January 30 , 2013
Many of us seem to understand realty intuitively, yet few have spent time in thinking through what really it costs to buy and sell real estate; and what are the risks involved. People swear by real estate - it is supposed to be a one-way street and much safer than other places to park money. And of course, there is the usual mixing up of your house with realty as an investment. The former is an emotional and convenience decision; the latter a hardnosed financial one. We are finance people, no real estate agents. We shall restrict ourselves to talk about realty as an investment.
Realty has some distinct negatives
On big negative for real estate is transaction cost. Real estate registration and stamp duty charges are as much as 5% and the brokerage can be 1% or higher. This means you need to hold on real estate for five years or longer. Beyond these cash costs, you may not be able to sell your property when you wish to. In finance parlance, it is said that realty is less 'liquid'. This is something you have to keep in mind - the value from real estate will not be available to you if you need it in a hurry.
In India there are other problems. Land titles are far from clear, and there is a many a charlatan out in the market. Some of you may have seen the Hindi movie 'Khosla Ka Ghosla'; others would have seen a friend or relative get cheated by a seller. Even without getting cheated outright, you may be taken for a ride by the builder - late completion, bad construction, incomplete paperwork, etc. There is little accurate information on prevailing market prices, so it's easier to fall for misleading ads in real estate.
Finally, we are aware of the problems tenants can create in a property. Refusal to vacate is the biggest one, but there are others besides.
The pros of realty
If real estate has so many disadvantages, why do people still go for real estate?
One reason for realty's popularity has been the prevalence of cash transactions. This is something that has almost been rooted out of equity and debt through strict regulation. How realty was, and continues to be, dominated by cash. So people, especially professionals and businessmen have seen it as a way to park funds outside the tax scanner. This is reducing in real estate too, though not at the rate one would like. If you are salaried of course, this doesn't matter to you - you don't have undeclared cash. So you should be looking at the costs, risks and returns of realty more closely before putting your money.
A genuine reason for buying realty is that it locks you in for many years by force. This is where human behaviour comes in. In other market linked assets like equity, there is a tendency to regularly look at markets and get tempted to sell. In realty, you remain blissfully unaware of prevailing value of your property, and just let it be.
Thus, the biggest benefit of real estate comes from its forced lock-in. Any long term asset makes sense only if held for several years; and real estate forces you to do this. It does away with temptation of trying to time markets and trade.