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

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Real Estate: The fall has just begun

Posted by Muthu on July 23, 2015

In global markets, gold has fallen over 40% in last 5 years and silver has fallen over whopping 70% during the same period. Commodities prices are also crashing. The Bloomberg commodity index is now at 13 year low.

We’ve written many times in the past about various asset cycles.

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. Commodities had a good run from 2002 to 2012 and it would not be a surprise if the current bear cycle last for next 2 decades.

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.

It looks like the current bear cycle in real estate has started some time in 2013. Real estate had a good run between 2004 to 2013. The earlier bear cycle for real estate started in 1996 and lasted till 2003.

Ambit capital has published a detailed report recently titled “Real Estate: The Unwind and its Side Effects.” It explains how unsold apartments are rising heavily in metros and tier 1 cities, property prices have started correcting even in Tier-2 cities as well, new launches are getting reduced, number of property transactions is significantly coming down etc.

Instead of like sharp corrections in stock markets, real estate market corrections are slow and last over many years. A fall of even 50% is not uncommon. In the 1996-2003 bear cycle, properties in many part of India fell by 50%.

Assuming this bear cycle lasts for 10 years, we may expect the real estate to rise again only in the early part of next decade. One significant change which is happening to real estate is that black money in the same has started coming down. The direction is very clear. As the environment and legislations are getting tough for black money, over a period, black money would play a significantly lesser role in the years to come.

Indian real estate prices have been kept very high and unaffordable for common man due to black money. During the current bear cycle in real estate, the black money also would be largely brought under control. If that happens, in my opinion, we can no longer expect mind boggling returns in real estate even in next bull cycle. Real estate would give around 2% to 3% more than inflation. If inflation is 5%, we can expect real estate to give 7% to 8%.

In a fair market, the rental yields are close to cost of borrowing. Whereas in India, the rental yields are 2% and the cost of borrowing is 10%. As interest rates soften, the cost of borrowing would come down. As real estate prices correct, the rental yields would also go up. This would narrow the gap between rental yield and cost of borrowing.

Another thumb rule is that the value of the property should not be more than 3 times one’s annual income. If your annual income 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. 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 the thumb rule, 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%.

It would not be a surprise that in next few years real estate prices fall to such an extent, that the rental yields may be around 5% instead of the current 2%.

In nut shell, the bear cycle in real estate has just begun. Don’t be surprised even if there is a 50% correction over next few years. Tone down your expectation on real estate even in the next bull cycle as black money would start playing a lesser role.

Learn to accept the following returns from asset classes over long run:

Fixed Deposits: Inflation + 1%

Gold: Inflation + 1.5%

Real Estate: Inflation + 3%

Equity: Inflation + 7%

27 Responses to “Real Estate: The fall has just begun”

  1. Ganesan said

    Thanks for the article.

  2. achal said

    Hi Muthu…What do you think will be the effect of this on equity market? Will the equity market not get affected as happened in the case of US housing crisis?

    • Muthu said

      Lower commodity prices are good for economy especially building infrastructure. I see money moving from real estate and gold to financial assets. I don’t think equity market would be affected by this.

  3. Hello Muthu,

    Superb Article !! I totally agree.

    I believe you meant to say NO longer in statement “If that happens, in my opinion, we can longer expect mind boggling returns in real estate even in next bull cycle”(NO is missing) in 11th paragraph.

    Thanks.

  4. nicegem007 said

    Let me add something more to it. It would be in three parts.
    You never owned it, even in a 25 year term, in the example mentioned above. If you take a Bankbazaar EMI calculator, for 20 year loan of Rs.75L, the interest payment at current value , as you compute now, comes around Rs.75L, means your net outflow is D O U B L E that of the actual cost. I am not adding the effects of rate change, Further, if you carefully watch the EMI pattern, the Interest payment is higher for the first 10 years, which means, the bank has taken full advantage of your D R E A M House in the first half, and later, when you realise the game, you no longer would try to get out of it. That is how a S I L E N T regret is incorporated, which you would not be A W A R E of it, or even if you have realized, you would not R E V E A L it to avoid embarrassment , you simply say ” I live in my OWN house”. REALLY?

