He took a plunge with just Rs 55,000 eight years ago. Today, his investments are spread across residential and commercial property and agricultural land, creating substantial wealth for him.
As Amitabh Bachchan spoke these lines from the 1975 Bollywood classic Deewar, the legend of the ‘angry young man’ grew bigger than ever before. But, for a moment, if we take the liberty of interpreting the then prevailing economic and social realities reflected in the film’s storyline, we find that Vijay, the character played by Bachchan could invest in real estate only with his ill-gotten wealth, while his honest younger brother, can only boast of having his mother by his side.
Today, thanks to the sweeping economic changes that India has undergone due to two decades of economic reforms, people with regular jobs are not only being able to save and buy their first homes in their late 20’s or early 30’s, but also service the home loans. But more than that, people now have the wherewithal to view real estate as a vehicle for wealth creation, supplementing their investments in stocks, equity funds and gold, among others, for future goals such as kids’ higher education and retirement.
If affluence created demand for housing and pushed up home and land prices and created billionaires overnight, such as real estate major, DLF’s K.P. Singh, when his company got listed, it also spawned numerous real estate investors, such as New Delhi-based doctor T. Chandan, 38, who has been investing in real estate for the past eight years. He took a plunge with just around Rs 55,000 and, believe it or not, today his investments are spread across residential and commercial property, and agricultural land. He has even invested in land near Lansdowne in Uttarakhand, where he plans to start a resort one day.
You might argue that, along with gold, land has been a favourite asset class among Indians traditionally. However, what has changed in the last decade and, more so in the last 5-6 years, is that real estate investing has got democratised. If people with silver spoons in their mouths, marrying into money, having accumulated ill-gotten money could invest in real estate or in some cases a lucky few managing to do so at the fag end of their lives, now people like you and Chandan can do it in your salad days.
But if you think that real estate investment is a fairy-tale ride, you are in for a rude shock. For, like any other asset class, this sector also has its share of ups and downs. Chandan, too, burnt his fingers when one of his investments in Delhi-NCR didn’t go according to plan. He says: “I am still waiting for refunds from that investment.” In this cover story, we look beyond just owning a house to live in and tell you not only why you should be making realty investments, but also help you examine threadbare various real estate investment options.
Why Real Estate
The last 20 years or so have seen the real estate sector grow from strength to strength, barring two phases—1995-96 and 2008-09 when the markets crashed. Government initiatives, such as tax incentives on home loans and availability of these loans at attractive rates, have given the residential property market a boost. This is even more true for residential property. Says Berinder Sahni, associate director, Investment Services, Colliers International, a real estate consultancy firm: “Considering India has a shortage of 22 million houses, residential property is a relatively safe asset class.” As for commercial property, the boom in the IT/ITES sector has acted as a major catalyst. As the Indian economy continues to grow at a healthy rate, things will only look up for the commercial property space in the long run, despite the fact that prices are subdued right now in major markets due to the availability of a huge supply. What’s more heartening, the boom in the real estate sector is limited not just to the Metros, but has also permeated into tier-II and tier-III cities.
Returns. The total returns that investments in this sector offer (capital appreciation+rental yields) are second only to equity in the long run. Affirms Pranay Vakil, chairman, Knight Frank (India), a real estate consultancy firm: “The return numbers that this sector throws up are pretty respectable.” Adds Jai Mavani, executive director, PricewaterhouseCoopers India, a consultancy major, “Returns from real estate have been better than investments in fixed deposits and gold in the long run and are second only to equities.”
The Expert-Speak
While investment in real estate has its attractions, like any other asset class, there are risks associated with it. We asked experts to rate their investment priorities within the sector. Being the tricky space that real estate is, some experts shied away from giving their priority listing. Here’s what those who did agree to share their views with our readers had to say
The roadmap
Before you decide to take the plunge, you need to have a closer look at the current scenario. First, let’s consider the residential property market. Warns Vakil: “This is not the right time to invest in residential property.” This statement holds true especially for select locations in mature markets, such as Mumbai and Delhi-NCR (barring Noida). This is because if you buy a property in any of these markets at current prices, the likelihood of capital values going up is remote. In fact, prices may correct in the near future. Says Akshaya Kumar, founder & CEO, Park Lane Property Advisors: “Capital values in the residential property market are expected to remain flat in the next 9-12 months. They could even fall by 10-15 per cent in select locations in Mumbai and Delhi-NCR.” Seconds Aditya Verma, COO, Makaan.com: “From August onwards, there will be buying opportunities.” But while prices are expected to correct in the very short-term, capital values are expected to go up over the next three years. Experts also believe that interest rate on home loans may not harden too much.
