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D.Muthukrishnan (Muthu), Certified Financial Planner- Personal Financial Advisor

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Cycles and some thumb rules

Posted by Muthu on October 5, 2014

Every asset class is cyclical. There is no such thing as permanent bull or bear market.

In stock markets, a bull market last on an average for 5 years and a bear market for 3 years. So it takes 8 years for equity market to go through one complete cycle. So any holding period for less than 10 years or so is speculation.

For gold, a bull market last on an average of 10 years and bear market for 20 years. So it takes 30 years for gold to go through one complete cycle. What is true for gold is true for many other commodities as well.

I’m saying the above based on my extensive reading and understanding. Again the term ‘average’ can be misleading, as one bull market in stocks can be for 10 years and a bear market can be for 6 years. The given number is an average over many cycles. Each cycle may vary.

As far as real estate is concerned, based on what I discussed with people who have been observing real estate in the country for long time, they say the bull cycle is usually for 10 years and followed by bear cycle for another 10 years. A complete cycle may take usually 20 years.

In bull cycle, the prices may go up by 5 to 7 times in 10 years. In the subsequent bear cycle, there is hardly any movement in price; even if it is there, it is less than inflation. Prices correct usually by 20% to 25% over few years. More than price correction, there is time correction. The prices get stagnant or keep falling marginally for next 10 year period. There is no liquidity as transaction gets lesser. There is over supply and lesser demand. Rents go down and it is difficult to get tenants for the properties and many may even lie vacant.

So stock market cycle is 8 years, gold cycle is 30 years and real estate cycle is 20 years. This is only a number for broader understanding and variance can be significant in each cycle for every asset class.

Vivek Kaul, in one of his articles has mentioned that average income of a Mumbaikar is Rs. 3.54 lakhs and average cost of a flat is Rs.1.2 crores. So it takes 34 years of annual income of average Mumbaikar to buy a home.

Reading this, I thought let me share with you some thumb rules for real estate.

The value of the property should not be more than 3 times one’s annual take home pay. If your annual take home pay is Rs.12 lakhs, your house purchase value should be Rs.36 lakhs. I don’t know what the average income for a Chennaiite is. It would definitely be lesser than a Mumbaikar’s income. In the absence of data, let me just assume it is Rs.3 lakhs. A good 2 BHK in any decent suburb costs not less than Rs.75 lakhs. So a Chennaiite need 25 years of income, if he wants to own a flat in his city.

From my interaction with many people, I find that they commit not less than their 10 years income for a flat. This is not accounting for interest component.

The house price to rent ratio should be around 15. If a house cost Rs.1 Crore and the annual rent is Rs.3 lakhs; the price to rent ratio works out to 33, which is very expensive. Going by international standards, if this ratio is above 20, then the cost of owning is considered higher than cost of renting. This means you would be better of paying rent.

If the above ratio is 15, then the rental yield will be 6.7% per annum (example: Property price is Rs.30 lakhs and annual rental is Rs.2 lakhs). So the ideal rental yield should not be less than 5%.

When we bought our house, we borrowed only 40% of the property value. Make it a point to save atleast 50% of the property value as down payment; till then live in a rented place. 10% down payment means you work rest of the life for welfare of the bank. I can write a separate piece on how much a house actually would cost you.

Home loan EMI as a part of your income (debt to income ratio) should not exceed 35% to 40% (maximum). Anything beyond this may put a huge strain on you especially in a rising interest rate scenario or any other contingency in life.

Usually husband and wife take the loan together and one of their salaries completely goes for EMI. A woman’s career can have breaks due to family situations and many are not prepared for this contingency. This not only leads to financial problems but marital problems as well.

Like I say for equity markets, in real estate markets too, we should aim for decent and not exorbitant returns. Aiming for doubling in 3 years or tripling in 5 years is a road to doom. Some may click but many may fail. In stocks, someone can make even 5 times in 2 years but this is more of exception than rule. In the long run, investors as a group cannot earn more than what market gives, be it stock or real estate.

As I’m in the profession of reviewing people’s financial health, I find that once I remove the value of self-occupied property, which is usually under 20 years loan and gold jewellery, the net worth is very meager even for high income people. With this kind of balance sheet you would never be able to retire; not only that unexpected injury or disease can even make you bankrupt.

So to retire, you should have 50 times your annual expenses in financial assets. This is in addition to owning a home with zero debt. This would ensure that your retirement is stress free and you’re ready to face any contingency in your retired life.

For those who find 50 times very high, aim for at least 30 times.

So if your annual expense is Rs.12 lakhs, it is preferable to have Rs.6 crores in financial asset. In any case, it should not be lesser than Rs.3.6 crores. This is in addition to being debt free and owning a house.

This is definitely possible.

As I wrote earlier, investing regularly for long term in equity would definitely ensure not only peaceful retirement but passing on good wealth to the next generation as well.

7 Responses to “Cycles and some thumb rules”

  1. Utsav Chaudhuri said

    Why is it said that anytime is a good time to buy a flat in Mumbai, if you want to stay in it?

  2. Nice article, thanks. I listened to Basant Maheshwari’s talk ( available on youtube) and he too mentions that financial security is when you have 50 times your annual expenses. His logic is that the general dividend yield is 1-2% and that should pay out your expenses. It was an interesting talk. As per your opinion do you think Gold in INR terms is in a bear market ( time correction ? ). If so will it be a good idea to invest in a SIP manner for the next say 7-10 years. Thank you.

    • Muthu said

      Thanks for your comments.

      Gold price in India is a function of global gold price and exchange rate.

      In the long run, as long as our inflation is higher than that of US, rupee may continue to depreciate against dollar.

      My personal feel is that as global economy stabilises, international gold prices may further come down.

      I’ve no clue as to what conversion rate would be in future.

      Gold is not of much use in a portfolio. If you prefer, please allocate around 5% to 10% in gold as a part of overall asset allocation.

      Gold ETF through SIP route is a good option.

  3. Bhupesh said

    Underlying principles for these rules are true but the number figures are directly copied from the developed world’ scenarios, need calibration for Indian market realities, 6% rental would mean real state prices should not appreciate more then 4-5% a year. Otherwise real state yield would be more then FD. Inflation and urbanization pressure being there it is unrealistic number.

  4. ltinvestment said

    Very good Article and Nicely narrated. I really accept the Retirement corpus for mantaning the standard of Living. But i also wonder, without doing any such Maths, Our parents are living happily and their parents did. Ofcourse Inflation and Lifestyle is different but in similarly Income also low.
    We are really suffering in proper planning of financial stuff which is why advisors necessity becomes unavoidable. But in India, why it is still in nascent stage.

  5. MRHDK2012 said

    “Vivek Kaul, in one of his articles has mentioned that average income of a Mumbaikar is Rs. 3.54 lakhs and average cost of a flat is Rs.1.2 crores”

    Such statements are meaningless and totally misleading. You need to look at the income of those people who are buying flats worth 1.2 crores. Definitely folks with income of Rs. 3.54 lacs /annum are not buying houses worth Rs. 1.2 crores.

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