  5. Gowrisankar N said

    Dear Mr Muthu

    Thanks for your efforts on the above article. Very informative.

    I have been tracking Chennai apartment prices in and around T. nagar, Anna Nagar, Kilpauk from Rs 500 per sqft to today’s Rs 12,000 per sqft, from 1990. I did not see any decline in price per sqft in the apartment segment in these 25 years, although the rate of increase has seen slowing down in some years.
    Could you please clarify / substantiate from your reading material on the info. on reduction in real estate price (more over 50% reduction in real estate price is never heard off).

    • Muthu said

      http://indiatoday.intoday.in/story/real-estate-business-in-india-faces-unprecedented-crisis-as-prices-plummets/1/276369.html

      • Rajendra said

        Conceptually this article is informative and true economy but practically not applicable in current situation / market.

        As long as developers have access to liquidity in the market, RE prices will not correct. Pls understand last 10 years, banks, nbfc, PE, housing finance companies & all large corporates (prop book monies) funds are at stake in the market. This institution still lend funds to developers. Good money given to developers / projects to save bad money. E.g. piramal funding Rs 1200 crs in omkar Alta Monte to give exit to existing lenders. Similarly piramal will get exit from new lenders. Until this cycle stop, real estate price will not correct. For piramal to make money, price need to appreciate by 10% yearly. Else developers will be forced to get new loan to fund Piramal 1200 crs interest expense roughly 200 crs per year. Like wise, all institution have deployed funds real estate sectors. HDFC is leader in this. Question is when will good money stop flowing to save bad money????

    • nicegem007 said

      What was the value of a Rupee in 1990 and what is it today? What are the surplus income levels from 1990 to this date?

  6. nicegem007 said

    Now, the Government will give tax breaks on the interest paid: say, on a 100% loan of 75 Lakhs, you pay around Rs. 72,000 (roughly) per month, the average interest part is around Rs.6.5 L per annum for the first 10 years…while the tax exemption is about Rs.1.5 Lakhs…interestingly , if you show it on rent, there is no LIMIT! The big boss allows you to lie….to get more gain out of it….if you stay in it, the additional burden is Rs.5L per annum, and this is not the PRINCIPLE Amount.
    After 10 years, the scene reverses. This time, the average ownership cost is Rs.6.5 L, and the interest cost is around Rs.3 L. So, the exemption still is not to your advantage . The OWNERSHIP is only given to you on a gradual basis, over 20 years period, and not at the beginning of the 20 year cycle.

  7. nicegem007 said

    Now people would argue because they WANTED to prove that they are more intelligent. Out of Rs.72,000/- EMI , deduct the rent you pay, that is your actual EMI. Comes around Rs.57,000/-. This way, the number of LOAN years will be reduced to 15. And if you pay some BULLET payments, you can reduce it to 10 years ….you can OWN it in 10 years….they do not realise what they say…instead of taking advantage of the situation , they wanted to get out of it as fast as they can….they put more money OUT of their pockets, while the bank takes the maximum interest in the first half of the loan period .
    One of my colleague revealed:
    Loan taken in 2002 : Rs.5L.
    EMI for a 20 year period: Rs.5,340/-
    Outstanding as on this date: Rs.3.1 L/-….
    I was shocked….to realize that when he approached the bank, he still had 12 more years of EMI left to be paid……now it is left to the readers to understand……

  8. nicegem007 said

    How much opportunity lost?
    Say, you opted NOT to own a house.
    There is a free cash of around Rs. 3.5 L last year.
    KITEX would have given you Rs.35 L, as it was available at Rs,100/-
    SHREYAS would have given you Rs. 25 L, as it was available at Rs.80/-
    Arrow coated products would have given you Rs. Rs.15L
    If you saw Arrow coated Products just another year back, …”
    MY DEAR MUTHU…….
    With Rs. 3.5 Lakhs, you would have gathered 35000 shares, and today, it is quoting around Rs.500/-……
    OMG! OMG! OMG!
    You would have RUPEES ONE CRORE SEVENTY FIVE LAKHS…..
    Have I lost my mind?
    ……
    BOLTI BAND!

