Real Estate vs Equity
Which One's Right For You?
Over the years, we have heard the comparisons as to which is the better investment: real estate or stocks. Both have their advantages and disadvantages, and there are several aspects of each that make them unique investments in their own way. To make money with either investment requires that you understand the positives and negatives of both.
Real estate is something that you can physically touch and feel – it's a tangible good and, therefore, for many investors, feels more real. Maybe this partially accounts for the high return on the investment, as from 1978-2004, real estate has had an average return of 8.6%. For many decades this investment has generated consistent wealth and long term appreciation for millions of people.
Real Estate - How it Works
Real Estate - How it Works
Generally, there are two main types of real estate: commercial and residential. While other types exist (mobile home parks, strip malls, apartment buildings, office buildings, store fronts and single-family homes), they generally fall into those two categories. Making money in real estate isn't as cut-and-dry. Some people take the "home flipping" route – searching for distressed properties, refurbishing them and selling them for a profit at a higher market value. Others look for properties that can be rented in order to generate a consistent income.
Generally, a down payment of up to 20% of the purchase price can be made, and the rest can be financed. This gives you leverage, meaning that you can invest in different types of properties with less money down, helping to build your net worth or income that you could make off the properties. While this can be a positive, if this leverage is used incorrectly, you may owe more on the properties than they are actually worth.
Equity / Stocks
From 1978-2006, stocks have delivered an average return of 13.4%. They can be more volatile than real estate but over the long run they have provided a much better return than real estate's 8.6% average.
Equity / Stocks - How it Works
Equity / Stocks - How it Works
With a stock, you receive ownership in a company. When times are good, you will profit. During times of economic challenges, you may see diminishing funds as the earnings of the company drop. Taking a long-term approach and being balanced in many areas can help build your net worth at a much greater rate, compared with real estate.
As with real estate, financing in stocks allows you to use margin as leverage to increase the overall amount of shares that you own. The downside is that, if the stock position falls, you could have what is known as margin call. This is where the equity, in relation to amount borrowed, has fallen below a certain level and money must be added to your account to bring that amount back up. If you fail to do this, the brokerage firm can sell the stock to recover the amount loaned to you.
Which is better for Investing in India?
Equity Vs Real Estate
Real Estate Investment
Case 1: Real Estate Investment
Following is the data being used:
→ Value of Property = Rs 75 Lacs (1500 sq ft @ Rs 5000/sq ft)
→ Required Initial Down Payment (@20% of Property value) = Rs 15 Lacs
→ Loan Availed (for remaining 80%) = Rs 60 Lacs
→ Loan Tenure = 20 Years
→ Loan Interest Rate = 10.15%
→ Few more administrative costs are as follows:
→ Loan Processing Charges & Other Expenses (@2% of Property) = Rs 1.5 Lacs
→ Registration Fees (@10%) = Rs 7.5 Lacs
Interest Paid over 20 Years = Rs 80.30 Lacs
And as you can see in the last column in table above, this property has also been able to generate post-tax and expense adjusted rental income. We used a few assumptions for rental income and expense which are as follows:
→ Rentals increase by 5% every year
→ Rental income from property is taxed at 20%
→ Maintenance expenses are recurring every 5 years: Rs 1 Lac (5th year), Rs 1.5 Lac (10th year), Rs 2 Lacs (15th year) and Rs 2 Lacs (20thyear)
All in all, these result in an amount of Rs 24.67 Lacs being generated from the property over a period of 20 years.
This means, that effectively the property costs about Rs 1.39 Crores as depicted in table below:
Now as per general perception (at somewhat backed by data too), the properties are known to appreciate in price. But here, we are not talking about property prices doubling every 2-3 years. We are talking about much sensible returns ranging from 9% to 12%.
Mutual Fund Investment
Case 2: Mutual Fund Investment
We are using the following data for this case:
Initial lump sum investment in MF schemes of Rs 24 Lacs. This amount is equal to the sum of Initial Property Down Payment (Rs 15 Lacs), Registration Charges (Rs 7.5 Lacs) and Loan Processing fees (Rs 1.5 Lacs).
Now the EMI amount in earlier case was Rs 58,459. This amount in this case can be used as monthly SIP. But we also need to consider the tax benefit of Rs 1 Lac availed on house loan investment – which is to be equated monthly. That amounts to Rs 8333 and resultant amount available for monthly SIP is Rs 50,126.
So here is the calculation sheet for two types of investment scenarios.
First one is where returns from MF move from initial 12% to 7% in later years. These are conservative numbers when compared to returns given by really good MFs.
Second one is a slightly aggressive returns assumption based analysis. Here the returns move from 15% initially to 7% in later years. But even then the returns of 15% are not that rare and have been achieved by quite a few funds in India for decades.
Now what happens when these funds are sold after 20 years? There wont be any tax as long term capital gains is not taxed in India for stock market returns. So for an investment of Rs 1.44 Crores (lump sum + SIP of 20 years), a corpus of Rs 10.28 Crs and Rs 7.06 Crs has been achieved. And mind you, this return has been achieved despite having paid the additional tax @ 8333/- per month for 20 years. And these numbers are substantially higher than the real estate investment even after tax saving.
