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It's dangerous to invest all savings to buy a house

Last updated on: August 08, 2014 20:02 IST

It's dangerous to invest all savings to buy a house

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Housing is a highly illiquid and, by definition, high-risk market, and individuals, in general, do not have the skills to manage this risk, explains Jamal Mecklai.

Till a small (relative to my age) number of years ago, I was a pure current account guy. I didn't own a house, a car, or indeed credit cards - Pravina was appalled when we were dating that I'd pay for dinner or whatever from a thappi of notes from my back pocket. 

I was quintessentially "asset-lite" - free as the wind, here today and here tomorrow, but perhaps gone the day after. Life was a breeze that whistled through my brain and tousled my hair.

Today, things are a bit different. I have a house, a car and indeed credit cards. But we are still asset-light, relatively speaking. We go to Goa several times a year - probably 100 visits over the past 20-plus years - but we don't - and wouldn't dream of - owning a house there. 

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Image: Housing is a high-risk market market.
Photographs: Reuters

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We don't have a second car (although, to be honest, that's more a function of parking failure at our building). And life is still a breeze, although there's very little hair to tousle and even less in my brain to whistle at. 

However, as part of the great global dream, we do have another property in Bombay, which I - asset-lite and simple arithmetic scholar (rental yield at around two per cent is much lower than a standard fixed deposit rate) - want to sell, but my wife - "you never sell real estate" - wants to hold. You don't have to ask - we are holding. 

But now's my chance. I saw an article in the Financial Times the other day, headlined "Only 40 per cent of Germans own their homes".

It was seen as an oddment and the article tried to explain how it was historic circumstance that led to this strange state of affairs.

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Photographs: Reuters
Tags: Bombay

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The free-thinking and open-minded Financial Times found it incomprehensible that the rental model might actually be superior to the globally prevalent (read Anglo-American) one, where everybody owns their own home and if they can't afford it, force feed it to them (zero down payment, teaser mortgages, anyone) till it all comes tumbling down. And then ... you start again. 

Now, many would agree that Germany is the most successful large global economy. It is rich; unemployment there is - currently, at least - lower than in the United States; and income inequality is at a much saner level than in most other countries. So, clearly, if the Germans aren't falling in line with the "a home in every bathtub" model, it is worth paying attention to. 

To try and understand all this, I called one of the smartest persons I know - Nachiket Mor. He has an intrinsic understanding of how risk should be distributed in an economy, and he explained why it is dangerous and limiting for the economy for individuals to lock up the bulk of their savings in real estate.

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Photographs: Reuters

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Housing is a highly illiquid and, by definition, high-risk market, and individuals, in general, do not have the skills to manage this risk.

A much sounder model would be for real-estate risk to be managed by institutions - funded by real estate investment trusts, or REITs, or pension funds - while individuals simply pay rent. 

As it happens, real estate hasn't even been producing attractive returns recently. A National Housing Bank study of actual transaction prices in 26 cities showed that, contrary to popular perception, real estate has yielded an average of merely 8.97 per cent per year since 2007 - not much more than fixed deposits, which are, of course, much more liquid and safer. 

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Photographs: Reuters

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The situation is even more critical in rural and low-income environments. A study of 300,000 rural households by IFMR found that almost 100 per cent of assets held were illiquid - land, housing, livestock or gold.

This limits mobility, which is critical for a more dynamic economy, requires occasional borrowing at exorbitant rates, and, worst of all, exposes the poor to sometimes catastrophic risk. 

To my mind, public policy needs to be driven towards rental housing. In a city like Mumbai today, easily 15 per cent of flats are held empty as investments.

If policy were focused otherwise - say, by eliminating the mortgage interest deduction - there would be fewer investment homes, real estate prices would fall, rental yields would rise and, over time - as we became more comfortable with an asset-lite life - most people would have a larger share of their income to spend (or save), all of which would increase the velocity of money - there, you see, I can talk like an economist - which would enable stronger growth at the same level of money supply.

 Of course, "asset-lite" is my personal temperamental preference. So it's great to see that it also makes good economic sense, judging not just by the opinions of some of the smarter people I know, but also by the Germans. 

This last may be just the trick I need to convince my wife to sell.


Photographs: Reuters
Tags: IFMR , Mumbai

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