Real Estate Investments Won’t Get Exceptional Returns of the Past

Preface

Most of my friends and relatives are still gung-ho about real estate (RE) as an investment. It is a place for them to park money for a horizon of more than two years. However, I am skeptical if real-estate investments would fetch the same attractive returns of the past two-three decades. I am also skeptical if it would be easy to liquidate real-estate investments at the ease it used to be a couple of years ago. But almost all of them agree to my views on avoiding real estate stocks. However, they agree to disagree with me regarding investing in a real-estate property. They look at me funnily as if I uttered a nonsense!

Why do I say investing in real estate may not fetch you the same exceptional returns the next decade or so, as it did in the last decade? Here are the reasons for you to think. Analyze if there is any truth in my stance:

Cause For The Past Real-Estate Boom

We need to understand the reason for the past boom before we get into analyzing the future. The underlying cause for the real-estate boom of the past decades were investment-based buying and black-money hoarding. Need-based buying was just a fraction of all the investments. A person may buy innumerable houses and acres and acres of land. However, his requirement is just one home to live. This behavior of buying excess real-estate properties is what we call investment-based buying. Why such behavior? To stash the black money safely. Is it for generating multiple streams of income? No, because the rental yield is a meager 1.5 to 2%. The other reason is the hope of prices going up further.

The sources of black-money generation include corruption, less declaration of income to tax authorities to evade taxes, illegal activities or businesses where income cannot be legitimately disclosed etc. All these days the black-money hoarders had the following options. They could bash their money. Cash is the easiest and the most preferred mode of payment in India compared to digital transactions. However, how much cash can you spend mindlessly? Our genetics are wired more to saving than spending. The other available options were to invest in gold, invest in the stock market through the Mauritius route, or invest in the real estate. If gold is to be hoarded, there is headache of protecting it. Hawala and investing in stock markets through Mauritius were feasible only for large chunks of money. Government gradually tightened the noose for gold and the hawala route also.

Safe Haven in Real Estate

Therefore, real estate provided the easy vent to hoard such illegitimate money. Investing in real-estate properties was easy. It could swallow any amount of money, from a few thousands to crores and crores of rupees. You don’t have to give security to your real estate properties, as you would have to do for gold!

As we all know, all these days investment in a real-estate property had two parts. The amount mentioned in the registration documents and the remaining unaccounted cash. Unaccounted cash AKA black money, accounted to around 20:80, 30:70 or 40:60. The lesser one in the ratio is the accounted money that’s subjected to income tax. Eventually, the greater one is the unaccounted money ( AKA black money) that’s not subjected to income tax. Thus the black money (either generated or received) found its way into real estate almost in every transaction involving a property transfer.

Pass The Buck

The sellers passed on the baton by buying more real estate, away from the cities. Thus, there formed a chain of property transfers in effect. Nobody cut that link to a halt without buying further. The chain kept on moving farther with more and more black money coming in. This inflated the prices sky high. However, the supply glut in the new, ready-to-occupy homes brought it to a halt a couple of years back. Supply outpaced demand.

Owning a home became a distant dream for the lower sections of the society and the middle class. For the salaried people, taxes are deducted at source. However, they paid their tax-paid money too as black money in the real-estate transactions! That’s the crazy part of the past real-estate booms.

Noose Around The Parallel Economy

As the boom was in progress, the government on its part gradually tied its noose around the neck of the parallel economy. Several measures to plug the loopholes were taken. It became more and more difficult to transact the black money or to convert the black money to legitimate wealth. It made it mandatory to quote PAN for remittances of Rs 50,000 or more in the banks. Remittances of over 5 lakhs or transactions of over 10 lakhs a year in a SB account were to be reported to taxmen. TDS (tax deducted at source) on fixed deposits got compulsory for interest receipts of Rs 10,000 or above a year. (At the rate of 10% if PAN is submitted and at 20% if PAN is not submitted.) Again, if PAN is not submitted, more trouble invited.

Through such measures, taxmen could easily track persons without PAN. They could keep vigil on the legitimacy of the transactions and deposits. Earlier, people used to scatter deposits around different banks and branches. Now everything is clubbed to the PAN irrespective of the bank or branch. The latest nail in the coffin – no cash transaction permitted above Rs 20,000, in a property deal. All these efforts gradually tightened the noose around the neck of black-money hoarders. Furthermore, RBI keeps recalling old rupee notes, printed year wise, every now and then. Certain criteria had to be met before tendering the notes. Thus a black-money hoarder can’t hold on to cash for a long time for the fear of losing value of the currency.

Fuel to the fire

State governments on their part hiked guideline values to equal or above the market values to earn their share of revenues through registration charges. If guideline value is equal to or above the market value of a property, there is hardly any difference between the registered value and the real transaction price, hardly any chance to transact with black money. Thus the black money changing hands came to a halt and in turn the transaction of properties, thus bringing the real estate market to a near halt.

The Future of Real Estate Market in India

What does all this mean to the future of real estate investment in India? Hereafter if you buy a property for 1 crore, you ought to pay Rs 30 lakhs as income tax. Moreover, you have to pay Rs 8.5 lakhs as registration charges (varies from state to state, 8.5% is the minimum average). Furthermore, if bought with loan and EMI, add the interest amount and the additional taxes depending on the tenure of the loan. The equation turned in favor of the government. Now the government, not the investor, has the lion’s share in the deals in the form of taxes. With so much outflow as taxes, it is no more attractive for an investor!

Since it is no more attractive, obviously there is a disruption in the greater fool theory. So there is not going to be commendable capital appreciation. Add to this the woes of depreciation and maintenance. Along with these, a meager rental income of 1-2% compared to the huge investment makes it look a ridiculous investment. (The good life of a building is 30 years.) If it is a vacant land, add the hardships of protecting it from encroachments.

As the black-money hoarding in real estate has become unattractive and cumbersome apart from diminished, meager returns, investment-based buying hereafter should become out of favor. Thus only need-based buying is going to be there. Hence any appreciation hereafter is going to happen only in select pockets. Those select pockets are the places where development is going to take place. Development in the form of townships, new highways, commercial centers or whatever. Comparatively, the already developed areas should witness stagnation. That’s why investing in a real-estate property is not going to fetch you the same exceptional returns the next decade.

Bottom Line

The black-money part in the real-estate transactions is getting done away with tighter government regulations. Therefore, investment-based buying is going to be out of favor. Hence real-estate investments are not going to be attractive as it used to be once upon a time.

As investing in real estate becomes unattractive with meager returns, now the billion dollar question would be “where would the savings of Indians end up?” Unlike US, Indian households save a part of their income howsoever meager it may be. The intention of Indian households going for gold is partially to use it as ornaments and partially to liquidate it in emergency. So gold has only limited scope in a household. And if real-estate investments are going to be unattractive, where would all the saved money find its way? Let’s wait and see.