Investing in Real Estate - Part 1

It has always been a dream for all of us to own our homes however small it might be. Some of the reasons for owning a home is to give a sense of satisfaction of having one's own roof, some sort of an investment which is long term, availability of loans by banks and financial institutions to fund the purchase and Tax breaks that one gets.

While the above points make sense for the home that one will stay, is it prudent to invest into the second property as a form of investment especially when one is seeing a booming stock market ?

Before i get into the justification, let me start of with an interesting view with some facts.

Over long periods of time, the stock market tends to give anywhere between 15% to 20% p.a returns. The real estate market tends to give anywhere between 5% to 10% p.a over long periods of time. However, there will be cyclical boom and bust in both the asset classes that will average the returns over long periods of time.

Now, given the above data if i ask where you will invest Rs 10 Lakhs (Rs 1 million), the logical answer will be the equity/stock market given that the returns that it generates is higher than of the real estate market. However, the fact that banks are willing to give loans to purchase property (ofcourse one will need to eligible and capable to repay the loans) makes a big difference to the above equation and let me illustrate with an example.

Let us take a 2 year period for our comparison. If one invested Rs 10 lakhs, it will be worth Rs 14.4 lakhs at the end of 2 years giving a return of Rs 4.4 lakhs on an investment of Rs 10 lakhs.

However, assuming that one bought a property worth Rs 1 crore by borrowing Rs 90 Lakhs 9banks tend to give 90% of the value of the proerty as a loan) and contributing Rs 10 lakhs from one's pocket (ofcourse one will need to eligible and get the loan as well as be capable to repay the loan). Thus if the property grew at 10% p.a., the value of the property at the end of 2 years will be Rs 1.21 crores and assuming that one borrowed the Rs 90 Lakhs at 10% p.a, one would need to repay interest only on the amount of money that one borrowed over this period of 2 years (say Rs 60 lakhs) which works out to Rs 12.6 lakhs on the higher end. Thus after considering the repayment of the interest, the capital gains works out Rs 8.4 lakhs. Thus an initial investment of Rs 10 lakhs yields a return of Rs 8.4 lakhs as against a gain of Rs 4.4 Lakhs in the case of equity/stock markets. Even if we consider payment of tax for the capital gain in case of the gains in real estate, it still will beat the returns when we compared it with equity. Thus, we get the benefit of leveraging in the case of real estate which is not so easily available in the case of equity.

If we consider a longer period of 3 years then the capital gains exemption in real estate will also kick in.

However for the above to happen, one would need to consider the following

1. Capability to be able to borrow the large sum of money from the bank.
2. Interest rate movements will impact the returns (Please note that, this will also impact stock markets)
3. Appreciation as per expectations.
4. Ability to sell the real estate easily.


In the next part of this series, i will explain how one can invest in real estate but not by directly investing in property.