Equity scores over Real Estate

Most Indians believe the real estate is the best asset class. This belief stems from its ever-increasing prices and the number of nouveau rich it has produced overnight. However, the return a developer or a builder can reap from reality is significantly higher than what an investor can.

The first misconception is that since God has stopped making land, it is best to invest in it. If one looks out of the window while on board an airplane, one realizes the folly of this argument. There is plenty of land available. In a country like India, encroachment and title clarity compounds the issue further for an ordinary investor.

The second misconception is that real estate is tangible and hence a good investment. Equity represents as much tangible assets as real estate. The difference is that we are unable to see it , and feel it, like real estate.

The third misconception is that realty doesn’t give negative or volatile returns like equity. The fact is most real estate will give a negative return, if you try to sell immediately after buying. The transaction cost in real estate from brokerage to stamp duty, and the difference between the buyer’s and seller’s price due to illiquidity creates immediate negative return. Since people don’t trade in real estate, and hold it for a long period of time, without looking at day-to-day prices, it gives them return over a period of time. If the same principal is applied to equities, surely these will give great returns like real estate.

The fourth misconception is that it gives better returns than equities. BSE Sensex has compounded from January 1, 1980 till October 3, 2011 at the rate of 16.72 percent annually (without considering dividend reinvestment). A flat in Samudra Mahal at Worli that was sold at Rs 700 per sq foot in the 70’s and was last transacted at Rs 107000 per sq foot has compounded at 12.79 percent annually (without considering transaction cost and maintenance charges). In simple words, the Sensex is up about 136 times in that period while the flat is up about 46 times. Equities have outperformed one of the most renowned Mumbai property by about three times, without looking at dividend reinvestment and maintenance outflows. Surely, in the last five or 10 years, real estate has outperformed equities, but that is the reason why equities look cheaper today.

One crucial difference is, while real estate requires outflow in the form of maintenance charges and repairs cost, equity creates inflows in terms of dividend. Obviously, if you rent out your property, it can create inflow, but then it creates another issue of getting the right tenant. Sometimes, realty returns comes from inherent leverage in the product, like booing of flats on down payments and paying money over a period of time. In equities, we are comparing returns on a non-leveraged basis.

Real estate, like any other asset class is cyclical. The return varies over different periods. Transaction cost, maintenance charges, illiquidity and non-transparency in the sector makes life difficult for an ordinary investor. Real Estate, like equity, has done well for the long-term investor. One should not put all the eggs in one basket. Asset allocation is the best way to grow wealth over a period of time.

Article by Nilesh Shah – Axis Bank

Think beyond fixed deposits when it comes to debt

When it comes to debt investors should think beyond conventional fixed deposits. Mutual funds offer a viable alternative to investors who are looking to invest in debt. There are various types of debt mutual funds that an investor can consider such as liquid funds, monthly income plans (MIPs), fixed maturity plans (FMPs), etc., all of which cater to varying time horizons.

Liquid funds offer the highest safety and invest in highly liquid and safe instruments such as call money, short-term bonds etc. The biggest advantage of liquid funds over conventional FD’s is that they are more tax efficient as interest on FD’s are taxable at normal rate where as dividends from liquid funds are tax free in the hands of the investor.

Fixed Maturity Plans as the name suggests come with a fixed maturity horizon and are close ended debt funds. These funds invest in bonds in line with the term of the FMP and hold them to maturity and hence do not carry interest rate risk. FMP’s are very similar to fixed deposits and can be considered as a direct alternative to FDs because of its tax efficiency especially for investors in the higher tax bracket. The Long Term Capital Gains (LTCG) on debt funds is 20% with indexation or alternatively 10% without indexation whichever is lower. FMP investors can also benefit from double indexation benefit which at times can lead to notional loss despite there being a profit. This loss can be used to offset some other tax liability thus doubly benefiting investors.

Monthly Income Plans are debt-oriented funds with a mix of equity and are ideal for people who need a regular income but at the same time are unwilling to take on big risk. The debt investments ensure stability and consistency while the equity instruments in the portfolio boost the returns and are thus market linked to the extent of the equity portfolio. MIP would make a good investment at this juncture for two reasons. One of the reasons being that majority of the funds are deployed in debt instruments. Bonds and interest rates have an inverse relationship and hence the hike in interest rates by the RBI would lead to fall in value of the debt instruments held by these funds and hence depressing their NAV’s. The interest rate cycle should turn going forward and when the RBI lowers rates the bond instruments would see appreciation giving a boost to the funds NAV’s. The second reason is that the equity markets have also been subdued because of the global uncertainties and domestic concerns such as persistently high inflation and regular hikes in policy rates by the RBI to tame inflation providing a double whammy for the NAV of these funds. Thus when the interest rate cycle turns and the global uncertainties settle down investors should benefit from the appreciation of both debt and equity. The only caveat being that investors should have a minimum two to three year investment horizon for investing in these funds.

Happy Investing

By Alok Basrur - Research Analyst - Concept Securities Pvt. Ltd.