Real Estate - is it a good time to Invest?
Real estate is a favorite asset class for a lot of investors in India. However, is it a good time to invest in a real estate?
In the current market, most of the real estate transactions are being completed by the end-user. Real estate prices escalate when ‘investors’ (and not the end-user) are in the market creating artificial supply constraint and putting upward pressure on the real estate prices.
Let’s understand why real estate has always been a ‘hot asset class’.
The previous generation in India has created wealth primarily by investing in hard assets such as real estate and gold. The same generation recommends buying a house for the new generation.
As the income increases, often people tend to buy a home. The thought process is that if the funds are allocated in real estate, they have taken appropriate action of allocating cash in an asset. Since real estate investment requires a lot of funds, only a down payment is made and the rest is in the form of home loan.
Often people associate buying a home as asset creation but in reality, it may be just a liability. Over the last decade, real estate prices have not increased by 10% per year. However, the cost of home loan has been between 8.5-10% per annum.
An additional reason why people invest in a real estate is the tax benefit.
Investment in real estate could give you tax benefits, such as Sec 80C of the Income Tax Act, provides a deduction for principal repayment on housing loan during the year to the extent of ₹1,50,000. Additionally, the interest component of the loan gets a deduction of ₹2,00,000.
If the amount of loan is less than Rs 25 lakhs, you may reap the full benefit, beyond that it will be only ‘cost’.
Investment in real estate can diversify an investor’s portfolio other than holding stocks and bonds. Although real estate comes with a serious liquidity constraint, investors may associate real estate investing safe but reality may be different.
Rental income is one of the reasons that people invest in real estate. Often rents catch up with inflation and can provide inflation-adjusted income. Unlike, the west, in India, rental yields are low and are often in the range of 2.5%-3.5% per year. Taking a home loan at 9% p.a. for a rental yield of 3% p.a. with the hope of property price appreciation may not be a good idea.
An alternate to investing in a real estate is Real Estate Investment Trust.
Real Estate Investment Trust (REIT) is a trust where the aim is to channelize the funds that could be invested into owning a real estate property to create income for the investors.
REITs, provide an opportunity for investors to hold shares in the real estate sector and in return generate returns. A few years back REITs were launched in India. The expected return was indicated around 9% p.a. Given the pre-tax return of around 9% p.a., investors were left with asking for more. Popularity of REITs in India will still take sometime.
When is the right time to buy real estate?
Low-Interest rates – With consecutive cuts, RBI has brought the repo rate at 5.40%. Repo rate is the rate at which commercial banks borrow from RBI. The rate, at which banks lend to people, depends highly on Repo Rate. This rate is directly linked with how much you pay for a home loan. Lower the repo, lower is the mortgage rate.
Rental Yields – Rental yield is simply the annual rent on a property divided by the price of the property. As the rent increases and/or price of the property decreases, rental yield increases.
Let’s take an example of a property in Gurgaon. It’s a famous DLF project, Hamilton Court.
The cost of a flat in Hamilton Court is around Rs 2.8 crores and it has not changed since the last few years. In Jan 2018, the monthly rent was Rs 50,000 per month but in 2 years, the monthly rent has increased to Rs 65,000 (30% increase in rent).
The rental yield has increased from 2.14% to 2.80% in two years. Repo rate has reduced from ~8% to 5.4%.
The right time to invest in a real estate is when the difference between rental yield and the repo rate is minimal. We still have to wait before any investment in Hamilton Court maybe justified. Please note that this assessment has to be done at a project level.
Usually a real estate cycle is around 15 years. We saw mortgage/repo rate close to rental yields in 2005. Let's hope the revival in real estate starts from 2020.
Keep a watch on the rental yield of the property you want to buy and the repo rate.