  9. nicegem007 said

    Please go and encourage people to take EMI route to OWN their houses, we need them there…..while ……

  10. nicegem007 said

    By the way, Ajanta Pharma’s SEVEN year returns????????
    Ajanta Pharma Ltd. 10066%
    Which means if you have invested this are.3.5 Lakhs in 2008, today it would be………Rs.352 Crores…….
    And my dear friend, that is Power of Conviction and Compounding…..

  11. sachin said

    real estate should start recovering slowly from 2016 in smaller town and city whereas metro city will see improvement after 3 to 4 years from now.

  12. nicegem007 said

    Here is another Gem with which I had lunch today, with my wife giving me the standard looks and of course admiring the young cousin.
    He booked a Villa of 220SQY and 2200 sft built-up-area ….WELL, in 2012, with an advance of Rs.10L. The loan was not sanctioned easily, and I spite of being a Software Employee, the builder could arrange the Rs.42L from Tata Capital. The amount was handed over to the builder from Tata a Capital in December, 2014, and the Villa would be handed over , in June2016……
    Will they allow the design to be changed? NO
    Will they pay any penalty for delay beyond the promised schedule? NO
    Will they pay the EMI until it is handed over? NO
    Will they reduce the EMI as the rate changed recently? One month EMI was reduced.
    Loan period? 20 Years. Isn’t it too long? The answer is “we will close the deal in 10 YeRs”
    Who said Mantri Developers is in Pune? Who can double your investment in three years?
    They are everywhere! Here in Hyderabad too..
    And by the way, do not say anything about it, otherwise the Cousin gets HURT! Especially, if it is from your Spouse side……
    Shshshsgahshshzh!!!!!!!!!!

  13. Siddhartha said

    Muthu, you have posted once again a marvelous article. It is a healthy food for thought for every reader that makes us read it again and again.

    Just a piece of advice, why don’t you write a book on Financial Planning (with an attractive title). You already have so many inspiring articles on your website (including archive) which could easily make a 300 page book.

    Take my words, if you do so, your book would surely be a reference book at IIMs and may be even at the Howard University School Of Business.

    All the best, Muthu!!

  14. Ashish said

    Mark Twain said: Buy land they are not making it any more! I agree with the bull and bear cycles you explained but then one needs to diversify investment. Also the math you put behind the property not being more than 3X of one’s income also does not sound appropriate. I have myself successfully closed a loan for a property that was 10X of my yearly income when I bought. It took me 4 years to close that. We need to factor the income growth of an individual. I still regret not pushing this more and buying the dream house as I felt it was expensive then and today I cannot buy it. Reason its too expensive but if I bought it earlier I would have surely closed the deal in 6-7 years.

    I invest in all commodity (as this is only thing you can liquidate even middle of the night), stocks (higher risk but higher gain), property (long term security, and regular returns in the form of tax savings and rental income)!

    Idea is to invest in the bear market and watch or liquidate in a bullish market!

  15. ratnakumar72 said

    very good article…

  16. Geeta said

    The article is too good to get information about when one should invest in real estate which is normally confusing decision for common people

  17. Jitendra said

    Thanks for article

  18. […] the forward to a blog by certified financial planner D. Muthukrishnan of Wise Wealth Advisors, http://mintne.ws/1MhqzZZ . Very sensible stuff; do read. And remember to build in the tax impact on the final average return […]

  19. Radhika Iyer said

    I feel the real estate has now begin to grow. Not in terms of cost but in terms of facility provided.
    The USP of the real estate ventures are focused on the quality of flats and the amenities provided to them. One such project is done by Radiance Realty under the guidance of Varun Manian.

  20. Ashish Awasthi said

    All this on assumption of magical number of 15… which is not going to happen because it implies 6-7% yield. At 7-8%, one would get home loansin coming years, so why will he consider renting instead f buying a home ???

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