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Is real estate really the best investment? Read this!

May 21, 2014 10:26 IST

Is real estate really the best investment? Read this!

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P V Subramanyam

You would be a fool to expect 200 per cent returns every time you invest in real estate. More so, when you don’t count the risks engaged in such an adventure

I regularly get calls from people wanting to invest in real estate. Some of these callers are perfectly good investors, understand IRR (internal rate of return), risks, returns, etc. However, they also get blinded when they hear something like this.

So how 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 (200 per cent) from the original price."

Me: Have you calculated the return?

"No sir... something like Rs 9 lakh was the buying price, now it is almost 25 lakh, not bad, is it?"

Me: Sure will you please use excel 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 per cent, and I am assuming that Rs 7 lakh was borrowed at about 12 per cent per annum from HDFC (oh, I am so happy for myself, thank you), your aunt took a term insurance of about Rs 10 lakh by paying 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 (which investors in real estate must also weigh in before getting a high on the kind of returns one can make) 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 (thank god! This is so rare nowadays).
3. She had her job, her husband’s 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 like store drugs or commit suicide there.
6. Her tenants have been good and paid rents regularly.

Do you realise that when it comes to investing in equities people worry about all kinds of non-existent risks also but while investing in real estate (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'.


Photographs: Dominic Xavier/Rediff.com