Real Estate has remained the favorite Investment of Indians across generations.
I work in one of the Indian IT company. The main agenda of everyone is to reach onsite and make money. The money earned at the client location is used to buy real estate. The real estate can be in the form of land, a flat or a commercial property. The more the no of onsite trips, the more the number of real estate properties.
According to me, the only property that you should purchase is the one in which your family lives. Everything cannot be judged or weighted according to the money. This is why we will ignore the money used to buy a home for your family for the purpose of discussion.
Investing in a Second Property
Now, the problem is when people invest in second properties or flats and call them as an Investment. These second properties are very far away from being considered as good investments. I’ll show below all the calculations to prove my point.
In one of our previous articles, we had covered as to why investing in mutual funds is better than real estate. After reading that article, one of my friends was still not convinced. The observations of my friend were as below:
Real Estate is a physical asset which one can see and pass across generations Real Estate can give us Passive Income The first point mentioned above is totally an emotional one. Just because you can see and feel an asset, doesn’t mean it is the best investment. Dividing a physical asset has never been an easy task. Getting a correct price at the correct time is very tough. And if left among the family members or siblings, it is a different story altogether. I am not saying that only negative scenarios happen. But each one of us has heard many stories about disputed properties.
Real Estate as a Passive Income
The second point raised above needs more discussion and with numbers. In cities, a major proportion of the people are investing their hard earned money in buying secondary flats for the purpose of passive income.
The main points put forward by them for their investment decision is as below:
Since IT companies don’t have pension, they will help us to give passive income in the long run They can give their flats to Kids after they get married The second point above is again an emotional one. Also, it is based on too many hypothetical situations to come true for the second point to become valid.
We will discuss more on the first point. Passive Income is important in later stages of life as there would be no job or pension. We need to plan in very early stages of our lives to sort out this important concern. But, many people delay this assuming that they have a lot of time left. We will discuss a case study below to understand the returns from passive income of the real estate.
Case Study 1
I am taking a case of a person who is of age 50. He has Invested Rs 50 lakhs to buy a new flat. The flat is in an average society in one of the Metros of India. For the purpose of calculations, I am taking a period of 25 years.
In this case study, I am going to take the Best case scenario with the below assumptions:
Rent would increase continuously at the rate of 8% every year Property price would increase at the rate of 6% every year(Increase in property price has been calculated by studying the average increase in the price of 10 major cities of India. The period is for the past 5 years.
There would be no maintenance required for the apartment for a period of 25 years No property tax to be paid There would be no month where the flat is vacant Initial Starting rent is Rs 15,000 per month For the purpose of simplicity in calculations, I am assuming that Rent money is paid as a lump sum to the owner.
real estate return
As we can check from the snapshot above, the first year returns are 3.6% of the Invested amount. It would reach a maximum of approx. 6% of the property amount in the 25th year.
Also, at the end of 25 years, you would have a 25-year-old apartment worth Rs 2.02 crore. Now ask yourself one question. Would you ever buy a 25-year-old apartment worth Rs 2.02 crore?
I conclude three points from the above discussion:
Assumptions are too good to be true and there can be a number of external factors which can increase the expenses Maximum return achieved as percentage of property price was 6%And a 25-Year-Old flat in average society. The resell value of the apartment is notional. There is no guarantee that you can find the buyers at the price you want. Case Study 2
Now in this scenario, another 50-year person decides to invest Rs 50 lakhs in Mutual funds. He has heard about a facility known as SWP. SWP stands for Systematic Withdrawal Plan where every month a pre-decided amount would be credited to your account.
In this case study, I am going to take the worst case scenario with the below assumptions:
Money withdrawn per year would increase by 10% YOY The return from Mutual Funds would be 12% YOY Per month withdrawal would be Rs 15000 in the initial year Money left at the end of the year forms the Initial amount for the next year For the purpose of simplicity in calculations, the return credited and the money debited for SWP would take place at the end of the year.
mutual fund return
As can be seen from the snapshot above, the person would be having Rs 2.95 crores in liquid money at the end of 25 years. This is because his money was invested into high growing assets of Indian economy.
I conclude 3 points from above discussion:
Money withdrawn at the increasing rate of 10% would easily beat the inflation Return expected from Mutual funds at the rate of 12% is easily achievable by a combination of debt funds, balanced funds, and large cap funds Assets at the end of 25 years is purely liquid and can be easily converted to Cash Analysis: Monthly Money Paid
I would like to do one more comparative analysis on the amount of money credited per month in both the scenarios.
real estate vs mutual fund return
There is a difference of approximately Rs 45 lakhs which were paid extra in the scenario 2.
In a comparison of the Best Case scenario (Real Estate) VS the worst case scenario (Mutual Funds), the MF scenario exceeded the return of real estate by Rs 1.5 crores.
The results are pretty straightforward. Investments in mutual funds over a longer period of time handsomely beat the return of real estate.
The next time you want to buy any real estate, run the required analysis and then make an informed decision.
Buying a real estate should not be an emotional decision but a calculative and a practical decision.