Should Real Estate Be A Part Of Your Portfolio?
We all have our own unique mindsets, ideologies, and preferences when it comes to our money. Whether it’s how we earn, how we spend and how we save, our priorities are different. But over the generations, one thing has remained largely a common interest for most of us: real estate. It has been part of many people’s portfolios and remains one of the most popular investment vehicles in our country with a deep emotional attachment. Indeed in a recently published study, India recorded $ 2.4 billion in real estate investments in the first half of 2021, up 52% year over year!
This number is also evidence of how popular real estate is in our country. But like other asset classes, real estate has its own ups and downs. Have you ever wondered whether it is worth investing your hard-earned money in this otherwise popular asset class in the form of real estate? Read on as we dig deeper and see if it makes sense to consider real estate as part of your portfolio.
Returns on real estate
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One of the most important determinants of the return on an asset class is which investments are selected within that asset class, the time and the duration for which the investment is held. So when choosing a location and project to invest in property, keep in mind that returns vary widely depending on location and market cycle, and since transaction costs are higher, a property change is almost impossible without the initial decision turning out to be the right one, which increases the odds to either sell it at sub-optimal prices or hold onto it for considerably long periods of time.
Plus, it’s more difficult to measure returns on real estate, unlike other investments like equity funds, which have benchmarks to weigh against. In real estate, certain cases in certain locations across the country have had far higher returns than others in land, residential, retail and commercial space. Usually the house price index is considered in the real estate sector. According to a recent study carried out in the third quarter of 2021, the house price index (change in the average price of properties under construction and ready-to-move-in) rose 0.3% for the whole of India in the third quarter of 2021 compared to the previous quarter.
But with all of this, the silver lining may be that selling the property isn’t the only way to make money on real estate investments. Let’s not forget the value of the rent or lease. With real estate, you have the option of leasing or renting the property. In this way, as the value of the property increases, you can regularly generate additional returns and at the same time not lose ownership of the property. Keep in mind, however, that the rental yield in India is on the downside, only hovering around the 3% mark.
Also read: Does it make sense to buy or rent a house?
Liquidity in real estate
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One of the main benefits we expect from our investment, especially one as large as real estate, is liquidity. The sooner you can liquidate the investment, the better. Here, real estate falls behind many asset classes. It is indeed a long and time consuming process to liquidate your real estate assets, especially at a good price and in the short term. It’s nothing less than a tedious process, which makes it a less reliable investment when money is urgently needed. Hence, liquidity is one of the main reasons you should think twice before investing your large part of your hard-earned money in real estate.
But if you’re willing to wait and see and stick with the long term, real estate offers quite a bit of potential and can prove to be a great asset, especially when other factors such as market demand, location advantages, etc. are cheap.
consistency
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Another important aspect to consider before investing in real estate is studying its consistency. Contrary to the myth that real estate investments get better over time, the truth is that these investments are very inconsistent. In fact, the development at your location does not increase the value of the property. Despite the development, the value may not increase, or worse, even decrease, due to increased traffic or poor accessibility to the city. So, before you step into a property and decide to invest, make sure you have studied in depth the scope of growth in the near future.
Quantum and easy investment
Funding levels play a crucial role when it comes to investing your hard-earned money. With real estate investments in particular, you would have to spend a huge amount of money to own a property. While you can take a home loan to accomplish this goal, even that would require at least 10-25% of the cost of the property as a down payment, which in most cases is in the hundreds of rupees. However, in case you do intend to rent this property, this rental income can be helpful in paying the EMIs of the home loan. This is how you reduce your financial burden.
Let’s take an example to check this.
Cost of the property- Rs 50 lakh
Home loan amount (assuming an LTV rate of 80%) – Rs 40 lakh
Home loan interest rate (assumed) -Rs 7% pa
Home Equity Loan EMI Amount – Rs 35,952 (for a 15 year tenure), Rs 31,012 (for a 20 year tenure), and Rs 26,612 (for a 30 year tenure)
Rental yield (assuming 3%) – Rs 15,000
Even if you take the longest 30-year tenure to bring down the amount of EMI, you will likely still be spending a sizable amount out of your pocket per month to meet the EMIs. However, remember that all of this is based on general practice and the expected rental return, interest rate, etc. When making a decision, be sure to make the appropriate calculations and then decide whether or not to buy the property.
Litigation
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As a real estate investor, you don’t want the investment to be embroiled in a lawsuit or litigation. History bears witness to countless real estate litigation that has dragged on over a long period of time, which proves to be a tedious task and experience for the investor despite the endless amount of hard-earned money invested. All of these cases and litigation can not only burden you financially and psychologically, but can even lower the value of the property and lower the returns it generates. Therefore, always try to ensure that the property, title deeds, etc. of your property are clean and free from disputes, both now and in the past.
After carefully considering all these parameters, the decision regarding a property rests on the shoulders of the investor. After weighing the pros and cons of investing your hard-earned money in real estate, especially for investment purposes, remember that any hint of uncertainty and regret in this case can jeopardize much of your decade-long savings from the vast amounts of money that come with related to this asset class. So be confident in your decision when adding real estate to your portfolio.
The new way to invest in real estate – REITs
First introduced by SEBI about 5 years ago, REITs are a relatively new but promising investment vehicle for investing in commercial property without buying the property directly. REITs are companies founded with the primary purpose of channeling the funds invested in various income generating commercial properties. Given that many people do not have the funds to buy real estate, even with loans, REITs can be a boon to them as they allow small amounts of money to be invested and allow investors to take partial ownership of a commercial portfolio acquire real estate investments. In addition, with the compulsion to invest at least 80% of the portfolio in completed, profitable projects, 90% of the income must be distributed to investors in the form of dividends, only 10% of the total investment must be made in real estate under construction, a must about have an asset base of at least Rs 500 crores and NAVs and capital portfolio must be disclosed and updated twice every fiscal year, REITs are well regulated and promising investment vehicles in India.
And much like mutual funds invest in a wide range of stocks like stocks, debt, money market instruments, etc., REITs invest in commercial real estate. Mandatory listing on the stock exchange, REITs can be a great way to invest in the real estate sector, which has been one of the most popular investment options in our country for many decades.
Right now it is ideal to view REITs as a tool for steady income and moderate capital appreciation. Remember, however, that factors such as increasing rental yields, increasing occupancy of vacant properties, adding new properties to the portfolio, etc. can also lead to higher returns on REITs. Additionally, REITs have the ability to bring a breath of fresh air to your portfolio and, with their market maturity in India, they certainly offer a glimmer of hope and improvement in the years to come.