Real Estate: A Good Way to Create Wealth

January 30 , 2013

Property is among the favourite investment options of many Indians. Some of those who can afford it prefer it even over equities. Certainly you cannot avoid exposing your investment portfolio to real estate if it is to ride over inflation levels in the long term. A portfolio poised to stay above inflation levels in the long term of 10-15 years would have a balanced mix of equities, real estate and gold.

In fact a close look at returns of various asset classes would tell you that over the long term period of 10 years the order of returns has equities at the top, followed by real estate, gold and debt securities like FDs and bonds. Also in the long term inflation rate lies between the growth assets (equities, real estate and gold) and income assets (FDs, bonds, debt mutual funds, etc). For instance in the 10-year period from 2001 to 2011 the Sensex returned 19%, Indian real estate returned about 14% whereas gold returns stood at 16%. 

Here real estate returns have been computed from National Housing Bank's Residex index for 20 cities in India. Higher than expected returns on gold can be attributed to global economic turmoil post 2008 and this is peculiar to just this decade. If you locked money in an FD in 2001 you'd have earned a return of 8.5%. In the same period inflation in the country grew at an annual rate of 9.6%. These percentages reinforce the fact that to build an effective long term investment portfolio you need to have balanced allocation to all type of asset classes.

Real estate can give returns in two ways- from capital gains as you sell property and/or through rental cash flows. In normal circumstances property price appreciation and rental rates appreciation would be close to each other. However this can be skewed at times.

There a few things in favour of real estate investment. The first argument is that in developing economies like ours economic growth and real estate growth usually go hand in hand. With rise in general level of wealth the demand for private and commercial real estate rises. According to a recent housing market review by Lloyds TSB, India is the top among 32 countries surveyed worldwide for 10-year real estate returns followed by Russia, South Africa and Lithuania. Until India reaches a certain level of economic development you can confidently participate in the real estate story and earn long term good returns over the income assets without fear of losing.

Secondly it has been observed that in times of economic strain when investors generally have less confidence in business performance, they tend to move away from equities for long term investment. They find gold to be most attractive. When gold prices stabilize, money flows from it to real estate where it is locked for longer periods. The long term nature of real estate investment gives it time for grow sufficiently accommodating short term irregularities.

Thirdly from tax point of view if your property investment has been financed through loans you can claim tax rebate on both principal component and interest component of the loan to the specified extent. In case the property is leased the entire interest component can be deducted. It is also possible to get exemption from capital gains tax by investing sale proceeds in the certain specified assets.

The fact remains that not everyone can afford to participate in the real estate show due to high initial investment required however it may possible to through paper format in some time. Real estate mutual funds (REMFs) are still not a reality in India. There are mutual fund companies that offer infrastructure funds but REMFs works on a different concept. For those who can afford, it is worth the time, money and effort to allocate some of their portfolio to real estate.

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