Wise Wealth Advisors

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

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Archive for the ‘Real Estate’ Category

40,000 times in hundred years= 11.3%

Posted by Muthu on August 7, 2016

I was reading this article written by Vivek Kaul.

A bungalow in Nepean Sea Road, South Mumbai was bought for around Rs.1 lakh in 1917. It is now going to be sold for Rs.400 crores. The value of the bungalow has multiplied by whopping forty thousand times in 100 years.

Real estate is always discussed in terms of how many times it has multiplied. Rarely anyone in that industry calculates XIRR or annualised returns. 40,000 times in 100 years when expressed in terms of XIRR is 11.3%. Not a bad return at all. But nowhere as glamorous as saying 40,000 times.

Many tell me something like that the property they bought 25 years ago has multiplied by 10 times. Sounds fantastic. But the annualised return works out to 9.6%.

When I say Birla Sun life Tax Relief’96 has provided around 26% returns in last 20 years, it doesn’t sound much sexy. When I rephrase that the fund has multiplied wealth by 100 times in 20 years, it suddenly looks very attractive.

Generally, we the advisors always talk in terms of annualised returns. If I say, you may expect around 15% annualised returns from equity over next 20 years, what it means is that the money getting multiplied by 16 times.

Do one thing. Use the simple function in excel or a financial calculator to calculate returns in terms of XIRR. An exotic 10 times in 25 years would be converted into a modest 9.6% XIRR. Comparison between asset classes would become meaningless if not measured in the same way.

Learn to measure everything in terms of annualised returns. This would not only impart better financial literacy, it would also reset your expectations to more realistic levels. If a prime property in Mumbai can ‘only’ deliver 11.3% over 100 years, you would learn to be contended with 9% annualised returns from your real estate investments.

The 2004-07 bull market in stocks, the 2004-09 boom in real estate are more of exceptions than the rule. As I’ve mentioned before, in the long run, you may set your expectations as follows:

Fixed Deposits: Inflation + 1%

Gold: Inflation + 1.5%

Real Estate: Inflation + 3%

Equity: Inflation + 7%

Next time when you meet me, let me know how much annual returns your real estate investments has delivered over last 2 decades.

The number may surprise you.

Posted in Real Estate, Wealth | 9 Comments »

Some thumb rules for house and car

Posted by Muthu on January 9, 2016

1) In a fair market, the rental yields are close to cost of borrowing. If cost of borrowing is 10%, rental yield also need to be around 10%. Then only it makes sense to own a house.

2) 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.24 lakhs, your house purchase value should not be more than Rs.72 lakhs.

3) 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. In other words, the minimum rental yield should be 5% to justify owning a property.

4) 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.

5) Home loan EMI as a part of your income (debt to income ratio) should not exceed 30% (i.e.) EMI should not exceed 30% of your take home pay.

6) The maximum you can pay for the car should not be more than 5% of your net worth. So if your net worth is Rs.2 crores, the car should not cost more than Rs.10 lakhs.

7) Makes more sense to buy a new car. But you should drive it for not less than 10 years.

8) 20/4/10 rule: If you decide to borrow for your car, you should at least put 20% down payment. The repayment tenure needs to be not more than 4 years. The monthly transportation cost should not be more than 10% of your take home salary. Transportation cost includes EMI, fuel and insurance.

9) The best rule: If you can save money and then buy a house and car by making full payment. No debt is the best option. Debt is slavery.

Posted in General, Muthu's Musings, Real Estate | 19 Comments »

It’s real

Posted by Muthu on August 27, 2015

As you are aware, in April of every year, we provide comparison charts of various asset classes since 1979-80, the year in which Sensex was formed with a base as 100.

Just to refresh your memory I want to share here the annualised return of Fixed Deposits (FD), Gold and Sensex for last 36 years:

FD: 8.41%

Gold: 10.25%

Sensex: 16.93%

This shows equity has given 2 times the FD returns and 1.65 times the gold returns.

This number doesn’t convey the reality.

As I’ve repeatedly told you, what matters is real returns; the returns after inflation.

Inflation during the above period was 7.73%

So the real returns look like this:

FD: 0.68%

Gold: 2.52%

Sensex:9.2%

This shows equity has given a real return of 14 times the FD and 4 times the gold.

So when it comes to real return; which is how our wealth actually multiplies, FD and gold stands no chance in front of equity.

We’ve only accounted for inflation. What about taxation? FDs are taxed at the tax slab you belong to and gold at 20% of the indexed cost. But long term capital gain of equity is completely free.

So if we adjust for taxation also, FDs would not provide any real return and gold would provide significantly lesser than 2.52%. Whereas Sensex would still provide 9.2%.

You may be wondering about real estate. There is no reliable long term data for real estate. Real estate would normally provide around 3% above inflation. So what is true for gold above would more or less hold good for real estate as well.

Also one more thing. Sensex had a dividend yield of close to 2% over 36 years. That is not included in the above calculation. Equity is already a huge winner in terms of real returns and adding dividend yield would only make it returns further extra ordinary.

Go for the real wealth creator. Go for equity.

Posted in Basics, Gold, Real Estate, Stock Market, Wealth | 2 Comments »

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%

Posted in Real Estate | 27 Comments »

How Donald Trump lost Rs.64,000 crores in real estate?

Posted by Muthu on July 20, 2015

As you are all aware, Donald Trump is a billionaire real estate tycoon in USA and is currently running as one of the presidential candidates.

Donald Trump father was a multimillionaire New York real estate developer who left him a fortune which was estimated at $500 million in 1982.

Over last 4 decades, Trump has developed his father’s business to a grand level and has a current net worth of $10 billion.

He has grown his father’s real estate empire during the last 33 years at an annualised return of 9.5% or multiplying wealth by 20 times.

During the above period, to achieve this return, he took excessive risks and due to excess leverage, he has filed four corporate bankruptcies. In nut shell, he made this return by taking undue risk with great difficulty.

During the same period, S&P 500 (an index of 500 of America’s largest companies) has provided an annualised return of 11.86% or multiplied wealth by 40 times.

By simply investing $500 million in S&P 500 index in 1982 and doing nothing whatsoever for last 33 years, would have made Donald Trump’s net worth at $20 billion instead of the $10 billion he has today.

His opportunity loss of investing in real estate instead of equity is $10 billion or Rs.64,000 crores.

This is yet another example of how equity is a much better asset class than real estate in the long run.

Please note that the idea of writing this piece came from reading this article.

Posted in Real Estate, Stock Market, Wealth | 5 Comments »