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Should You Invest in Real Estate or Mutual funds?

Residential housing prices in the country have more than tripled in the past decade. Does it make a strong case for investing into real estate?

Residential housing prices in the country have more than tripled in the past decade.

It has appreciated by 13.8% annually for the period Mar’09- Dec’18, as per NHB Residex data (All-India) - beating consumer inflation by a wide margin. During the period, prices in Mumbai (15.7%), Delhi (15.9%) and Kolkata (15.3%) saw the maximum increase followed by Bengaluru (10.0%) and Chennai (10.6%).

Does it make a strong case for investing into real estate?

Returns: For starters, during the mentioned period, equities as an asset class managed to outperform real estate returns – albeit by a small margin of 60 basis points. Equity performance as measured by Sensex was up by 14.4% during the period.

However, if you had invested in equity funds, outperformance could have been much more.  20 equity funds (excluding pure midcap, smallcap and sectoral funds) gave average annualized return of 18.3%.. SBI Bluechip (17.6%), HDFC Top 100 (18.0%) and Aditya Birla Sun Life Frontline Equity (18.5%) were among the popular equity funds in existence from or before  2009 that handsomely rewarded its long-term investors. While real estate has appreciated, equity funds have a better score card. Going ahead, we expect equity funds to deliver about 12% annually keeping in line with the growth of the economy.

Convenience: Buying real estate involves considerable paperwork and constant oversight. It takes time to get possession and involves transaction costs in the form of stamp duty and registration.

Buying real estate involves considerable paperwork and constant oversight. It takes time to get possession and involves transaction costs in the form of stamp duty and registration.

Moreover, after the purchase, it requires hands-on monitoring to attend to maintenance-related issues like fixing sewer lines, painting or building-related repairs.

In contrast, investing in mutual funds is a breeze. You can buy and sell funds at the click of a button without any transaction costs. Unlike property, you can easily switch from one fund to another without hassle.

Liquidity

Sell your fund and its investment proceeds get credited into your bank account in a matter of days. Moreover, there is no ambiguity as to its pricing – as NAVs are declared as per regulatory norms.

In case of real estate, selling can take months or even years. This is because you need to actively solicit buyers through advertisements or hire agents (who charge a fee of 1-2%). There is, also, no single market price. That could mean many negotiations before arriving at an agreed price.

Minimum size

One can invest as little as Rs 1000 into mutual funds as against locking lakhs into a single property. This makes mutual funds much more accessible to anyone, even those with smaller savings. Investors also get a diversified portfolio of stocks from varied businesses which reduces portfolio risk.

Buying real estate involves considerable paperwork and constant oversight. It takes time to get possession and involves transaction costs in the form of stamp duty and registration.

Poor yields

Rental yields are about 2-3% per annum. For instance, a house property valued at Rs 1 crore might fetch Rs 21,000 - Rs 25,000 in rental income every month. This varies a lot with the location. A stable liquid fund delivers around 7% annualized returns. This translates to roughly Rs 50,000 plus per month if the same crore were invested there.

You would need to shell out money on taxes, maintenance and repairs even if your property remains unoccupied. While the property buyers could benefit from capital appreciation, they hardly capitalize on it – given the paperwork, cost as well as tax implications.

Taxation

Long-term capital gains (LTCG) on equity funds are taxed at 10% without indexation. However, in a financial year, up to Rs 1 lakh of capital gains are exempt. 

In case of house properties, you get tax exemption on interest as well as principal component of home loans. When the property is sold, you pay LTCG at the rate of 20% after indexation.

Take-away

When you consider aspects of convenience, liquidity, diversification, transparency and wealth-generating potential, equity funds have an edge over real estate.

Over the long-term, real estate might deliver 2-3% over inflation but it doesn’t make a lot of sense as an asset class if you have to borrow to finance your purchase. Buy a house to live in it. For your financial goals, there are better, and more accessible, asset classes like equity and fixed income.


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