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

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Delay your house

Posted by Muthu on May 10, 2015

As you would have noticed, I wrote lot of pieces last year. It has again come down to around two a month. The frequency depends on my ability to generate ideas. Whenever possible I’ll write more frequently. Otherwise, I’ll try to stick on to at least twice a month.

Today I’m sharing (with some modifications) a piece I wrote last year.

I happened to meet two friends from our industry recently.

The conversation went around the year 2002 when all asset classes were at multi year low, with all round pessimism and gloomy global scenario after 9/11 incident.

We people who prefer equity are a tiny minority in this country. We feel equity is not given the right place it deserves in investors’ portfolio despite it being better than real estate.

We reviewed some presentations which had data as to real estate prices in prime areas of Chennai around 2002.

I chose Adyar for this piece. It’s because Adyar is the place I live. Some time ago ‘Economic Times’ carried data as to how Adyar is the richest locality in Chennai. We purchased the flat we live during the above period (2002-03). We paid Rs.2300/- per square feet for the 1000 Sq.ft 2 BHK we live in.

After 12 years, a similar flat (a new 2 BHK) is quoting around Rs.15,000 per sq.ft. We paid Rs.23 lakhs in 2002, the value of which is Rs.1.5 crores now.

If I want to sell the flat, it would go for lesser than Rs.15000 per sq.ft as it is more than 10 years old. However for the purpose of this discussion and to the joy of real estate enthusiasts, let us assume we would be able to sell the old flat at the price of the new flat.

We took one fund in 2002. We choose Reliance Growth Fund since one of the friend was from there. The NAV of Reliance Growth Fund (RGF) as on 1’st January 2002 was Rs.19.75 It’s NAV as on May 8th 2015 was 778.55.

RGF was once an excellent performer and turned out to be an average fund during last couple of years.

If I had invested Rs.23 lakhs in RGF instead of Adyar flat, it’s value would now be Rs.9.06 crores or say Rs.9 crores.

Unlike house where I’ve to pay 20% capital gains tax and where I would be getting lesser value than market price, in RGF there is no tax on the gains made and I get 100% of NAV (after adjusting for STT).

Out of the Rs.9 crores proceeds:

I can now buy a 3BHK+ 1 Study (2200 sq.ft @ Rs.15000 per sq.ft) for Rs. 3.30 crores in Adyar itself.

I can also buy any high end luxury car for around Rs.40 lakhs.

The balance Rs.5.3 crores, by prudently investing in instruments like MIP, I can withdraw 9% per annum. This means I get Rs.47.70 lakhs per annum or a nice pension of around Rs.4 lakhs per month.

All we should have done is to invest in equity in early part of the career and bought the house in the later part.

I’m not against real estate. In my opinion, it has potential to generate few percentage points more than inflation in the long run. Also we all want to own the home we live in.

Since we tie up huge net worth including decades of future income also into the house, we never get opportunity to create big wealth which equity is capable of providing us.

We need to debate if it would be wiser to create wealth during the first 20 years of career through equity and then go for owning a house.

This is just a thought. The idea may have merits and demerits.

To me, merits appear significant.

25 Responses to “Delay your house”

  1. Raj said

    Well it is possible to raise debt to fund RE purchases. Your Rate of Return would be much higher due to debt.

    The same is not true for MF purchases.

  2. Rishub said

    I think you should also look at this from an RoE point of view since you will get ~4x leverage when buying a house as one would usually take a home loan. Also, looking at buying a fund at a certain point in time leaves one to the luck of timing.

  3. Prateek Chaudhary said

    Interesting thoughts…..nothing beats long term wealth creation though equity investing.

  4. Sreekanth Yelicherla said

    I can challenge the author! Despite after reading the article, there are people who still think real estate is really generating meaningful returns. I don’t honestly want people to realize it either. Someone’s loss is someone’s gain.

  5. i always find your articles very interesting.. this time you calculated from 2002 lows . do you think same kinda return next 13 years.. also how much return possible via balanced conservative fund 65 debt and 35 equity ?? pl. guide …..

    • Muthu said

      Going forward, for next one decade, we may expect 18% annualised return from equity funds. 65% debt and 35% equity- you may expect around 9% to 10%.

  6. Dr. viraj shah said

    Well sir,what about the calculation of the rent which you need to pay during those 13 years when you are not buying a house and invest in equity?

    • Naveen said

      Good question. I am just about to ask the same question.

      • Kumar said

        from 2002 to 2015, say 13 years … 13000/- per month and it comes to hardly 21 lakhs for these 13 years.. 9 crores – 21 laksh= ____……… still not convinced that equity is the best for those who dont understand any other business than equity? wake up guys….

