January 30 , 2013
Real estate as an asset type should ideally figure in every individual's investment kit. It is a growth asset that is known to give returns way over the level inflation can climb. Since real estate is a tangible asset for many people it is the only 'real' investment that exists. However this is not the case and as with any other asset it is not good for your portfolio to be overexposed to property.
Any given asset class has certain positive aspects and negative aspects about it. So a prudent investor would diversify portfolio across them in a suitable proportion to get best results. Let's begin with the positive aspects of real estate.
Real estate investment has historically given returns staying much above the inflation rate in the long term. Inflation of the country in the last decade 2001-10 grew at an annual rate of 9.6%. Average annual real estate return in the country was 14% in this decade.
Property investments can earn cash flows besides giving value appreciation in time. You can lease property to earn rental inflows on it.
The best thing about property investment is that you get locked in for a long period. Any sort of investment yields good returns when held for a sufficiently long period and in case of real estate you automatically end up doing that. You don't churn properties like you might do with shares as the markets swing up and down.
Now coming to the negative aspects. Since diversification of real estate investment across properties is not practical, unlike say in equities through mutual funds, to an extent returns depend on whether you were right with your choice. If you go wrong with your choice the entire money can go down the drain. If you looked at individual real estate investments in specific locations would find rates much higher or lower than the average, even negative returns in some cases.
Real estate industry lacks proper regulation. There is no transparency of price. The big guys of real estate- the builders can take you on a ride demanding more money for completing a project that got delayed and for other things.
Property has high maintenance cost. You need to pay property tax and utility bills. Not-so-good tenants can add to your woes.
Most of the negativities can be eliminated through real estate investment in paper format. But sadly in India REITs and REMFs have not taken off yet. You can read about them in the article Property Investments in Paper Format in Viewpoint section of this page. When these become a reality retail investors will be able to participate in a healthy real estate industry.
Until then you should go soft on real estate and turn your focus to equities for long term investment, through mutual funds if you are an amateur and individual shares when you are educated enough on it. Equities cannot be avoided if your investments are to yield good returns in the long term. Sensex returned 19% in the decade we discussed above. Diversified equity mutual funds have given returns surpassing the Sensex. Investment in gold gave 16% in that decade. You can systematically expose your portfolio to gold as well.
So go ahead, get a life beyond real estate!