I decided to pen down my thoughts on why it is such a bad idea to look at real estate as an investment class - especially first time buyers (like I was) looking at cheap (that's a relative term) investment which will magically grow once you purchase that house/apartment. Especially in the current situation. Also, especially if you are looking at buying something for 'investment' and not to 'live' in it.
I want to use my use-case for ease of explaining.
I bought a house in 2007 and sold just a few months shy of holding 7 years in 2014. Also, since I took a loan to buy the house - I did end up paying more through all these years for the interest component. Some rough calculations later - I have a number of Rs 49L for the overall ownership cost (based on loan closure). For the sake of maintaining simplicity I have not considered time value of individual loan payments which will make my overall returns worse still (not better). Considering a discount rate of 7% (inflation), here's what I see (all values in Rs.)-
Annualized return of 5% is not what you would have hoped when buying a house - would you? That quickly turns negative if you take inflation into account which hovered in range of 7 - 8% through the period. Investing in a index fund would have returned 10% annually (Jan 1: Sensex at 14,090).
Well - you may ask, what am I getting at? I'm jotting down a few mistakes I did as a real estate investor which one can easily avoid (lest I forget and make another mistake in future). Here are my top 5. I hope you can benefit from my mistake!
- I have only talked about the purchase price and sale price and not about the most important aspect - where and what did I invest in. As they say - the three most important things in real estate investment are location, location and location. Its better to invest in a property in a very good location (when you find something within means so to say).
- Avoid buying when something looks costly and indicators suggest that you are not able to afford prices being asked. Is the EMI equal to the rent you are paying currently? Are you just buying the house as an 'investment'. Buying a house which costs >3 times your annual income with a costly loan (as a thumb rule anything over 2% points over 'Fixed Deposit' rate would look high to me).
- I learnt it the hard way. The first investment should be a property to live in, not to look on. As Francis Bacon told in 1500's - "Houses are built to live-in and not to look on". Especially since any real estate investment needs 'taking care off' - it does no usually generate effort-free rental returns i.e., its better to think in terms of return on unit effort put-in; rental yields you calculate and actually end up with after expenses are quite different - its usually a modest 2 - 3%. And if you think you can increase rents 10% y-o-y think again :-)
- Investing to get tax benefits as your primary reason (especially on the first property) is not such a good idea! Its good to pay your taxes.. someone needs to pay for the roads, lighting, government running (I know.. who likes it?), etc.. But if you find a nice property to live-in and save on rent plus create a nice environment where your children grow - that is an added benefit.
- Think before you jump. Its much easier to invest in a cheap index fund or an actively managed fund or better still invest in stocks yourself which would be highly enjoyable especially if you like do some thinking behind your investments (I ended up making 21% yearly returns from 2007 until 2013; taking away 2014 which would skew the returns further since this year returned close to 78% ytd). Its a good question to ask if you are ready to make an illiquid, not-so-easy-to-dispose real estate investment!
A normal question to ask oneself: Are there metrics worldwide which rationalize price paid for housing. Well, I read an interesting forbes article a few years back. 'Income to Home price ratio' is an interesting historical indicator.. read on, here's something I picked up -
The price-to-income ratio looks at the total cost/price of a home relative to median annual incomes. Historically, the typical, median home in the US cost 2.6 times as much as the median annual income (so if the median income in an area was $100,000, the median price of a home would typically be about $260,000: $100,000 * 2.6).
A similar scenario exists in UK. A January 2014 article on www.economicshelp.org points out that "First time buyers in London are seeing house prices at a record 7.5 times average earnings. For the UK as a whole, the ratio of 4.3 is still above long term trends." Most people in Germany prefer not to own homes. Here's why: article.
In comparison, if it takes 20 - 30 years of annual income to buy a home in any tier 1 city of India, what it clearly means is that the real estate companies have priced themselves out of the market. Looking at the huge inventories built up by companies like DLF, Unitech, Purva, Shobha, Prestige, others (on top - the enormous amount of debt these companies carry).. its prudent to think again.. is it not better to wait than rush in to buy?
Finally - Is the juice really worth the squeeze?
Ciao till next time...Harsha
