Around 6 years back I wrote an article that talked about how buying an apartment for 90 Lakhs is not an investment and its associated risks. This was one of the most popular articles on my blog and was one which had 100+ comments on people arguing with me how I have got it all wrong and that real estate prices would never correct in India( the comments are lost after i moved from one hosting provide to another). It was as if I had attacked the strongest beliefs of people. Given that the last article was written in 2013 I thought it would be prudent to relook at this. Don’t go by the headline, suggest that you read further to get the basic facts right.
To keep the numbers clean and straight forward I am making the following assumptions to build the story again.
- The cost of an apartment in any city in India is around 70 lakhs. + 5 lakhs interiors (again conservative numbers)
- Assume that the apartment is funded by using the loan to cover 70% of the value.
- Going with a very conservative estimate that 30% of the value of the house is funded out of savings (normally not true as this too is funded by other types of loans).
- Loan tenure is around 20 years thus the EMI would work out to be Rs 45,561 using an interest rate of 8.5% ( Loan amount 52.5 Lakhs -70% of 75 lakhs).
- Rental income from this property has been taken as zero because it is assumed that you are staying in the same place.
What is the actual cost of the apartment?
One of the biggest mistakes which people make when looking at the cost of a home/apartment is they tend to ignore the cost of finance of the home when calculating the value of it. This is the interest that you have paid for the home loan and is not included in calculating the returns on the home purchase (will not call it an investment).In the above example, the total cost of the house at the end of 20 years is 22.5 lakhs ( your share of investment) + 52.5 lakhs (loan) + 56.84 lakhs of interest on the housing loan. Thus the cost of purchase of an apartment is 1.31 CR and not 75 lakhs. So one needs to consider this number to determine the actual returns on the investment. Till now we have established the basic facts on how much a house/apartment actually costs. Now we need to build a comparison with an alternative investment to see how much return we need to be able to make in order for it to be justified as an investment.
Comparative investment bucket
To make this comparison simple and direct I am choosing to go with an index fund for investment. This then removes the additional effort which one has to put in selecting a stock or a mutual fund and also the chances associated with it. An index fund is a passive investment management product where a fund house just mimicks the equity index by purchasing the index constituents in the same proportions as the stock’s weight in the index. This means that as an investor all you have to do is stay invested in the index fund and the fund house takes care of the work required to buy and sell stocks as and when index weights change. The assumptions in creating the alternative bucket for comparison is given below
- Taking the Sensex returns for the last 15 years, the Sensex has moved from 5193 (August -2004) to 37387 (August -2019). I have not considered returns for the last 5 years as the returns are even better. Based on the CAGR returns of Sensex comes to 14 %. Assuming that the next 20 years will not be as good due to the declining interest rates I am taking a conservative return of 10% for the next 20 years.
- The investment bucket would consist of the following – 22.5 lakhs of money that you would have invested for the home loan equity component. As this money is available right now it will need to be invested in an index fund right away. We will consider that you would do SIP of Rs 45,561 (Home loan EMI ) for the next 20 years with returns of 10%.
- Thus the 22.5 lakhs invested would be 1.39 CR after 20 years and the SIP would be worth 3.45 CR, thus with this approach, you would have 4.84 Crores.
Comparing the two asset classes from ROI and other risk factors
Even with a conservative assumption of 10% returns we see that going with the SIP for an index fund in India( may not be true for other countries), we will be able to amass around 4.84 Crores of money. Thus the apartment would have to yield at least 4.84 Crores ( on investmet of 1.31 CR) to be better than investing in an index fund. Given the past performance of the real estate, this outcome is very much possible but one needs to understand that things have changed a lot in the last 4-5 years which would mean that this time the real estate may not move as it has in the past.
- A lot of the increase in real estate in the past has been driven by black money parking but the last 3 years seems to have taken the wind out of this activity leading to over 1.4 trillion Rs of inventory which is unsold. Due to this a major trigger for growth in real estate prices is not valid and with more reforms happening this is unlikely to go back to previous levels and make take 5-10 years to stabilize before a movement at all.
- With rental yields at 1-2% of the value of the property and a weak secondary market, we may not see money flowing in for investments like earlier. This means another leg of supply has been cut.
- The resale value of apartments after 20 years. We have always been mesmerized by the value of apartments going up due to what we see in Mumbai. But do check out the apartments built around 20 years back and you see that the style and preferences have changed due to which it may not be easy to sell the apartment after say 15 years. If the purpose is an investment you should invest in an asset that can be easily liquidated and not one where one has to wait for 1-2 years for buyers.
- Lastly one needs a have a home to take care of staying in your later years (when you may not be earning regularly). Thus one cannot look at an investment in a home and consider it as an investment for future returns because eventually, you would need a place to stay so this is not as an asset for sale.
Buying a house is an emotional decision
I am not building an argument against buying a home but the main point which I am driving is that buying home is to meet the emotional need for security. This is a deep phycological need and one should surely plan to buy/own home as it protects you against future needs (say after 50 years). But we need not muddle this emotional requirement with that of the financial requirement building a corpus for future needs. As a generation, we have got too carried away with the bull market in real estate from 2003-2012 which saw returns of more than 5-10x but this does mean that it will repeat again in the next 10 years. With more reforms and regulations coming in we will see that it will become impossible for black money to flow into the real estate and this the prices have to moderate. Thus one needs to plan for investing in other assets apart from buying a home and one need not leave under the false impression that buying an apartment means that you are investing for your future.
The suggestion is thus to look towards the stock market which has a much longer history of giving more than 17% CAGR for at least 40+years ( Sensex returns to date). With the growing popularity of index funds from trusted companies like HDFC AMC it has become a simple choice to invest in them without having to worry about stock selection. In fact, the most successful investor of all-time – Warren Buffet recommends that investing in an index fund is the best way to beat many investment professionals and it is the best asset that a novice investor can invest in.
If you have further questions on this I would be happy to answer and help. Please send me an email at avinashmkb78(at)gmail.com.