Is real estate a profitable investment?

Anuj Puri, Chairman - ANAROCK Property Consultants, answers this question and discusses the impact of the rate cut on real estate.
By Guest |  12-06-19 | 
 
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Morningstar invites thought leaders from the investment community to share their insights. Views expressed are personal and should not be construed as investment advice.

This question has been a concern among all stakeholders - financial planners, property owners, investors and prospective buyers - over the last few years. And only because real estate, particularly residential, did not yield the same returns as it did during its Golden Era of the early 2000s.

Past trends reveal that between 2013 to 2018, residential property price appreciation in India bottomed out to a mere 12% – effectively a little over 2% on a yearly basis, even for properties in prime locations.

So, if one bought and sold such a property within this period, their returns would have been less than satisfactory. After all, during the boom era between 2004 and 2008, the average 5-year return for housing across the top 7 Indian cities was over 60%.

A drop of nearly 40% between 2009-2012, if we consider growth only in the unorganized real estate sector.

Slowdown – Not a unilateral phenomenon

Where, exactly, did this unwholesome trend apply in a land known not only for its political and societal diversity, but also for sheer geographical spread? After all, everything doesn’t happen the same way at the same time in the third-largest country in Asia and largest country in South Asia.

Or, for that reason, in terms of the political implications in different states that separate a huge land mass, each governed by different authorities with different political objectives and the economic imperatives that govern each particular segment.

The all-important ‘location, location, location’ factor aside, the capital value appreciation of pure land went beyond 100% in India’s questionable boom period. Cities like Hyderabad saw exponential land price appreciation in 2004-2008 - amounting to over cent-per-cent growth in its major areas.

What was at play?

Primarily, prevalent favourable policies benefiting the state back then. Similarly, Pune saw a significant IT boom during the 2009-2013 period, which eventually caused land prices to appreciate by as much as 60% during this period.

We are talking about the phenomenon of some parts of a huge country performing extraordinarily well, while others didn’t. India is simply too big to generalize about. If we compare the country to a physical body, some parts received less nutrients and were poisoned by toxic elements, while other parts suffered less or no similar exposure and remained immune.

The available 5-year returns trends for Indian residential real estate certainly indicate that the previous haphazard growth in Indian real estate market was gradually replaced by more realistic and mature market behaviours. Taken holistically, perhaps far too slowly - but every part of the massive corpus called India represents a different chain of impulses, requirements and performance levels.

Some markets are almost completely end-user-driven, which puts the lid on speculative price hiking. Other markets are more amenable for investors – albeit, in the new market environment, only those with a long-term view.

Changing market dynamics, and the acceptance of such change, happened in pockets rather than unilaterally. Wherever they are and wherever they invested to whatever extent, investors have had to come to terms with this change.

Just like in the stock market, long-term investors who see the big picture have responded differently than short-term speculators who can only appreciate a quick buck. 

The new residential money-spinners

Residential real estate is no longer a singular concept in India. Backed by government sops, affordable housing can feasibly give returns to the tune of 8-10% in the long term. There are also a number of alternate residential real estate investment options – including serviced apartments, senior living, Smart City-based housing, and co-living.

The monthly rental ROI for these residential sub-categories is a lot higher than for mainstay mid-income or luxury housing. Much depends on how much an investor has kept abreast of the rapidly-changing Indian housing market.

For instance, co-living units can offer as much as 8-11% of ROI – a much higher yield than the current average yield of 1-3% in garden-variety residential properties. How many investors are gauging the intricate variances that drive returns on investment in Indian residential real estate, and how many are just going by the old thumb rules?

There are immensely profitable asset classes in Indian residential real estate investment, but far too few investors are actually scanning the radar for them. 

Commercial real estate beckons wealthy investors

In earlier years, most small ticket investors banked heavily on residential properties for their investments. Today, wealthier investors are eyeing commercial properties and ‘sunshine’ sectors like warehousing. Also, REITs (Real Estate Investment Trusts) have finally kicked off in India, and commercial real estate is attracting a lot of attention from real estate investors.