Coming to commercial property, experts believe that the correction that was due has already happened. Says Kumar: “If you buy now, you can expect capital appreciation of 5-7 per cent in the next 12 months. And over a three-year horizon, the outlook looks good.” There are two ways in which you can invest in real estate. First, by taking a direct exposure. This would mean a direct investment in a property of your choice—be it commercial, residential or even plots of land. The second option would be taking an indirect exposure by investing in income yielding assets, or through the private equity (PE) route. Your choice would depend primarily on your risk appetite and the amount of investible surplus you have. Let’s examine the various options:
Direct Exposure To Real Estate
Currently, this is the most popular option. With every property you buy, you would need to do the required paperwork and pay the stamp duty and registration fee. You would also have to pay the necessary taxes once you exit the investment.
Plots of land. Remember the Anupam Kher-Boman Irani starrer Khosla Ka Ghosla? Nothing can probably describe a land-buyer’s travails better. It’s true that investments in land offer the highest returns in the sector. In the decade gone by, land values have appreciated by 300-400 per cent. But, with higher returns come much higher risks. As Vakil says: “It is not everybody’s cup of tea.” This holds true primarily for raw or agricultural land. This is because there are too many processes—and tedious ones at that—involved in getting the land-use changed, getting the plans made and passed, and so on. If you don’t have the time and heart to do the running around, or are not too conversant with the procedures, it is advisable for you to stay away from this form of investment. Last but not the least, there is a zoning risk with such investments. On the other hand, raw land is also the cheapest among the different options available.
There are, however, safer options to invest in land. You could buy land through housing development boards or at a government auction. Or, you could buy plots of land offered by developers in gated communities. Irrespective of the source you buy the land from, ensure that you erect a wall once you get the possession. If possible, keep a guard as well and regularly visit the land. If your finances permit, you could buy a large parcel, divide it into smaller ones and sell them off after doing some developmental work. Vakil explains: “There are few buyers for large parcels of land but many more for smaller parcels.”
Residential property. This is the most common form of investment. There are different sources from which you can buy a residential property—developers, housing development boards, independent houses and the secondary market. The availability of home loans has made this avenue particularly popular. For example, if a property costs Rs 100, you don’t need to pay the full amount from your pocket. All you need is a minimum of Rs 20, and the balance can be provided through a loan, provided you meet the requirements of the lending agency. This is not the case with other investment avenues in the sector or, for that matter, even other asset classes. Say, if you want to buy stocks worth Rs 100, you need to have Rs 100 with you. Similarly, if you want to buy land worth Rs 100, you will need to have Rs 100 with you.
But again, there is risk involved when you invest in an under-construction residential property. If the developer doesn’t have a proven track record, chances of things going wrong are very high. So, if you go for such a property, invest in one that is closer to completion. The premium that you may have to pay for it is worth every penny. However, getting a ready-to-move-in property from the primary market is a bit difficult. The next best option, therefore, is the secondary or resale market. In the primary market, there are two sources from where you can buy property—either directly from the developer, or from housing development boards. Houses from the housing development boards usually find favour among buyers as they are cheaper. But the recent housing scheme of the Delhi Development Authority (DDA) has shown that this difference is not all that great. On the other hand, this option has a few disadvantages. The allotment of the houses is typically done through a draw of lots, which is, at most times, riddled with controversies. Also, the quality of construction offered by a developer of repute and the amenities on offer tilt the scales heavily in the latter’s favour. However, note that even developers of repute have gone astray as far as timely completion of projects are concerned.
Says Anshuman Magazine, CMD, CB Richard Ellis South Asia, a realty consultancy firm: “If you are investing in residential property, you are doing so for capital appreciation. The other advantage is that you build an asset.” If you hold on to your investments for the medium- to long-term, and if you have chosen the location with care, chances of your investment doubling in 5-7 years are bright. Rental yields, however, are the lowest in residential property and hover around 2-4 per cent post-tax. So, they may not be the best choice if you are looking at a steady cash flow. Also, the rental yield is less than the rate of interest you pay for the loan to buy the asset in the first place.
Commercial property. For the retail investor, anything other than residential property is commercial property, which can broadly be divided into office property (comprising corporate office property and IT/ITeS buildings) and retail property.
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Here, you have three options. First, you can buy an under-construction commercial property with no guarantee. This means that the developer does not guarantee you any returns. So, when you get the possession, the onus would be on you to find a tenant. Not only would finding the right tenant be a problem, but handling the complex paperwork regarding the lease agreements could also be a Herculean task. You must have been flooded with SMSes inviting investments in commercial property, where developers offer a guaranteed return till the time you don’t get a tenant. This would actually work in your favour because the developer—who usually has much more expertise and reach than you—will try his best to get a tenant for you as soon as the building is complete. However, as Anshul Jain, chief executive officer-India, DTZ International Property Advisers, says: “You also need to check the capacity of the developer to give you the assured return.”
