Real Estate gave Lower Returns than Mutual Funds or Equity

While writing about the prosperity of the black money declaration scheme, a research analyst referred to the collapse of real estate as a ‘viable investment option’. The analyst was opposed by people carrying the idea of real estate not merely being a great investment but the only viable investment option.

A prominent Delhi-based real estate developer claimed that every wealthy person in Delhi had become rich through real estate. While such a claim was unverifiable and rhetorical, it could be argued that rich people purchase a lot of property and the price of that property rises. Many people have second apartments, purchased as an investment on a loan which was being repaid with some difficulty out of a salary. The apartment now was worth some number of crores but was practically unsalable and rental yield was a ridiculous 1 per cent or so a year if one could find a tenant. Real estate ‘investors’ of this category have been asking themselves uncomfortable questions, though they haven’t yet been prepared to accept the obvious answer.

The problem blinding everyone is that there are a plenty of anecdotes of people of past generations doing amazingly well out of real estate. Everyone knows families who owned a house bought 50 years ago, which when sold after decades, made them rich. The problem with getting inspired by this is that the entire model of real estate value creation has metamorphosed or changed.

There are 5 Sources of Real Estate Value Creation:

• The legal `state change’ from agricultural or unutilised land to residential or commercial.
• The creation of a physical environment that makes the real estate usable which comprises construction and infrastructure.
• The improvement or enhancement in actual livability as an area becomes completely populated and gradually comes into the mainstream.
• Inflation and economic growth over a particular period of time.
• The periodic booms and manias and slumps which impact real estate.

In older days of investing in real estate, you bought a plot of land in an area that was substantially underdeveloped, and over the next 20 to 30 years, you could capture all the value created under numbers ‘2 to 5’ above. Things have been way different in the last 10 years when real estate investors have purchased apartments. In this novel model, stage ‘1 and 2’ are completely taken over by land acquisition agency and the developer between them. However, by creating enormous hype around real estate, engineering massive price inflation and high-pitched marketing, developers have captured lot of future value accretion which would happen in stage ‘3 and 4’.

As a buyer, you’re told that one day the area in question would become the next central Delhi or south Mumbai and you should pay money for a future price right now. Many did so and now have a long wait. Some of this excitement about the incredible long-term returns of real estate sprouts purely from ‘mathematical illiteracy’. One of the people spoke to the research analyst about a piece of property in Mumbai whose price multiplied 100 times since the mid-60s. The person probably didn’t realise that this was a rate of return of barely 9.7 per cent a year, the analyst concluded.

Source: www.dynamiclevels.com