One common reason of attraction is seemingly huge profit in real estate. One need to give only 20% from the pocket and the bank gives 80% to buy a real estate. When one buys an Equity Mutual Fund, nobody funds that. “I paid Rs. 20 Lakhs; bank gave Rs. 80 Lakhs and bought a house for Rs. 1 Cr. I paid EMI for 5 years and now I am selling for Rs. 1.4 Cr. From Rs. 20 Lakhs to Rs. 1.4 Crore, this is such a great investment”. Nobody bothers to do a simple IRR formula calculation in Excel as this may be hardly a break even investment if one considers repayments, taxes and transaction costs.
Is this a right behaviour? Every family has a unique situation. Every investor is on a different phase in the learning curve. Sometimes, one learns by observation and sometimes only by experience. Below mentioned parameters can be of help, while making such a decision.
Goal based + Flexibility: One should make a goal based investment. This means that the maturity of the goal and the asset either matches or one is able to withdraw progressively before the goal maturity. While it can take far longer or be far difficult for one to withdraw from Real Estate and Equity Markets may not be doing well when the goal is due, clearly in many ways, Equity gives far more flexibility than the real estate. You could pause, decrease, increase or stop your SIPs. You can also decrease or increase your Home Loan EMIs with a corresponding change in the tenor though such changes may have an impact on your cost of borrowing and may involve lot of paper work.
Liquidity: Real Estate investments are illiquid in nature and disposing a real estate can take lot of time. Equity Mutual Funds can also be in a negative zone at a time but if withdrawals are planned sensibly then using SWP (Systematic Withdrawal Plan) gets one the best price even in the worst period. Selling an Equity Mutual Fund is far easier.
Risk Tolerance: The nature of Real Estate Investment gives limited choice. A conservative investor can stick to ready possession projects by reputed builders but then the price appreciation may be only nominal. Once an investment is made in Real Estate, no changes are possible unless one sells the investment. In case of Equity Mutual Funds, one has far greater choices to invest based on risk appetite. One can focus on required capitalization, take small exposure to a sector and opt for actively managed or index based management as the need may be. With increasing age, the SIPs can be shifted to different funds to tone down the aggression. The investment in Equity Mutual Fund is well diversified against the risk of a single project in Real Estate. One can look at Commercial Real Estate, Plots and Industrial Real Estates though the risk and return magnitude are of different nature and once again individual investments are a single point of risk.
Regulations: Real Estate does not have any regulator as such and the valuations are subjective. The investors will need to depend upon general consumer grievance forums and judiciary channel in case of any dispute with the builder. Mutual Funds Companies (Asset Management Companies) are well regulated and they follow the compliance laid down by SEBI (Securities and Exchange Board of India) and AMFI (Association of Mutual Funds in India). Mutual Fund affairs are far more transparent with Daily NAVs, Monthly Fact Sheets and regularly reports as per the mandate. A regulator for Real Estate is being expected from a long time.
Timing: In Real Estate the price commitment is one shot. While you can pay over period of time, say linked to construction progress, the price is agreed in the beginning. In case of Equity Mutual Funds, following SIP approach allows one to average out the purchase price.
Tax Savings: Real Estate allows one to save tax on the principle as well as the interest payment. The current limit is up to Rs. 1.5 Lakhs for Principle repayment under Section 80 C and Rs. 2 Lakhs for Home Loan Interest payment under Section 24 (B). When one has more than one residential real estate, the interest payment can be claimed for tax exemption without any limit, subject to certain norms. The gains on selling a residential real estate for holding period of > 3 years are treated in Long Term category, get indexation benefits and can be tax exempt subject to reinvestment and other norms. On the other hand, investments in Equity Mutual Fund can be liquidated after one year and being treated in the long term category, does not attract any tax.
Returns: It is difficult to benchmark returns in Real Estate given the lack of transparency. While Equity Mutual Funds do have their performance cycle, sensible holdings over a long period of time i.e. at least 5 years, are likely to get decent returns on an inflation adjusted basis. There are many studies available on internet that compares the performance of Equity & Real Estate as an asset class.
So who wins? Objective here is not to say that Equity Mutual Funds are ever green and Real Estate is always bad. Equity Mutual Fund investing gives rewards only when a methodology is followed. Real Estate has potential to get sizable profits if the bet works out well. Asset Allocation decisions should be taken keeping in mind factors like current priorities, goal duration, risk profile, target asset allocation and liquidity. Blindly investing in ‘yet another’ real estate because everyone seems to be making money is certainly not a winning style.
This article was originally published on Moneycontrol.
The author can be reached at firstname.lastname@example.org