Makes Sense - Does It Make Sense To Look At Real Estate As A Part Of Your Portfolio?

We all have our unique mindsets, ideologies and preferences when it comes to handling our money. Whether it's about the way we earn, how we spend and how we save, our priorities are different. However, generations after generations, one thing has largely remained as a common interest for most of us, is real estate. It¡¯s been a part of many people¡¯s portfolio and remains one of the popular investment vehicles in our country, with a deep emotional connection as well. In fact, in a recently published study, India witnessed a US $ 2.4 bn worth of investment in real estate in the first half of the year 2021, which is a 52% year-on-year growth!

This figure is again a testament of how immensely popular real estate is in our country. But just like other asset classes, real estate too has its own shares of ups and downs. So, have you ever wondered whether it's worth investing your hard earned money in this otherwise hugely popular asset class in the form of real estate? Read on as we dig deeper and find out whether it makes sense to look at real estate as part of your portfolio.

Returns on Real Estate

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One of the most important determinants of the returns from an asset class are what assets are chosen within that asset class, the timing and duration that the asset is held. So, when choosing the location and project while investing in real estate, remember that returns vary tremendously over locations and market cycles, and since the transaction costs are on the higher side, it is nearly impossible to switch properties if the initial decision doesn¡¯t turn out to be the correct one, thus spiking up the chances of either selling it at sub optimal rates or remaining stuck with it for considerably long periods of time.

Also, it's harder to measure returns in real estate, unlike other investments like equity funds that have benchmarks to weigh against. In real estate, specific cases in certain locations have generated far higher returns than others across land, residential, retail and commercial spaces across the country. Usually the house price index is looked upon in real estate sector. As per a research conducted recently in the third quarter of 2021, house price index (change in the average price of under-construction and ready-to-move properties) grew 0.3% quarter on quarter for pan-India in Q3 of 2021.

But amidst all this, one silver lining can be that selling the property is not the only way to earn from real estate investments. Let¡¯s not forget the value of rent or lease. In real estate, you have the option of either leasing or renting the property. This way, you can earn additional regular returns while the value of the property is appreciating, and at the same time not lose ownership of the asset as well. However, remember that the rental yield in India is on the lower side, and hovers just around the 3% mark.

Also Read: Does It Make Sense To Buy A House Or Rent One

Liquidity in Real Estate

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One of the primary benefits we expect from our investment, especially one as huge as real estate, is liquidity. The sooner you are able to liquidate the investment, the better. That's where real estate falls behind many asset classes. It¡¯s indeed a long and time consuming process to liquidate your real estate asset, especially for a good price and in the short term. It¡¯s no less than a hassle-filled process, thus making it a less reliable asset when in need of urgent funds. Hence, liquidity is one of the major reasons why you should think twice before investing your large chunk of hard earned money in real estate.

But if you are willing to wait it out and remain invested for the long term, real estate does offer some promise and can turn out to be a great asset,especially if other factors like demand in the market, location¡¯s upsides etc are favourable.

Consistency

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Another crucial aspect you should consider before investing in real estate is to research its consistency. Contrary to the myth that real estate investments tend to always improve over time, the truth is these investments have been highly inconsistent. In fact, development in your location does not ensure a rise in property¡¯s value. Despite development, the value may not witness a spike, and at worse, even see a downfall due to reasons such as increased traffic or poor access to the city. So, before jumping in and zeroing in on any property for investment, make sure you have deep dived and researched about its scope of growth in near future.

Quantum and ease of investment

The quantum of funds plays a crucial role when it comes to investing your hard earned money. Especially for real estate investment, you would have to shell out a huge chunk of money to own a property. Although you can avail a home loan to realise this goal, even that would require at least 10-25% of property¡¯s cost as down-payment, which in itself comes out to be in lakhs of rupees in most cases. However, in case you aim to rent that property, that rental income can be helpful in paying the home loan¡¯s EMIs. hence reducing your financial burden.

Let¡¯s take an example to check this out.

Cost of property-Rs 50 lakh

Home Loan Amount (assuming LTV ratio of 80%)- Rs 40 lakh

Home Loan Interest Rate (assumed)-Rs 7% p.a.

Home Loan EMI Amount- Rs 35,952 (if tenure 15 years), Rs 31,012 (if tenure 20 years) and Rs 26,612 (if tenure 30 years)

Rental yield (assuming 3%)-Rs 15,000

So, even if you take the longest tenure of 30 years to lower the EMI amount, you are still likely to shell out a sizeable amount out of your pocket per month to fulfil the EMIs. However, remember that all these are based on the general practice and expected rental yield, interest rate etc. When taking the decision, ensure to do the adequate calculations and then decide whether to go ahead with the real estate purchase or not.

Litigation

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As a real estate investor, the last thing that you would want to see is the investment being caught up in a legal dispute or litigation. History is witness to tons of legal disputes surrounding real estate that have gone on for a long period, which turns out to be a tedious task and experience for the investor, despite putting endless amounts of hard earned money into all of it. All such instances and litigation can not only financially and mentally drain you, but even bring down the value of the property and lower the returns generated from it. Hence, always try to ensure your property¡¯s ownership, title deed etc are clean and dispute free, both at present as well as in the past.

After giving a deep thought to all these parameters, the decision regarding real estate is something that rests upon the shoulders of the investor. Once you have weighed the pros and cons of investing your hard earned money in real estate, especially for the purpose of investment, remember that any glimpse of uncertainty and regret in this case can put a lot of your decades worth of savings at risk, given the huge chunks of money involved in this asset class. So, be confident with your decision if you go ahead with including real estate in your portfolio.

The new way of investing in real estate - REITs

First introduced about 5 years back by SEBI, REITs are a relatively new but promising investment vehicle to invest in commercial real estate without directly purchasing the property. REITs are companies created with the main purpose of channelising the funds invested in different income generating commercial properties. Given that lots of people do not have the funds to purchase real estate, even with loan, REITs can be a boon for them, as it allows investment in just small amounts and makes it possible for investor to get fractional ownership of a portfolio of commercial property investments. Moreover, with the compulsion to invest at least 80% of portfolio in completed, income generating projects, 90% of the income to be distributed to the investors in the form of dividends,only 10% of the total investment must be made in real estate under-construction properties, a must have asset base of at least Rs 500 crores and NAVs and capital portfolio must be disclosed and updated twice in every financial year, REITs are well regulated and promising investment tools in India.

And similar to how mutual funds invest in a wide array of securities like equity, debt, money market instruments etc, REITs invest in commercial real estate. Mandatorily listed on stock exchanges, REITs can be a great way of investing in the real estate sector, which in itself has been one of the most popular investment avenues in our country for many decades.

Currently, its ideal to look at REITs as a tool for regular income and moderate capital appreciation. But remember that factors like rise in rental yield, increasing occupancy of vacant parts of properties, addition of new properties to the portfolio etc can lead to increase in REITs¡¯ returns as well. Moreover, REITs have the ability to being that fresh air into your portfolio, and with its market maturing in India, it certainly offers a ray of hope and improvement in the coming years.

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