Are Real Estate Returns hyped over Equity?

Are Real Estate Returns hyped over Equity?

Understanding returns from Real Estate Investments

Sentiment holds Investment in Real Estate very high in India.  It is everyone’s dream and ambition in India to own real estate. By real estate we mean a home or investing in a second home. While it is well-known that Gold and Real Estate are the much preferred asset classes, (types of asset) the Indian market has also looked favorably upon Insurance and now investment in Equity to an extent.

However, Real Estate is still the much preferred investment choice. You may ask what choice has to do with returns. Yes. Choice and Preference have a great influence on returns and on its perception. Search the internet and you will find loads of information about how people have booked losses by investing in equity and equity funds, but hardly any on real estate losses. Why is it so? Why do we have a great return experience in when it comes to real estate and not so in equity or any other investment?

Investing when markets peak and exiting when low

Over the last 5 to 10 year period equity funds delivered a 10% CAGR (Compounded Annual Growth Rate) in a worst case scenario and a 20% when best. All that an investor had to do was to simply buy and hold on to it. But sadly, most people have not made this return mainly because they wanted to time the exiting of an equity fund. They did not wait for the best time to exit.

Whenever there is a downturn in the market, they not only struggle to keep up to their commitments on the SIP investment, they are also tempted to pull out fearing a further fall. Investing when markets are peaking and exiting when low is possibly the worst thing to do when it comes to equity funds. Opportunistic investment is not the route to returns.

Also Read: Risk Profiling is a Revelation – The sooner the better

If the investor does the same thing in real estate he is bound to make losses. But truth is hard. They do the exact opposite in real estate. People buy real estate when they have the need. Especially when there is a strong need to own a home.  And when they want to sell and see a general slump in the markets they hold on to it till they get a better price. Another reason for investors to be tempted to pull out or sell equity funds is because of the transparency factor.  The returns, appreciation or depreciation can be tracked on a daily basis. Returns on real estate can be tracked only when realized.

Wrong Comparison: A 100% return. But what is the timeline? What is the CAGR?

Before we actually venture into calculating returns, let us understand the right way to measure returns. A CAGR is a measure that indicates the average rate of return over a period of time. Usually for consecutive years. If you want to track the average growth of return over of a single investment over a period of time then the CAGR is the measure you must use. It is a simple metric which can be mathematically represented as below:

Let’s decode this to simple terms. If Anish invested INR 1,00,000/- in a portfolio on Jan 1^st 2010 it is of no surprise that the rate at which the portfolio grows would be inconsistent. His portfolio grew to 1,30,000/- in Jan 2011 and to 1,40,000/- in Jan 2012. It spiked to 1,95,000/- by Jan 2013.

To find the CAGR we will have to divide the final value of the portfolio by the initial value of the portfolio which is (195000/10000 = 1.95) . We will then raise this result to the power of one and divide it by the number of years which is 3.

[(195000/100000)ᶺ (1/3)] – 1

=[1.95 ᶺ 0.3333) – 1

= 1.249 – 1

= 24.93%

Thus Anish’s Compounded Annual Growth Rate is 24.93%. This is the annualized gain of Anish’s portfolio over a 3 year time period. Well, if this is the measure we use for one investment class it is only prudent and just, that we use the same measure for all investment classes. Let’s do the same for the home that Anish bought. He invested 40,000 a month for a period of 15 years to own a home which would make the cost of his home INR 72,00,000/- (the amount is inclusive of both interest and principal repaid on the home loan) If the value of the home became INR 2 crores by the end of 15 years it does make a huge difference in Anish’s wealth. However, the CAGR would work out to a paltry 7.04%. If an equity fund were to yield this much people would definitely consider it a loser!

Real estate returns are high because of the high investment and longer commitment periods. It is highly unlikely that someone would take a loan for an SIP. (which is also not the right thing to do). Comparing absolute returns and returns over different time periods are also not wise things to do. An investment that stays in the market for a period of 15 years is definitely bound to give better returns. The only difference an investment in real estate would make is the ‘need’ and ‘utility’ quotient.

To know more about measuring the growth of your investments visit a financial advisor today!

This article has been contributed by K.N. Sridharan, CEO WinRich