WHERE DO REAL ESTATE PROFITS COME FROM?
The usual sources of real
estate profits have dried up. Buy a house only to own it. No more mega returns from
real estate.
Last week, I wrote about
buying a house. The main message of my column was that one should buy a house
for no purpose other than to live in it.
Real estate makes for a
poor financial investment. My argument was that treating real estate as an
investment option is unwise, because the ticket size is huge and liquidity is poor.
Further, when you do wish to liquidate it, the entire investment has to be sold
at one go.In addition to this, you may or may not be able to sell when you want
to, since the entire market disappears for long periods during a slump.
A lot of people point to
the huge gains that were made by property owners in the past. The myth of real
estate being a great investment is mostly a result of mathematical illiteracy
about compound growth. People will tell you about how the value of a certain
plot of land or house grew 50 or 100 times in 40-50 years. This sounds
fabulous, but is actually nothing special. The BSE Sensex has become 300 times
its value in 38 years. Even a gain of 100 times in 50 years comes to only 9.6%
per annum, which is good, but definitely not exceptional.
In today's column I'll
argue that even these gains in real estate could only have happened under the
old model of real estate investment.They cannot happen now. Let's try to
understand where real estate returns came from historically. There are perhaps
five sources of gains in the price of a given property, and the final profit is
a product of these. First, the original change in usage of a piece of land from
agricultural or barren to residential or commercial.Second, the development of
physical infrastructure which makes this land usable for the new purpose.
Third, the improvement in livability or commercial viability as the area
becomes more and more populated. Fourth, the periodic booms and busts that
afflict real estate, and fifth, the general inflation of the econ omy that
becomes part of the visible change in the property's price.
When your parents'
generation bought property, they often did so at an early stage. As a result,
all the gains from the second to the fifth point above accrued to them over a
two or three decades. Things are very different now. You typically buy an
apartment from a real estate developer. In this new model, all gains from stage
one to three accrue completely to the developer and whoever came before the
him. What is even worse is that the developer also tries to capture much of the
value of the later stages in advance from the buy er, and often succeeds in
doing so.
The intense marketing hype
around real estate developments is intended to convince you that one day in the
imminent future, the property you are buying will be among the most desirable
in your part of country. Therefore, you must pay up now.
Basically, to put things in
investment terms, your acquisition price is at a high multiple of a value that
will supposedly be attained in the far future. This future value is whatever
the developer is trying to push.
Therefore, the price of a
property in South Mumbai or South Delhi may have grown 50 times in 50 years.
However, the flat on the outskirts of these cities that someone is trying to
convince you is worth `5 crore today is not going to be saleable for `250 crore
in another 50 years. The reason is not that compounding is going to fail in the
future, but that much of the future value is already included in that `5 crore
that the developer wants today. He has already factored the future value into
this current price.
The real estate investment
model has changed, and as far as the individual buyer is concerned, it has
changed for the worse. Much worse. Therefore, it's only logical that savers
should buy only one house, the one in which they are going to live. If your
lifestyle and family require many houses, then that's fine, but don't make the
mitake of considering it to be a financial investment
Dhirendra Kumar.
ETW1MAY17
No comments:
Post a Comment