borrowed (and he is still paying the EMI, of course). He had paid the builder almost all the money and he got it registered in his last week.
The Math is as follows:
He had paid about 35,60,000 in 2007 to the builder and he was paying an EMI of Rs. 15000 to the lender. He paid about 3.5L in 2014 to get it registered, and now the flat is available for occupation. The RE broker has told him that at best he can expect Rs. 7k as rent (this to me is a stunningly low rent yield on current market prices estimated to be between Rs. 65L and Rs. 70L).
So how much is the return, once more Mr. S? Well your mind tells you it is 20%, but if your money has LESS THAN DOUBLED in 7 years – it is a yield of about 10%p.a.
This at a time when he has been paying EMI on a loan which is currently costing him about 11% p.a.
Rebuttals please?
Siva
What is the current Market price?
Shankar
Many people don’t understand time and price correction in RE. So thinking we are good at mental accounting, we are giving the return % from RE which are usually wrong OR not worth for the risk taken.
I used to think that for average salaried person, house should be under liability section (living in the house) and not as an asset (returns from rent and/or price appreciation).
Hari
very diff to calculate
B
Pls categorize ur articles……
Helps during re reading…
Srinivasan
Subra Sir,
I added all the costs(Price paid+EMI+Registration) so it became Rs.51 lakhs to acquire the house. Now I took market price as 70lakhs. So the actual return on is investment is only 4.63% which is less than SB a/c of Yes or Kotak bank. Can you correct if my return calculation is flawed ?
subra
Srinivasan,
the best thing is to go to Pattu’s site – http://www.freefincal.com and use the Real estate return calculator. The way you have calculated is to say YOU GOT 4.63% – ON ZERO CAPITAL – after all u did not have the money. WHAT YOU ARE NOT SEEING IS THE RISK that you took…
Raj
Srinivasan,
The risk is far greater and we are not realizing the possible impact at all. An example: Hope you are aware of the Crashed building in Chennai which is being constructed. Those who booked the apartments have paid the builder in full after taking a loan from the bank. Building crashed and the worth of the land is also questionable since it is inside a lake. They have a loan for which they may have to pay half of their monthly Salary as EMI, BUT DIDN’T GET ANYTHING IN RETURN.
Srinivasan
Subra Sir,
Your one liner is correct. I should take only 20lak+3.5lakh as initial investment as rest is borrowed. I did the calculation assuming property sold after 7 years for 70lakhs and 15lakh+interest = 29lakh(10% rate) is paid after sales. So anyways this is also quick dirty calculation, return on investment comes to 8.19%, which is like FD rate. Thanks for your link to Pattabiraman sir very useful website. I have bookmarked it. He makes some very valid assumptions, but still leaves appreciation rate to audience, which can cause bias.
Raj, the kind of risk you state is very huge and probability is very less. Yes the buyers of the flat were demanding loan waiver for their purchase, very pitiable and sad state indeed.