  7. Sarav said

    Very useful insight. Would appreciate if this can be done on Apple-to-Apple comparison. You should subtract 12 years Rental expenses (SIP in RGF) from Equity Case (Rs 9 Cr). Otherwise the magnitude in Equity Case is misleading. Would appreciate if you could post this number also. Sarav.

    • Sarav said

      Simplistic comparison (least assumptions without complicated leverage, EMI etc) would be : House Case (Flat was bought with own funds) Vs Equity Case (one time initial investment in RGF less Rental expenses – 12 years monthly SWP in RGF)

  8. sujay said

    Nice article Muthu,
    This is the first time I read your blog, It’s a nice article. Just to simplify things, when one has no enough funds to buy a flat without taking a loan, it would be nice to invest 7-8 lakhs (30-35% needed for down-payment) in RGF in 2002. This would be around 3 crores by now, one can as well still buy 1bhk flat and have 1.5 crores invested. People are worried of the rent one had to pay rent all these years, but again one has to pay emi in case of a home loan.
    Regards,
    Sujay

  9. piyush08 said

    so totally agree.. but this is a slightly flawed analysis given point of view..
    and its strange I’m saying this cause I have forever been a believer in equities over everything else.. but after 12 years of looking/reading/experiencing finance i appreciate point of view of both sides better

    this whole comparison is correct, but does it validate real life behaviour? Reliance growth fund fell 62% from peak during 2008. If you built up a corpus of 10 crores in RGF by 2008 peak and saw it fall by 62% in 2008, how long would you hold on before selling? How long before you sold? Would you sell when it bounced back to highs or have the conviction to hold till now? And this is not just 2008, every few years a midcap fund will see 30-40% drawdowns. Who has that kind of conviction in equities. Despite being such a strong believer in long term positive returns, I’ve seen real life situations where I’ve got out. And I’ve felt just get out I don’t care anymore, and no more equities for me. So this kind of excel analysis ignores that human context.

    My dad believes real estate is a great asset. Why? He bought something @ 1800/sqft in 2003, and now 12 yrs later its at 9000/sqft. Wow! great returns. When I ask him to calculate approx how much that meant in CAGR, he thinks its 20%. In reality, its 14.5%. Good return, but when you put it in % terms doesn’t look all that big. Equities, even if in 30-40% proportion in your portfolio should be able to beat those returns. But wait a sec – we again ignore real life behaviour. with real estate one can’t see prices on a daily basis – there is no up and down happening. there is no one counting on a hourly basis how much profit/loss you’ve made from your portfolio. there is no crash happenings.. no prices falling everyday and no one on TV talking about it going down further. there are no penny stocks equivalent where prices keep going down and down till they reach 0. and biggest of all – there is no decision making to be made on an ongoing basis when there is lots of profit on the table – should i book it, or should i hold on, what if i don’t book and it comes down.. what if i seel and it goes up.. etc etc.. in reality though it may see like with demat and online trading equities should be much easier to hold and with such difficulty in exiting – real estate is difficult to hold. But with no decision making to be done – real estate just becomes so much easier to hold – just buy and forget about. No worries.

    In reality, even though real estate gives lower returns than equities, most people make way more money in real estate investing because they just end up holding it for far longer. What’s the use of compounding if you hold positions for 1-2 quarters. So I’d rather gain from fruits of compounding with a lower IRR than higher IRR but short holding periods. Easy to say hold investments for 20 yrs, very difficult to do with equities. Only loss making equities positions are held for 20 yrs. The profit ones are booked as soon as lock up period expires. If only psychologically I could think like Rakesh Jhunjhunwala. I’d rather try and do what works, than try and change my and my parents psychology to convince them to first buy equities in large proportion of their new worth and then hold onto it through 62% drawdowns.

    Btw – I totally ignored the leveraging affect from buying a property on loan. My dad only paid 15 lakhs for a 35 lakhs property which is now worth 1.75 crores. I paid 15 lakhs for a 1 crore property in 2010 which is now worth 2 crores. So that’s a 1 crores profit on capital of 15 lakhs. But maybe that’s just a bull market phenomenon in real estate where gains outsize the funding cost. Maybe in normal years they sort of keep pace, so the returns won’t be so outsized like it has been. But again, there are tax benefits and rental income etc. I’ve done some detailed calculations which say if i fund property purchases with 70% bank funding and get 3.5% rental yield (reality in bangalore, but not in delhi/mumbai), and i claim tax benefits on the interest paid portion, and property prices go up just 8% annually, I’ll make a good 14.5% IRR over 10 years(taking into account all cash flows, upfront payment, EMIs, rent, taxes saved etc). For every 30 lakhs i put in, I get net gain of 1 crores 15 lakhs at end of 10 yrs. So i end up with total 1.45 crores at end of 10 years for every 30 lakhs i put in now. This is only at 8% CAGR in capital price of the property. No worrying about daily up down of market.

