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Real Estate, Not That Great Long Term, says Ajay Shah

Ajay Shah writes that Real Estate is not a great long-term investment:

Too many intelligent people in India believe that one can never do wrong by investing in real estate. Some facts will help bring more sense. Consider investing in the best commercial real estate of Bombay — Nariman Point — in 1994. The price was Rs.35,000 per square foot. Today, almost 20 years later, the price is Rs.25,000 a square foot.

Over this period, Nifty produced returns of 362%. Inflation ate away 272%. Net of inflation, Nifty delivered an average annual return of 1% while Nariman Point commercial real estate delivered -9%.

This is, of course, just an anecdote. Many individual real estate investments have done very well and have occasionally outperformed equities. My point is a limited one. We should not mindlessly assume that real estate is always a good investment. We should not assume that real estate will always outperform equities — as the above example shows things can be as bad as underperformance (compared with the Nifty index fund) of 10 percentage points per year over a 19 year period.

Why did Nariman Point underperform over this period? Because of new supply. That is the heart of the problem of real estate as an asset class.There is no long term returns in owning steel or bricks. Every time there is a real estate boom, it triggers off fresh construction. This supply quenches the boom.

He makes many good points – for instance, that dramatically increasing FSI will create more supply in the same areas. Or that all of India’s population could live in an area of just 1% of our land:

If you place 1.2 billion people in four-person homes of 1000 square feet each, and two workers of the family into office/factory space of 400 square feet, this requires roughly 1% of India’s land area assuming an FSI of 1.

The rough calculation goes like this:

  • 1.2 billion people = 300 million families of four each.
  • 1000 sq. ft. per home = 300 Billion square feet of residential space.
  • And in the same vein you need 120 billion square feet of factory space.
  • That is a square where each side is 200 km.
  • But parking will be a mess.

Increasing FSI is really painful only because of the lack of parking and wide roads. The minute you have 30 floors and six apartments per floor and 10 such buildings in a complex, you need parking space for about 2,000 cars, and then work out a way to get these cars in and out of the roads without destroying traffic. Or, we need way better public transportation.

There isn’t really a lack of space in India – anyone who’s driven the countryside will attest to that. Yet, we artificially keep space availability low, through stupid laws like farmers can’t sell their land to non-farmers or that non-Himachali people can’t own land in Himachal etc.

What Ajay misses is that owning land comes with additional issues – that you can never really be sure about the ownership of the land, because of horrible record keeping in the country. That someone can ‘occupy’ your land illegally and it will take you more than a decade to recover it. And that India’s property taxes are very low – less than 0.1% of the current market value of the land, which is likely to increase as well, along with FSI, as governments attempt to finance the building of infrastructure, police, fire support etc.

Overall, while I agree that it will take very little to do actually fix issues of lack of supply in real estate, there is absolutely no political will to do so. In fact, I imagine that any party which actually did this would piss off people so much they will feel the damage in elections; however, it has to be done for developing India, even if it means the destruction of a few big men that call themselves developers.

  • Anshul says:

    Bang on Ajay. I think it is same for CP in Delhi. New CBDs starting emerging in mid-nineties. But people have short memories and such data is not available on the internet

  • ananth says:

    What about the rental yield for the nariman property for the last 20 years? Also I think he is picking one outlier to prove his point. The same can be said for the the worst performing stock in Nifty.
    While theoretically he may be right practical issues and vested interests will keep property prices high for some time to come

    • Good point about rental yield. What’s the rate there now? About 125 to 350 per sq ft as I see on Magicbricks, meaning between 4% and 12% a year pre expenses. That should skew the metric a bit; though I would put yields at the lower end of the range.
      Outliers lie in both directions – you get those with 50% increases in the last 1 year as well. But overall, it tends to be lumpy and very difficult to price properly, so you can’t really put a generic finger on it.

  • Dhananjay Redkar says:

    Why would readily available and cheap houses piss off people? Any party which manages to do that will actually be assured of long term political success. Whats stopping parties from across political divide to take such step are the financial interests of the politician. There is hardly any big project in Mumbai Pune Nashik belt in which politician doesn’t have a stake.
    Real estate is the golden egg laying goose and politicians are in no hurry to cut if off in a single shot.

  • mintdesai says:

    Some very good points.
    I come from family who has seen both losing money as well gaining money in real estate. I believe that both losing and gaining money is much drastic in stocks as well.
    You will be able to find lots of people both who have lost lots of money in stocks as well.
    One outlier does not prove anything.
    We need to look at some average data and see if RE is better or worse compared to

  • Ravi Ramenani says:

    Hello there, sorry for being picky isn’t 500 Billion Square feet ~46000 Sq. Km? 1% argument does not change since India is ~ 3.3 Mil Sq. KM and 1% is ~33000 Sq.KM.
    I just have to get it out, I have this affinity towards math ..
    Great article and blog.