The third option is to invest in 1,000-2,000 sq.ft of a floor. This way, you become one of the many owners of the same floor. In such investments, usually, the tenant is already in place and, after you have invested in the property, you would start getting the rental yields as per the terms and conditions of the lease agreement. Says Jain: “Look at the tenant’s profile and his capacity to keep paying the rent.” Vineet K. Singh, business head, 99acres.com, takes another view: “In the assured return projects, you are taking a calculated risk since most of these projects have FDI backing. Ensure that they have a good track record.”
Typically, for a Grade-A office building, the lease is for a period of nine years. But the tenant has the option of moving out of the property after three years and, therein, lies the risk for the retail investor. If you have invested in a property where there are multiple owners of the same floor, finding a new tenant could be tough. Says Verma: “There have been many instances of people going wrong with their investments in commercial property after their first tenant’s tenancy period is over.”
So, you need to factor in a certain amount of vacancy. Says Jain: “In the long-run, investments in commercial property are not great.” When you have multiple owners of a floor, maintenance is an issue and that could result in deterioration of the property, thereby, affecting the rentals. So, you should ideally pull out after five years. If you have invested in a small office space, typically less than 5,000 sqft, finding a new tenant would be difficult. Pulling out of the investment would be tough as well. Says Mavani: “The market for such properties is very unorganised.” Most international property consultants do not deal in properties of this size. Ideally, look at small office spaces. These typically cater to the needs of small and medium business enterprises and professionals such as lawyers, chartered accountants and designers. Says Sahni: “Considering that India is an entrepreneurial nation, these office spaces have considerable demand.” You can also look to rent these space out to banks for setting up ATMs.
Commercial property provides a steady flow of income. Rentals could range anywhere between 6-14 per cent. The capital appreciation that you may get after pulling out is actually a bonus. Says Shobhit Agarwal, Joint MD-Capital Markets, Jones Lang LaSalle India: “Commercial property is largely meant for people who are looking at regular returns. The risk is largely on the quality of the tenant and the strength of his cash flows,”
Indirect Exposure
Buying a property, doing the necessary paperwork and finding the right time to exit can be quite a task. This is where indirect investment in real estate comes in.
The fund route. The first option is to invest in funds that invest across properties and, then, distribute the rentals among investors. This is a fairly nascent phenomenon and is typically happening in the commercial property space. Two funds in India do this—IL&FS and Anand Rathi, a brokerage firm. These funds aim to raise money in the domestic market by investing it in fully built-up assets, putting those assets on lease and passing on the rental yields to the investors. Unlike other funds, which primarily invest in under-construction projects and fund developers, thereby taking the development and project risks, these funds only take the tenancy risk. Which means that they invest only in fully completed buildings. Says Mavani: “Thus, the capital you invest is protected because these funds own these buildings.” These funds have the potential to deliver returns in the range of 11-12 per cent. The only disadvantage being that the entry limit is high. The minimum investment amount is Rs 25 lakh-50 lakh. But if you have the necessary funds, this is a better way of investing in real estate because you don’t have to get into the nitty gritty.
Private equity route. This option is suitable for the well-heeled. The entry limit for this route is pretty high and varies across private equity (PE) funds, and usually runs into lakhs. The money will typically be locked in for 5-7 years. Once you have invested with a PE fund, it will invest the money in one of the developer’s projects after due diligence. Since you indirectly bear the execution risk along with the developer, the returns are pretty high, usually in excess of 20 per cent. But be ready to pay high management fees.
Holding period. The sector’s bull run, especially in the residential property market, saw most investors getting into a project at the initial stage and moving out even before its completion. By not taking the possession of the property, they got away without paying the stamp duty, operating only on the basis of the allotment letter issued by the developer. In most cases, their holding period was not more than 24 months. So, how long should you hold? The above example will work in your favour only if there is a bull run. Such frenzy in markets is not expected for some time to come. Much like other asset classes, real estate, too, is subject to cycles. To make the most of your investments, ideally hold on to your investments for five years, especially in case of commercial property with multiple owners. In case of investments in residential property, hold on for at least 5-7 years. If you exit before three years, it will not be tax-efficient.
When you make a choice, remember that the option that suits your neighbour or friend may not suit you. Says Agarwal: “The full menu does not serve the purpose. It is segmented. All the products are good, but each one is suited for a different set of people.” Also when it comes to taking direct exposure to real estate, choose the location with care and make an informed decision.
Realty On Reels
Deewar (1975) Vijay (Amitabh Bachchan) invests his dirty money in real estate and flaunts it to his honest brother Ravi (Shashi Kapoor). In 2011, even with a regular job you can create substantial wealth from real estate.