The recent oversubscription of the Embassy-Blackstone REITs definitely sends out clear signals to global as well as domestic investors – it’s a good time to grab a piece of the Indian office property pie. In fact, we expect REITs investors to become more bullish and eye stakes in multiple Indian commercial assets which may be listed under REITs in the future.

In REITs, small-time investors rightfully sense the unveiling of a major new investment avenue comparable to that available in more developed nations. Meanwhile, Indian commercial properties are drawing a lot of interest from big-ticket investors. This segment has performed much better in India than its housing segment over the last few years.

Housing sales across the main Indian cities have stayed subdued, especially after demonetization (DeMo), the implementation of the Real Estate (Regulation and Development) Act, 2016 (RERA) and the Goods & Services Tax (GST).  Meanwhile, commercial office leasing ROI increased y-o-y.

Residential – Down, not out

In the past, a lot of investors made a killing on Indian residential property - in short periods - by timing the purchase and sale of housing units. Were they wrong about their investment approach, or were they wrong about their chosen asset class? Certainly, given the rebooted regulatory environment and existing strictures that prevent ‘flipping’, speculative short-term investment in the Indian housing sector no longer makes sense.

To realize 8-10% annual returns or more today, housing investors must have a horizon of at least 5-7 years. Meanwhile, they can earn rental income from an asset that has perennial inherent demand.

In developed countries with organized property markets, alternate residential real estate investments done for the long-term have earned returns on par with those of equity and mutual funds - with far less volatility. India is currently on the path of such organization, with rapidly increasing transparency, governance and discipline. There are much better times ahead.

For now, Indian housing prices will remain at status quo. In the future, the pent-up demand of more than 10 million units will hold sway and drive up the rental and capital values of all but the most ill-chosen housing. From urban to suburban and from peri-urban to rural areas, the inherent demand for housing - and the potential returns on investment – is beyond question.

Will the RBI key lending rate cut benefit real estate?

RBI reduced its key lending rate by 25bps. The lending rate now stands at 5.75, and this is the third consecutive rate cut since February 2019. This rate cut may send out positive notional signals – but real gain can be realised only if banks pass on the benefits to actual homebuyer borrowers. The apex bank will need to ensure that this actually happens at the ground level since there has been little evidence of such transmissions in the recent past.

In the current scenario bereft with rising NPAs and the ongoing NBFC crisis, things look quite bleak at the moment. The reason why most banks are not really able to pass on the benefits of RBI’s rate cuts is that their deposit rates are still very high. This ultimately makes reducing interest rates to borrowers unfeasible.

Nevertheless, this rate cut will only have any really significant impact on the housing market if and when banks reduce their lending rates to homebuyers.

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Sameer Karve
Jun 14 2019 03:39 AM
Anuj, you rock ! This is one of the most balanced, unbiased views I've come across in the recent past. Appreciate the mention of contemporary housing trends like co-living. Thanks for your effort in educating investors.
GUNESH APTE
Jun 13 2019 04:30 PM
One of the main reasons to buy Real Estate in India, is the passion and personal feeling attached to it. Indians tend to get carried away and calculate returns on real estate, just by considering Buy Price and Sell Price, where as real returns are (Sell Price) - (Brokerage) - (Stamp Duty paid during buying) - (Maintenance incurred across multiple years of holding) - (Property taxes paid). This is some where near to 5% to 8%, not more than that. So it is clear that, people do not invest in real estate for returns but mainly for stable asset.
Now, as of today, since cost of raising funds is still high, banks/NBFC may take longer to pass on rate cuts to people. It will be a year of some positives for real estate but it will happen slowly, which is actually good thing. Now people have lot of avenues to invest, so real buyers will be the beneficiaries.
Also, Rental yields in India are at all time low at 2%-2.5% in Mumbai, which indicates that, prices of flats are still above the normal range. Rental yield should become 5%-6% as it was before 2000, to make it attractive as investment.
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