  • Akhil Khanna says:

    Rising prices, Declining Transaction Volumes, Years of Unsold Inventory piling up. The Indian property market is showing classic signs of what was earlier called Hoarding and is now called Investing. This ponzi scheme goes on till the builder / investor is able to raise funds pay back previous loans and hold onto unsold stock to avoid selling by lowering prices. The game is up when they are unable to raise further loans. Shradha Group of West Bengal multiplied.

  • Murty says:

    I totally agree with Ajay. My case would be one of the very few. I remember my 2001 year thoughts about possession of a FLAT , in Hyderabad, and the decision against taking one. After 12 years, I do not regret that decision. Apart from how I have invested the surplus, I did not understood at that time , why people are mad about the OWNERSHIP. I also observed the high handedness of Banks, and the peer pressure is tremendous. If you don’t follow the BANDWAGON, you are on OUTLAW.

  • balvir Singh says:

    I think Rental values are automatically setted off by Dividend yields of Equities. also Real estate requires maintainance and also attracts depriciation on building componants. So I think the comparision stands valid.

  • subash says:

    we forget one point in Indian psychic. we need a social security.This century old system still keeps intake in the Indian mind set.

  • Vishal says:

    NCPA Apartments at Nariman Point was sold at 9-9.5k levels per sq. ft. in 1991-92. Good luck trying to get a flat even if you’re willing to shell out one lakh per sq. ft today.

    • Murty says:

      1990————9500/SFT, for a 1000SFT would have been 1 Cr. my friend! Imagine the worth of 10 million in 1990, and now. That would have been somwhat around 8 Cr. now. (By 1997, 2Cr., By 2005, 4 Cr., and by now, 8Cr.)If you add the yiled, plus tax savings, blah blah blah…… Lets say it is around 10 Cr.
      Now you say 1Lakh per sft , for 1000 sft would be the same!
      What the HECK! Both would be foolish investments!
      You would have bought at least 10 acres in 1991 with that amount, assuming you bought the NCPA APT with cash!
      The idea is not to think of Nariman Point now and compare it with what would have been…. but what you do at present with that 10Cr. That is important.
      Remember, I made a rough estimate for the returns of 1 Cr in 1991 after 22 Years. It could be more!

      • Vishal says:

        Wasn’t trying to say what 1 crore would be today. Just saying that the author’s “35k has become 25k” is plain wrong and totally misleading.

        • Murty says:

          Neither am I blaming you. These days , everyone is a great ANALyst, and anyone can write on any topc…Look what we are doing!
          The auther has no point here because, he started with a Commercial Rental Yield and finally landed in Residential SOUP! (Suite).IT is a genreal purpose article on ET, which as usual is a controvercial space. Rather, shall we say all brainy!
          professors are supposed to teach! right? Not to write! especially when they are surrounded by too many Intelligentia!

        • Vishal says:

          I just realized that I hadn’t even read the article, apart from what Deepak posted. Shall do so now. But I’m assuming it will be hilarious.
          Another ‘great’ article. This time its the guys at HDFC talking like they know something.

  • Murty says:

    You should have read the comments below that article too. What else you expect the presenter who might be expecting for an elevation? Even Mr. Parekh would have been quite impressed. What else he has to do? Whether this intelligent guy is speaking the truth or not, he had millions of Financial Wizards out there , who are willing to be SLAVES for the nest 15 to 20 years. He need not worry.
    HDFC was there, and it is here now, and will be there in future. That is the only thing that can be stated as a FACT.No doubt, the Rajkapoors of the Modern Era Flurishes like this.
    There is NEWS and then there is PAID NEWS. Even Deepak got hurt once for my rude Comments!

  • DJ says:

    I see a lot of people saying one data point doesn’t prove anything. And, I agree. Which is why these indices are useful. Gives a better sense, although the history is short. I remember Shiller commenting recently that he collected housing data in the US for the past century and the returns were 0 after inflation. I think RE is good for exactly that – its a real asset that will keep up with inflation. Nothing more or less. In a developing country with inflation flare ups and limited stock market depth, it has its role as an inflation hedge. Many middle aged people missed out on this inflation hedge in the last decade. Additionally, it is easier to leverage RE (mortgages are common) than stocks. That is all there is to its value as an investment.

    • DJ says:

      Oh, and I didn’t mean to implicitly suggest that RE is the only inflation hedge. Stocks are known to be better inflation hedges. Real returns are positive in the US for the same century as an example. Although, plenty of long (multi-decade) periods of 0 returns (not sure about real returns though) in the stock indices. And, moreover, one has to consider costs of owning RE. I think like everything, there are periods where valuations are very cheap for any asset class that opportunities present themselves. But, then one can’t know beforehand how long it will take for valuations will play out, etc. Easy to say anything in hindsight.