Human beings have felt the allure of land since time immemorial. Families, regions, nations and civilizations have gone to war in order to claim land or protect it. Alexander, Caesar, Ashoka, Hitler – to name just a few historical figures – held land to be synonymous with power. Why wouldn’t they? Owners of land usually ended up in the ruling class while landless people led a life of toil and turmoil. Is it any wonder then that, when it comes to land, we are as greedy and insecure as territorial animals? And till date, our DNA seems to carry our desire to own and bequeath land.
Today, availability of loans and affordability has made it easier for people to own property. As a result, real estate, which used to an asset class for the classes, is now an asset class for the masses. Not surprisingly, millions of us are convinced that this is the best financial asset class of all times. I beg to differ.
Here are 9 BIG reasons why smart investors should avoid investing in real estate:
1. An under performing asset class
A majority of properties:
• Give more or less the same returns as Fixed Deposit over a period of 30 years
• Barely beat inflation in a given 5-year period unless the market is incredibly gung-ho about real estate
• Offer an annual rent anywhere between 2 to 5% of the total asset valuation – less than returns on an FD and less than the EMI payments being made. It’s noteworthy that 100% occupancy is not guaranteed. Therefore, returns could be even smaller
If we had an index to measure this asset class’s performance, I daresay it would have fewer fans. And in the absence of performance barometers, investors who have blind faith in real estate tend to acknowledge only stories of windfall gains – legendary accounts of, for instance, how farmers ended up buying Mercedes. We can explain this phenomenon by understanding the unpredictability of real estate.
2. An unpredictable asset class
If you invested in land in Amaravati, the upcoming capital city of Andhra Pradesh, 10 years ago, you would swear by real estate. If you invested in land in the village of Devanahalli, the site of Bangalore’s airport, 20 years ago, you would have made a pile of cash as high as a villa.
Windfall gains come to the extremely lucky or the incredibly astute or those who have prior knowledge that a particular area is about to experience a development boom. In every other occasion, real estate remains an underperforming asset class with huge periods of stagnation.
Prices don’t skyrocket because of the quality of construction or some other skill-based parameter. They skyrocket only because of the property’s location, which makes real estate an unpredictable asset class. Let me illustrate this by giving an example.
In the mid-80s, two wealthy brothers divided their family’s properties and went their separate ways. The elder brother, being more influential, decided to keep the bungalow in north Bangalore. Although this property was smaller, it was located in a “happening” part of the city. So he gave the larger property, located in south Bangalore, to his younger brother. A decade later, the IT revolution had begun in full swing and real estate prices in south Bangalore surged to an unbelievable high. Meanwhile, prices in north Bangalore had stagnated.
3. Emotionally-charged asset class
Investors tend to link properties to memories and emotions. A piece of land doesn’t stay a pure investment. It becomes the place where births, weddings, deaths and other milestones of life were experienced. That’s why most investors forget about return on investment and that’s probably the chief reason the underperformance of real estate goes unnoticed.
4. Liquidity is not guaranteed
There are many liquidity challenges in real estate:
• It could be a buyer’s market when you need urgent cash, and it might not be easy to find a buyer
• An urgent sale usually fetches much less than the true value of the asset
• Even today, many buyers insist on a portion of the deal being conducted using black money. This is unethical and risky
• Since real estate is a blunt asset class, it cannot be easily divided between members of the next generation. Both harmony and liquidity can diminish
5. A litigious asset class
Investors might experience interminable litigations due to many reasons such as family disputes, encroachment by tenants or anti-social elements, a government entity wanting the land for a public project, ambiguity in government records etc.
I personally know clients who have had to fight for 25 years to prove that a particular piece of land belongs to them.
6. High upkeep effort
For every property you own, you need to pay taxes and utility bills, maintain it in shipshape condition and also find new tenants as and when needed. Comparatively, other asset classes barely require time and energy.
7. Challenges in tracking
If you invest in 5 mutual funds, you can track their performance on a daily basis with the click of a button. But if you own 5 properties, can you physically check upon them on a daily basis?
8. Value-addition doesn’t yield returns
An investor might add fixtures, interior décor and gadgets to enhance the experience of living in a property, but the next investor may want to customize the property in a different manner and will, therefore, be unwilling to compensate the seller for the extra investments made. Funnily enough, buyers and sellers often can’t agree on even vaastu considerations.
It’s like topping the ice-cream with chocolate sauce and dry fruits and then discovering that the buyer will pay only for the vanilla scoop underneath.
9. Humans outgrow homes
Successful people tend to outgrow their homes – they might crave added amenities, more floor space and/or a better location. It’s a lucky investor indeed who, at the age of 28, buys a dream home that serves her at 65.
Sometimes, factors beyond our control make a property obsolete. In Bangalore, for instance, buying villas outside the city made sense in 2004. Today, traffic has thickened so much that one is better off buying an apartment close to the place of work.
Given these deal-breaking factors, I would classify real estate as an institutional asset class. Here, I allude to institutions that have the wherewithal to hold the investments patiently, maintain them, brand them, litigate if necessary etc. Such institutions have a much better chance of growing their wealth using real estate.
I perfectly understand that owning some property might offer peace of mind. Or at least make the owner less anxious about the future. Other than those emotional gains made by the owner, there is little to advocate real estate as a desirable, even viable, asset class. And the boldest among us might decide to live their entire lives as tenants.
According to Robert Kiyosaki, the author of Rich Dad, Poor Dad, these perennial tenants are the smartest among us.
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