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Monday, July 17, 2017

Why real estate is not a good investment right now

By Babar Zaidi
Investments in property have earned insipid returns in the past few years. Find out why this trend is likely to continue for some time.

Home loan rates are down, property prices are stagnating and the new Real Estate (Regulation and Development) Act (RERA) promises to safeguard the buyer against delays and frauds. 

If you go by what real estate developers, housing finance companies and property agents say, this is the best time to invest in property. Or is it? 

A recent research report by consultancy firm Knight Frank shows that home prices in eight major cities rose very tardily in the past three years. 



In some markets, including the National Capital Region (NCR) and Kolkata, property prices have actually come down since 2014. Of course, this is not true for the entire real estate market. While prices have come down in some markets, some cities have witnessed a consistent rise. Within cities too, some pockets have done poorly, while others have flourished. 

This is why ET Wealth assumed four different growth rates to see what investors can gain from real estate. We assumed that the  buyer would put a downpayment of Rs 10 lakh and take a home loan of Rs 50 lakh (at 8.5%) to buy a property. Another Rs 6 lakh would be spent on legal costs and registration, taking the total cost of property to Rs 66 lakh. 



How much will you earn from real estate 
Returns from property will depend on the expected rise in prices and could vary significantly across locations and cities. Here’s how much buyers would earn if property prices are assumed to rise at four different growth rates. 

Why real estate is not a good investment right now

Assumptions: Buyer in 30% tax bracket. He earns monthly rent of Rs 10,000, which will rise by Rs 1,000 every year. Buyer also claims Rs 2 lakh deduction for home loan interest. IRR formula used for calculating returns. Home loan EMI is Rs 43,391 for 20 years at 8.5% 

How much would the same investment in other asset classes be worth 


Why real estate is not a good investment right now
In five years, the property will be worth 

Why real estate is not a good investment right now
Net gain for the buyer and returns earned 
Why real estate is not a good investment right now
In 10 years, the property will be worth 
Why real estate is not a good investment right now

Net gain for the buyer and returns earned 
Why real estate is not a good investment right now

We then looked at the situation after three years. If the property prices rose by 3%, the investor would be in Rs 7.86 lakh in the red. Even though he earns rent (Rs 10,000 a month increasing by Rs 1,000 every year) and claims tax deduction (Rs 2 lakh) on the home loan, he pays 8.5% on the loan while the asset grows at 3%. 

What would the investor have earned had he chosen to buy gold? Instead of the downpayment and legal costs incurred on buying the property, had he put Rs 16 lakh lump sum and a monthly investment of Rs 43,391 in a fixed income option that earns 6%. 

Similarly, if property prices rose 9-12%, the investor would make money but still have less than what he could have earned from hybrid funds or equity schemes. As things stand, property prices are not likely to move up too much in the next couple of years. 

The Knight Frank study does not paint a very rosy picture. The huge number of unsold units (more than 1.8 lakh in the NCR) and the long time taken to sell a property (up to 35 quarters in Faridabad) are worrying signs that point to a dull future. “Property is not likely to move up significantly in the next 2-3 years,” says Gulam Zia, Executive Director, Advisory, Retail & Hospitality, Knight Frank . 


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