Gharonda (1977) Sudip (Amol Palekar) is devastated after he is scammed in a housing project. (Worse, he loses his girl thereafter.) Even today you need to check out the credibility of the developer. The twin risks remain.
Trishul (1978) R.K. Gupta (Sanjeev Kumar) abandons his wife and son, Vijay (Amitabh Bachchan), and remarries to become a real estate tycoon. Today, with easy access to information and loans, you have a simpler way to wealth.
Khosla Ka Ghosla (2006) Land shark Khurana (Boman Irani) squats on K.K. Khosla’s (Anupam Kher) land bought with the latter’s lifetime savings and demands more to let him have it back. Investing in land remains as risky as ever.
Why Look Now
It takes time to invest in a suitable property. Here’s why you should be getting ready to buy one:
- House prices expected to stay flat—select locations in Mumbai and Delhi-NCR could see a 10-15 per cent drop in prices—in the next 12 months, before perking up.
- Correction in commercial property has already happened and prices are soft now. So, if you book now, you can benefit by way of capital appreciation to the tune of at least 5-7 per cent per annum, along with a rental yield of around 8-10 per cent in case of rented out property.
- Over a three-year period, much more capital appreciation can be expected in
commercial property.
Look Before You Leap
How to avoid the minefield that the real estate sector is:
- Zero in on professionals at the point of contact to make informed decisions
- Do proper research and carry out due diligence on the developer and the project before deciding whether to invest in it
- Be sceptical about what the developer says. Don’t take everything at face value
- Be wary of the real estate agent’s marketing spiel
- Keep an open mind on advertisements by developers that may be misleading
- Go through paperwork carefully at the time of signing the documents
- Choose the realty investment vehicle that suits your goals
- Be realistic about returns
- Stay away from impulse to get over-exposed to the sector, which is highly illiquid.
Spoilt For Choice
There is a lot to choose from when it comes to investing in real estate
Direct Exposure
Plots of land
- Raw agricultural land
- Land from housing development boards
- Land through government auction
Residential Property
- Apartment from housing development board
- Apartment from developer
- Independent houses
- Secondary market property
Commercial Property
- Small offices
- Floors with multiple owners
- Small retail space
Indirect Exposure
- Funds investing in yield assets
- Private equity
Real Estate In Your Portfolio
The biggest question that comes up when you are building your portfolio is how much exposure should you take to real estate
As Gaurav Mashruwala, a Mumbai-based financial planner, says: “There is no thumb rule. It purely depends on what your goals are.” Adds Sunil Rohokale, executive director, ASK Investment Holdings: “This is purely a function of what stage of career you are in and your risk appetite.” Let’s make some assumptions. Suppose, you are in your 30s, are not that risk averse and have Rs 100 with you. This is what you can do:
- 60-65 per cent to growth assets (typically giving 15 per cent return);
- 25-30 per cent in fixed income yielding assets (expected return 10 per cent) ; and
- 5-10 per cent in liquid assets (expected return, 5-6 per cent).
If you do a weighted average of this portfolio, it actually beats inflation and, after that, you take home 4-5 per cent. And, it’s in the growth asset portion where real estate comes into the picture, says Rohokale.
How do you allocate your growth assets between real estate and equity? It depends on how much you understand the two asset classes. “Real estate should ideally constitute at least 20-30 per cent of your portfolio. If you are good at equity, the rest of the money goes into equity. If you are good at real estate, then 60-70 per cent of the money can come into real estate and the balance in equity, debt, and so on,” says Rohokale.
Remember, real estate is a highly illiquid asset. So, ensure that you have enough funds to take care of sudden cash requirements. Also, buying and selling real estate is a tedious process. Once you have taken the plunge, its an asset that requires active management.
The Tax Angle
Taxability of sale proceeds is an important puzzle piece in cracking the real estate jigsaw
Taxability of Gain
- When you sell before three years: It will be taxed as short-term capital gain. Gain is added to income and taxed as per the slab.
- When you sell after three years: It will be taxed as long-term capital gain at 20 per cent after indexation.
Docking Capital gains tax
- Use the capital gains to buy or build a new house. This new property must be bought one year before or two years after the sale of property on which capital gains have been made. It can also be used for construction of a new property not more than three years after the date of transfer of the old property.
- Invest the capital gains of up to Rs 50 lakh in tax-saving bonds issued from time to time under Section 54EC of the Income Tax Act. With a three lock-in and returns of around 6 per cent a year, such bonds are issued by bodies such as the Rural Electrification Corporation and the National Highway Authority of India.
By pankaj anup toppo With inputs from Sunil Dhawan
toppo AT outlookindia.com
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