Does it make sense to invest in real estate?

# Does it make sense to invest in real estate? ## Why real estate? Real Estate can be a powerful asset class to own by yourself if can satisfy atleast some of these criteria 1. You have a networth enough to comfortably cover the EMI or have purchased a property with cashflows enough to cover the installments. Do note this includes the amount you need to pay down payments as banks will require a percentage of the property value to be paid as down payment before they sanction a loan 2. An addendum to the previous point - the property you intend to purchase has some notable value such as being near a famous college, near a commercial locality or is very accessible. 3. You have the right sort of connections or manpower to defend your property (especially if it is land in an area you do not live in presently) against trespassers/encroachers and legal troubles ---- For the sake of this article, we are not counting your primary home as that's an asset you purchase for your own consumption ie to stay there as opposed to an investment. In a way this is similar to jewelry. You will not benefit from cashflows (apart from savings on rent) or appreciation unless you sell. ---- ## The Case against Real Estate 1. Unlike stocks and bonds, real estate is an illiquid asset that takes time to liquidate and the process can take time and money even once you have found a buyer 2. If your goal is chasing rental yield, then it is very unlikely that you will manage to beat even FD returns. The average year hovers between 2-3%1 in most major cities | City | Rental Yield | | --------- |:------------ | | Delhi NCR | 2.84 percent | | Bangalore | 3.66 percent | | Mumbai | 2.70 percent | | Ahmedabad | 3.13 percent | | Chennai | 2.99 percent | | Hyderabad | 3.22 percent | | Pune | 2.86 percent | 3. Rental yield for commercial space hovers around 5-12%2 but these are out of reach for most investors, the best way for retail investor to get such yield is to invest via REITs. 4. Finding tenants, renovation of the house is nice for the first time but tends to become a pain in the butt for subsequent attempts(which might lead to no tenants for a substantial amount of time) 5. Renovation,property taxes and annual society maintenance bring down the yield. ## Return on investment And the main reason why I hate real estate and very few people take this into consideration is "ROI on your real estate" - Let's assume you buy a flat worth 80lakhs. You give 20lakhs as down-payment and take 60 lakhs as loan with 6.8% (2021 home loan rates) interest for 20yrs. **So in short you are investing 1.3Cr total(over the years) for a property of 80lakhs**. | Item | Cost | |:-------------------------------------------- |:----------- | | Down payment | 20,00,000 | | Loan amount | 60,00,000 | | Interest Rate | 6.8% pa | | Interest Amount | 49,92,090 | | **Total Amount Payable** | 1,09,92,090 | | **Total Amount Invested(Loan+Down Payment)** | 1,29,92,090 | - **Now lets rent it for 20yrs with rental yield at 2.5%(with initial valuation) with rental inflation at 8% and that comes to be at 91Lakhs over 20yrs.(Best case scenario where flat is occupied for whole 20years and constant 8% inflation on rent)** | Year | EMI(per month) | Rental income(per month) | |:---- |:-------------- |:------------------------ | | 1 | 45,800 | 16,700 | | 2 | 45,800 | 18000 | | ... | ... | ... | | 14 | 45,800 | 45327 | | 15 | 45,800 | 48953 | - Now we can talk that you can tax exemption of upto 1.5Lakhs Rs per year under 80c and there is no limit on tax ememption on interest payment. - You can also get deduction upto 2Lakhs when you claim for Section 80EE and Section 80EEA per year if your property qualifies for it. - As you can see in above table that out of 20yrs loan period, **it is at 15th year when your rental income itself can cover the EMI of the house**, so your dream of living on rental income would take alot of time. And one more point can be made that if you are trying to live on rental income only then i dont think only one rental unit would complete your dream. You will need more units and that will again skew the maths. - Now suppose we sell that home after 20yrs at double the amount that is at 1.6cr(double of 80lakhs initial price of flat). But due to indexation, your property's cost will reach upto 2.5Cr Rs and you can show 1.7Cr Rs as loss in ITR and set off those losses in subsequent years with other LTCG. ## Conclusion ***Investment of 1.3Cr(over the 20 years) gave you return of 2.4Cr(over the 20 years removed LTCG) and do you know what was the CAGR on this investment???(just pure returns not considering deductions)*** **3.32% CAGR** > Even if we use real calculus to solve all these equations then also i dont think CAGR will reach upto 5-6% even in the best case 3.32% CAGR is low compared to many other asset classes we know about. >If you want the status that I own 10rental units and work all days even after retirement then go ahead buy those properties and think all day about real estate. It might work for you >If you just want the rental income and no status and baggage with it, go with REITs Just buy it from exchange and enjoy your whole rental income with all hassle done by dedicated "fund managers" * With respect to taxation, Real estate is awesome due to so many deductions and LTCG loss which you can use to set off other LTCG gains. * But problem with real estate is that most people talk in numbers more than percentage. * Investors say "I get 40k per month as rental income", "I got 1cr profit when I sold my flat". But absolute numbers are not a good way to understand profitability. * If people want to buy real estate for Investment then they should talk in CAGR, like I get 2% CAGR on rental or 4% CAGR after selling this property * If people start thinking about real estate in terms of profit in percentage over time then they might realise how other assets are better in return with lesser efforts. ## TLDR - Don't rely only 1 rental unit - *There is a huge difference between "Doubling your invested amount in 21days" and "Doubling your invested amount in 20 years" Thats why CAGR matters* ### Footnote 1. https://www.99acres.com/articles/why-is-rental-yield-one-of-the-lowest-in-india.html 2. https://www.financialexpress.com/money/commercial-property-an-emerging-asset-class-for-investors/2149579/