Watch out before you invest in real estate

Undoubtedly real estate has shown a phenomenal appreciation in the last decade. Despite the 2008 global meltdown, the residential market of real estate has been resilient to the extent of surpassing its pre-2008 peaks in terms of valuations and yields. Real estate as an investment is hugely supported by our Income tax laws – income/loss from house property, capital gains exemptions on reinvestments and wealth tax exemptions are few to mention. Given the demand in residential, office and retail spaces, investors living in tier-1 cities have in some way or the other allocated a decent chunk of their portfolio to real estate. In the present times the options of investing in real estate are not just directly buying the spaces but indirectly through structured deals, P/E investments, REITs, and real estate mutual funds.

However, let’s take a step back to assess why we are not poised for a similar bull run in the times to come. People who have been allocating higher proportions of their wealth to real estate across all different types of real estate need to pause to assess the risk they have chosen to live with.

The housing market has changed. Things are lot different now when compared with what they were Pre-2008 years. Builders have been struggling for capital and equity. Projects’ executions are delayed. New projects are taking way too long in clearances. Too many new builders have appeared and it takes a toll on you to verify their credential and past successes in the real estate sector. Newspaper reports these days are full of investors being duped by builders. Recent episodes of arrests of such builders for their projects in Haridwar, Ajmer, Bhiwadi etc. are few worth mentioning. Investments in new construction projects are now arduous task of verification, building trust and being patient with the money invested, leave alone the EMI burden that you carry with no rental yields until the point of possession of your property.

It is Illiquid. It takes a while to liquidate your real estate asset. If you need the money, you need to set aside at least 3-6 months to liquidate the property. Sometimes it has taken up to a year to wrap up the deal, leave alone any litigation that may arise due to poorly executed transaction thus blocking your sale proceeds. You cannot unlock a property’s value partially. Either it is sold or not sold. There is no partial redemption, like in mutual funds, to take care of liquidity needs that do not require the entire sale proceeds of your property.

It is for the long term. Whenever you invest in a property, if you are availing tax advantages, you better stayed in it for at least 8 to 10 years. It has been a store house of wealth in the past decade. Besides being a functional value, it has created wealth for millions of people in our country. And they were able to do so only when they realised that it was the tenure for which the property was held that mattered.

The allocation to real estate stays in your portfolio for long. When you sell the residential house, to exempt your capital gains from taxes, you will need to reinvest in property again unless you are willing to pay the taxes. So, if you have intentions of reducing your exposure to real estate, you may not be able to do so immediately unless you take an exit route paying capital gains taxes. These taxes can be enormous. Alternatively you can invest the capital gains in bonds (NHAI or REC) but they have a cap and give yields that don’t even beat inflation. So, if you would like to capitalise on equity bull cycles or fixed income investments in the future, ensure that you have a decent chunk allocated to other asset classes that are not real estate.

Prices have shot up more than expected. It is amazing how the realty rates have increased in last few years across the country. Although dispensable incomes have increased, property has gone beyond affordability levels for middle class families in several micro markets of Mumbai, Delhi and Gurgaon. Some analysts are calling this market a bubble in real estate. And if so is the case then we are better off watching how the industry and market responds until the Land Acquisition Rehabilitation and Resettlement Bill is passed and its impact assessed by the experts.

No doubt India is a growth economy. It is fair to assume at least 5.5 to 6% GDP growth y-o-y in the upcoming decade given the recent FDI reforms, demographics of our country, education system and some anticipated policy changes in the economic environment. And when you have such strong forces of growth, real estate if supported well will serve as an important infrastructural layer to catapult our country to new levels of development and urbanization. It is up to you as an investor and/or planner to leverage the development cycles of the nation and maintain a healthy portfolio balancing risk and returns on your investments.