In
the mid-nineteenth century, our forefathers didn't have many options
for investment. There were only bank deposits, postal savings schemes,
gold and real estate. After the emergence of the stock market, very few
people used to invest in equity shares. Real estate has been the
perennial investment favorite of our forefathers. Some people have also
inherited properties and probably have not sold them yet, and held on to
them, as they could be good for capital appreciation.
Today, a
lot of things have changed. After globalisation, we have a number of
investment options open to us like mutual funds, bonds, PMS, ETFs,
international funds and other alternative investments but still we see
people investing heavily in real estate. Why do people invest in real
estate?
Capital Appreciation
Majority of the investors have a belief that 'property values never fall'. This statement is true to some extent, since historically, in the last 23 years, property prices have fallen only during the period of 1999 and the prices recovered by the year 2004 (as per the data from Ready Reckoner - Mumbai). The primary reason for any kind of investment is appreciation. In the last four tofive years, the real estate sector has performed extremely well and has given superlative returns. These have attracted investors and also, there is less volatility in property prices, as compared to equity investment.Regular Income
Ready to occupy properties can be leased and you can earn regular rental incomes. Rental income is another attraction, since you earn regular rents that add to your income, along with capital appreciation. Usually, investors increase the rent annually by 8-10 per cent. The net rental income, what you get in hand is less of taxes and maintenance and other operating costs. Though, there is a regular rental income, there are chances of a vacancy for certain periods due to poor market conditions.Easy availability of debt capital, is a lumpy investment. If you do not have sufficient funds to buy a house, you can take a home loan for the balance amount. Today, home loans are available at the rate of 10-11 per cent pa, from banks and housing finance companies (HFCs). Investors take a home loan to increase the return on property investment. As long as the investment (ie property) return is greater than the interest paid to the lender (ie home loan interest rate), there is positive leverage and thus, the overall return magnifies. So, with the help of leveraging, you can take the benefit of price appreciation in property prices, by contributing only a certain sum of money from your pocket and the balance amount by taking a home loan. Leveraging is one of the key benefits, for real estate investment over other investment instruments, since you cannot leverage for investing in mutual funds, fixed deposits (except for Futures and Options, where you can leverage but they carry high risks).
Diversification
As it is said, you should not put all the eggs in one basket. You must diversify your investment portfolio and not go overboard on a single asset class. Lower the correlation (price movement of two assets in the same direction), greater are the diversification benefits. The real estate market is considered to have a very low correlation with other asset classes like equity and debt i. real estate prices are not affected by the price movement in equity or debt markets and vice-versa. Thus, real estate, as a component of your overall investment portfolio, helps you reduce the overall risk and diversify your portfolio.Inflation Hedge
Just like gold is considered as a hedge against inflation, similarly, real estate is also considered as a hedge against inflation; which means, property prices and lease rents increase as the inflation increases at a similar pace. This helps you earn real returns (ie net of inflation).
Every coin has two sides; similarly real estate investment also has its
pros and cons. Real estate attracts high tax on rental income as well as
appreciation on sale of property (capital gains), poor liquidity and
uncertainty of lease renewal when the lease expires. Real estate
investment (except land) has both, bond-like and stock-like
characteristics. Lease rental payments serve as periodic fixed coupon
(interest) payments like bonds and price appreciation like shares, which
depend on the state of the overall economy. It is important to review
your real estate investment periodically and maintain appropriate asset
allocation. Diversifying your portfolio with real estate investment is a
good strategy but you should not have a real estate heavy portfolio.
Published in: Times Of India - Times Property
