Real Estate or Mutual Funds? This might be one of the most controversial debates I am starting on Stable Investor. But I had to write about it someday. And by the number of mails I receive from readers asking me to answer this question, it seems that there is much more than just financial logic behind this question. Peer pressure, family pressure and just getting done with this big decision in life are some, which I can think of right now.
Note – This post is a combined effort by Ajay (who has previously authored interesting posts like how to invest your surplus money and how he created a corpus of Rs 3.7 Crores in just 10 years) and myself.
But if you expect us to give you a clear answer at the end of this post, then please tone down your expectations. We do not intend to provide a thumb rule or even a judgment for that matter.
This question of whether you should invest in Real Estate (for investment) or Mutual Funds, can only be answered by you and you alone. This article should ideally be read in that spirit.
So lets go ahead…
In words of Ajay, a home is a place to live and it should not be linked to one’s investment strategy. There should not be any second thought given about buying your 1st property for self-occupancy whether with or without tax benefits.
My take on this question is not as strong as that of Ajay. But I do agree with him about the power of equities in the long run. As far as my real estate is concerned, I am still weighing my options and am yet to finalize my long-term real estate strategy. As of today, I don’t own any personal property but my family does have a house in our native city.
So why am I delaying this decision unlike many of my friends who are already paying hefty EMIs every month?
I know it might sound odd to those who believe that one should invest in property starting with the very first salary they get. But I am sorry… I don’t belong to that school of thought. I have full faith in power of compounding and investing in equities. And I will only buy my first piece of real estate when I am comfortable enough to service my EMIs. I don’t want to have myself stuck in years of paying EMIs where I feel burdened at the end of every month. I don’t want to be slave of my EMIs.
But that was about me and my philosophy…. 🙂 So you can ignore it…
And for those who think that instead of paying rent, its better to pay EMIs – I have an answer. Paying rent might seem like an expense. But EMI also has a significant component of interest, which even in accounting term is nothing, but Expense. So this argument does not stand completely true.
Once again I repeat that the objective of this article is to highlight the differences in returns earned by investing in mutual funds and those earned by investing in a home funded through a loan, in the name of investment and tax-saving.
We have tried comparing two cases:
One where investment is made in real estate and other where it is made in mutual funds.
So here it is…
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
After doing some calculations which are depicted below, we arrived at quite interesting numbers.
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%.
Lets see what this part of the calculation leads us to:
We will evaluate 3 scenarios where property appreciation is taken as 9%, 10% and 12% continuously for 20 years. And this evaluation is depicted in table below:
Now when 3 different scenarios are considered where this property appreciates by 12%, 10% and 9%, the expected net gains are Rs 5.1 Cr, Rs 3.4 Cr and Rs 2.75 Cr respectively.
Agreed that these are some really big numbers.
But before you start putting your hands on your mouth after reading them, lets check out the second case where we evaluate similar investments in mutual funds.
Case 2: Mutual Fund Investment
We are using the following data for this case:
Initial lumpsum 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 Don’t People Invest in Mutual Funds?
Since you are reading Stable Investor, chances are high that you would be a mutual fund investor. But there are many who avoid mutual funds to invest in real estate. Lets see what are the possible reasons for them to do so:
- Lack of knowledge about mutual funds and equity markets.
- Lack of understanding about the power of compounding, the power of equity as an asset class and clear knowledge of wealth building via SIP.
- Lack of knowledge about asset allocation.
- Risk and loss aversion.
- Unable to determine financial goals and estimate the amount required.
- They have already utilized all the tax benefits available to them because of home loan. Now they have no tax-incentive to invest in mutual funds. And hence they don’t do it!
- Bad past experiences. And these are primarily due to wrong fund selection or wrong time horizon or wrong advice (like combining insurance and investment or wrong thinking that saving and investing are same).
- As daily price movement of MF through NAVs is available, the daily mental valuation of the asset, forces one to take frequent buy and sell related decisions. This is driven by general lack of patience in investors.
- Mutual Funds cannot be funded through Black Money.
- Unlike real estate, no long-term loans are available for investments in mutual funds.
- More people talk about losses made by investing in funds (for whatever reasons) and very few people talk about their success in meeting financial goals through funds.
- Mental fixation with recent huge loss events (like 2000, 2009, 2013 etc.)
- A major chunk of saved money has already gone into real estate, which leaves almost no money to invest in mutual funds.
- And as substantial money is not invested regularly in mutual funds, one does not feel that substantial money can be made through mutual funds.
- You don’t get to hear every day that a fund having a NAV of Rs 28 has grown after 15 years to Rs 805 – a return of 25% per year (Check Reliance Growth Fund). Such returns are very high ones and rare and cannot be matched by real estate investment or investments in other asset classes.
Now lets test your memory…
Do you remember how much did petrol cost in the year 2000?
It was around Rs 25. As of today, it is about Rs 66. Now suppose you had invested that Rs 25 in real estate, which grew at 12.1% as mentioned few paragraphs earlier. This would have grown to Rs 139. Enough to buy 2 liters of petrol today. Now if this was invested in a mutual fund, which somehow could manage 25% return, it would have grown to Rs 711. Enough to buy at least 11 liters of petrol.
That is how equities work. That is how compounding works. That is how value of your money is preserved and increased by investing in right asset class for long periods of time.
And this is a repetition of earlier statement. One should not give any second thought about buying your 1st property for self-occupancy, whether it is with or without tax benefits.
However, based on our comparative analysis above (and estimated returns), one should think twice (or even ten times…) before buying a second home for investment purpose. One should carefully weigh all the available data and then take a wise call. Just because your friend or family member is investing in real estate does not mean that you should also do it. You should evaluate your own financial goals and think about how you plan to achieve it, and then decide whether you want to ‘invest’ in real estate or not.
A hard and physical asset will always give a huge mental comfort and satisfaction over other financial assets like mutual funds. But it is also true that it may not always be the best available investment option. In fact, investing in house funded through loan, is a huge long-term liability – which chokes the ability of the person to save and invest in other right instruments for future.
In our opinion (and it is ours and you can ignore it), after purchase of the 1st property for self-use, if there is any surplus cash left to invest, you should invest it as per your asset allocation (which includes debt, equity, gold & real estate). If the asset allocation permits you to invest in real estate, you may very well do it. But if it doesn’t, then you should refrain from investing in it. Investing in real estate for the sake of saving tax may not be the best thing to do.
As stated at the beginning of this article, this is one hell of a controversial debate. And there is not straight-forward logical answer to it. There are no thumb rules or any other rules. The question of Real Estate Vs Mutual Funds can only be answered by you an you alone.
We have simply made an attempt to clear the myth that “Real estate investing is the only best Investment Option” available for everyone. We have done all the calculations by estimating the returns net off expenses. We cannot just ignore expenses like those who just tell you the number of times their property has appreciated in value.
Please note that this post may be biased towards Mutual Funds investments.
Do let us know about your thoughts on Real Estate vs. Mutual Fund debate.
Returns mentioned in this post are only assumptions and not guaranteed ones (for both Mutual Funds and Real Estate). While there is investment return record available for mutual funds, we could not get a credible investment return data for real state (we took NHB data as guideline). Moreover, the real estate returns vary vastly from location to location.