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Real Estate As A Financial Investment

For many of us, buying real estate is towards the goal of providing for shelter for our family. However, today real estate has also become a practical alternative to stocks and FDs as a financial investment. This is a beginners guide to understanding real estate as an investment option.

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Characteristics of Real Estate as an Investment

Real estate has a combination of characteristics that are not available through other asset classes, thus making it somewhat unique as an asset class.

1. Protection against inflation: An investment property can offer the buyer a good protection against inflation. In this regard it is like Gold, in that usually real estate retains its intrinsic value. However, unlike Gold, one can earn income through real estate through rental income. Depending upon the existing price level in the economy, one can increase the rents in times of high inflation thus retaining the purchasing power of one's rental income. In addition, real estate offers the prospects of capital appreciation as well.
2. Tax incentives: All around the world, different countries offer different incentives to buy real estate. For instance, its very common for governments to offer some kind of tax subsidy for a property purchased for residential use (whether by self or let out). In some countries there are tax advantaged trusts through which investors can own real estate (REITs), and these are expected to emerge in India as well.
3. Diversification: There are many different categories of real estate investments. The most commonly understood in India is residential, but other types that are also growing are commercial (office buildings), retail (malls and shops), industrial (factories and warehouses) and lodging (hotels). Each of these has different drivers and different return characteristics.
4. Maintenance costs: Finally, if you have invested in any of the above type of properties, it is likely that you will have annual maintenance costs (cleaning, painting, ongoing repairs) and the occasional capital expenditure to upgrade the property every few years. Investments such as stocks and FDs don't have these associated expenses.

Investment Related Issues

When it comes to the process of making a real estate investment and exiting from it, there are a few things that you must keep in mind.

1. Transaction costs: When you buy or sell property, there are many associated costs associated: brokerage fees, stamp duty, registration fees, tax liability in case of gains. All these costs can add a material amount to the purchase or sale price of your investment.
2. Liquidity: Some investments like stocks or FDs can be readily converted into cash in hand. Real estate on the other hand is not "liquid", i.e., it takes time to convert it into cash. If you need to have easy access to your money, please be aware that real estate deals take weeks or months to complete.
3. Cash: Property investments are always the cleanest because of the cash versus cheque component of real estate deals. Unlike mutual funds where KYC norms require that the investment be made in cheque and the PAN card details be shared, real estate investments can have a huge cash (undeclared money) component to them. This might no suit everyone.

7 Point Checklist For Investing In Real Estate

1. Desirability of the location: This is the single most important criteria to value real estate.
2. Reputation of the builder and quality of construction: Just like some second-hand cars retain much of their original value, properties by some developers are worth a lot more than others.
3. Payment terms: Time-linked or construction linked payment plan, and cash vs. cheque component. This will affect your cashflow in other aspects of your personal finances.
4. Project approvals and licenses: This might affect your ability to get a home loan if project approvals have not come through yet.
5. Contractual guarantees: For assured return schemes get a written guarantee from the builder and post-dated cheques in your name. Understand the delivery date of your project
6. Demand and supply: Over or under-supply will affect both the capital appreciation potential and the rental yield you might expect.
7. Floor space index and carpet area: Local rules on the built up area and the available square footage (carpet area) might reduce the usable area. Recognize that what you pay for might not be what you get

Comments

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mohan said : 18/11/2009	very useful and creates awareness, usually everybody can see only Face of anything, message insists to see back of the Face.thanks