    I still believe in ability of shares to give superior returns, I have no doubt about it. But knowing my own ability and general psychology, I’ll simply go and leverage to buy real estate instead to make some meaningful returns.

  10. DJ said

    Is the investment in RGF lumpsum or thru SIP mode?

  11. aman said

    Hi Sir,

    A good article which makes us think about RE vs Equities. My question is though different. You commented that “If I had invested Rs.23 lakhs in RGF instead of Adyar flat, it’s value would now be Rs.9.06 crores or say Rs.9 crores.”

    1) To a retail investor, would you recommend investing INR 23 Lakhs (not a small sum) in a single lump sum
    2) If you had the sum of 23 Lakhs upfront, wouldn’t you have diversified between say 3-5 funds, would have carried an SIP, invested in lump during corrections, left some money in the bank etc….

    By just selecting a fund and use one lump sum time frame, the results are extremely skewed towards the topic of the article.Please don’t feel I am criticizing you, however, if you could write one more article, capturing my above points, it would be much more credible.

    Nevertheless, appreciate your efforts in increasing financial literacy among small investors and please keep up the good work. Regards

  12. Murty said

    My point is, if one has such a high conviction in equity, after generating such a huge income, say 6 crores, why would one throw a part of it on Real Estate again? Transfer this to the next generation and teach them the importance of investing in equities……after all, if 23 Lakhs can make YOU a 6 Crorepati, your Lucky ones will get 15 crores after another cycle…..any comments?
    I think , in spite of the calculations, on ROE, everyone is skeptic, and ready to buy a house on cash….my two cents are to the land you can get with 23 lakhs at the beginning of the cycle, or with the 6 Crores at current levels ….if it is now, you can buy hmmmmmm,m…….!!!!!!!! ONE HUNDRED ACRES OF LAND……@ 6 Lakhs an acre….
    .in 2002, with 23 Lakhs, I could have bought………..the same ONE HUNDRED ACRES of land, which would have fallen in the current PRIME locality….Guys,….take your calculators and compute, at a minimum of 60 Lakhs an acre, ( 4484 * RS.12,000/SQY) minus the infra cost, which is 20%, which means 80 Acres @ RS .60 lakhs ……hold your breath…..FORTY EIGHT CRORES……
    Bottom Line: WE ALL HAVE DIFFERENT CALCULATORS…..

  13. nicegem007 said

    With 23 lakhs in 2002, I could have bought 100 Acres, which falls in the current prime property zone, and could fetch me Rs.48 Crores……any comments?

  14. K.I.Korah CFGP® said

    Muthu sir you said it correctly.Informative and educative for both investors and financial planners.

  15. SalimMomin said

    Hi Muthu!
    Somehow I feel that what you have written that has similarity with what I have been trying to explain to my clients about long term investments approach into Diversified Equity Funds.
    One of my relatives who left India in year 1985, a very successful businessman in US. Came to India and purchased the flat (though they already had one in the same housing-society) in year 2003 with Rs. 40 Lakh (2 BHK) now that flat has current value (considered 31st March, 2015) of Rs. 1.85 Crore.

    If you are an investor, had invested the same amt. in one of the best performing (best doesn’t mean giving you “superlative” returns year on year, but I considered best are those funds who have maintain their consistency during the multiple up & down cycles of the market and stick to their Investment Objective and Portfolio building / constitution) Equity Funds then it would have the present value (till 31st March, 2015) of Rs. 7,33,79,985. Interesting or not??????

    The biggest drawback (lack of Financial Literacy and lack of Conviction) which I have seen among Indian investors are that they have never considered Equity Funds could also generate huge wealth in a long run for them.

    My study allows me to say that after 12 – 15 Yrs. what Equity funds could generate returns that same you can’t expect from Bond, Gold and even from Real Estate investments too.

    Is it possible to sell just one Bed room and bathroom to get Rs. 50 Lakh??????
    YEEEEEEEEEEEEEEEEEEEEEEEEEs, it is very much practically possible in Equity Funds to redeem only that much of units equivalent to Rs. 50 Lakh.

    Thanking you!

    Regards,

    Salim Momin, CFP
    http://www.integrowth.co.in
    https://wordpress.com/posts/salimmomin.wordpress.com

  16. Satish Sarthi said

    Very well crafted, balanced, data rich article. Thanks for sharing

  17. ALWIN JAMESVIRGIN said

    Spot on..nobody likes to take the risk

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