This means a net expected gain ranging from Rs 5.61 Crs to Rs 8.84 Crs.
Compare these numbers with those of Real Estate case and you will understand what this article is trying to point you towards.
Why do People Invest in Real Estate?
We have tried to list down a few reasons which we though people have for investing in real estate. And here were are not talking about the 1st House but about the 2nd property, which is treated as an investment:
→ There is mental comfort in buying a hard asset that you can see and feel (also applicable to gold).
→ It is an asset that can be funded largely through long-term debt (75% Funded by banks). No other asset provides such a benefit.
→ It is a big asset, which you can acquire and then comfortably pay back via monthly payments (EMIs) over a very long period of time. Once again, no other asset provides this benefit.
→ The comfort we get by doing mental accounting about tax savings in real estate investments. One always feels happier when one is told that they don’t need to pay tax or no money would be deducted from salary, because of tax savings due to loan-funded real estate investment.
→ Second income from spouse, which can be used to get additional tax benefits (by being a 1sthome loan for the spouse) by taking a home loan.
→ Comfort of getting a stream of rental income. An income, which you get without working for – passive income. But most of the times, people forget about the linked expenses.
→ General opinion that it is a hedge against inflation.
→ Mental fix that there is Zero Risk in real estate purchases (in reality, there are more risk than most other investments like gold and mutual funds).
→ Justification that it is an investment for the next generation(s).
→ High return expectations due to the recent past records (say last 15 Years).
→ Black money at work!!
→ Pride of owning multiple real estate investment and being known as the ‘Landlord’.
→ As there is no daily ticker, the daily mental valuation of the asset does not take place.
→ Mental satisfaction and happiness when disclosing to others that you own multiple properties.
→ The perception that since everyone is investing in real estate and profiting from it, even I should do the same and make easy money.
→ You always hear story from neighbors that they bought a flat for Rs 900 / sq ft 15 years ago and now it is worth Rs 5000 / sq ft. Here mental maths comes into picture. Mentally you might think that this 900 to 5000 appreciation is more than 5 times and a very profitable one. But neighbors comfortably forget to tell you about the expenses they incurred in these 15 years or in repaying loans. Actual returns are always calculated net of expenses. Its neighbor’s envy and owner’s pride (copied from an old Onida TV advertisement). For those who want to turn Rs 900 to Rs 5000 in 15 years, it’s not that tough. You can do it at 12.1% per year.
Why do People Invest in Mutual Fund
When considering investment opportunities, the first challenge that almost every investor faces is a plethora of options. From stocks, bonds, shares, money market securities, to the right combination of two or more of these, however, every option presents its own set of challenges and benefits.
→ Beat Inflation - Mutual Funds help investors generate better inflation-adjusted returns, without spending a lot of time and energy on it. Suppose you have Rs. 100 as savings in your bank today. These can buy about 10 bottles of water. Your bank offers 5% interest per annum, so by next year you will have Rs. 105 in your bank.
However, inflation that year rose by 10%. Therefore, one bottle of water costs Rs. 11. By the end of the year, with Rs. 105, you will not be able to afford 10 bottles of water anymore. Mutual Funds provide an ideal investment option to place your savings for a long-term inflation adjusted growth, so that the purchasing power of your hard earned money does not plummet over the years.
→ Expert Managers - Backed by a dedicated research team, investors are provided with the services of an experienced fund manager who handles the financial decisions based on the performance and prospects available in the market.
→ Convenience - Mutual funds are an ideal investment option when you are looking at convenience and timesaving opportunity. With low investment amount alternatives, the ability to buy or sell them on any business day and a multitude of choices based on an individual's goal and investment need.
→ Low Cost - Probably the biggest advantage for any investor is the low cost of investment that mutual funds offer.
→ Diversification - Going by the adage, 'Do not put all your eggs in one basket', mutual funds help mitigate risks to a large extent by distributing your investment across a diverse range of assets. Mutual funds offer a great investment opportunity to investors who have a limited investment capital.
→ Liquidity - Investors have the advantage of getting their money back promptly, in case of open-ended schemes based on the Net Asset Value (NAV) at that time.
→ Higher Return Potential - Based on medium or long-term investment, mutual funds have the potential to generate a higher return, as you can invest on a diverse range of sectors and industries.
→ Safety &Transparency - Fund managers provide regular information about the current value of the investment, along with their strategy and outlook, to give a clear picture of how your investments are doing.
Certain mutual fund investments are tax efficient. For example, domestic equity mutual funds investors do not need to pay capital gains tax if they remain invested for a period of above 1 year.
MFs are managed by professional fund managers, responsible for making wise investments according to market movements and trend analysis.
MFs allow you to invest your savings across a variety of securities and diversify your assets according to your objectives, and risk tolerance.