By: Ramesh Nair
The Sensex has always been a barometer of the countryâs general economic âmoodâ. The real estate index, on the other hand, is an indicator of the sentiments towards real estate developers. It consists of 11 real estate scrips which â when the index was formed in 2007 â represented approximately 95% of the capitalization of real estate companies in the Sensex.
The BSE Sensex is currently at 18,800 levels, while the realty index is at 2,300 levels. This is in stark contrast to January 2008, when the Sensex was at 21,000 and the BSE Realty Index was at 13,400.Â While the Sensex is currently down 10% from its peak, the realty index is down a tremendous 82% from its peak.Â However, at the same time, if one had bought an apartment in the peripheries of most of the key Indian cities, its value would have risen by anything between 5-15%.
The real estate market is similar to the stock market, with its peaks and troughs always seeming to make perfect sense in retrospect. Also, both the real estate and the stock market reflect the economy of a country and offer good investment opportunities. However, the risks must be understood along with the opportunities.
The profit margin inherent in stock investments has always been higher when compared to other asset classes. Stock market investments offer advantages such as liquidity and flexibility, which real estate does not. Stock prices also offer growth rates that the real estate market can rarely match. Stocks are also relatively easier to acquire and require lower investment to buy, sell and hold as compared to real estate, which has high transaction and other related costs such as broker commissions, legal fees, property taxes, insurance and maintenance costs.
It is also far easier to track stock prices, which are centrally traded, than real estate prices, which change hands in individualized and often opaque transactions. Real estate also requires active management and monitoring.
For most of us, owning an apartment or house is not a matter of owning a financial asset but of settling down and homemaking. Nevertheless, home ownership is also the most primary form of real estate investment. Moreover, unlike stocks, real estate is a tangible asset that provides for greater psychological comfort, security and satisfaction. Also , the ROI for real estate is reasonably consistent because of the phenomenon of property appreciation.
Stock markets are far less predictable, as evidenced by various âBlack Mondaysâ or âBlack Fridaysâ on which the Sensex tanked by between 8-12% of its value in a single day. Though real estate values have certainly slumped in some cities in the last few decades, no real estate market ever dropped by 10% in one day, week or even month. In fact, the Indian real estate slump of 2008 is taking several years to bottom out in most markets. Even if the value of a home drops, the chances of the home owner abandoning for another option are negligible. Factors like the cost of moving, emotional attachment to the location and other ties to the locality such as the childrenâs school, relatives, neighbours, friends in the vicinity and proximity to the workplace invariably discourage the average home-owner from moving away.
This is in sharp contrast to the stock market, where an investor may decide to trade in his entire stock portfolio in a matter of minutes with just a click. If one buys property and holds it for the long term (7-10 years) one isnât likely to lose. Real estate values generally go up in the long run, with few exceptions. Fundamentally, the real estate market is a lot less volatile than the stock market.
Real estate investment also offers benefits such as tax deductions on home loan interest, continuous capital appreciation and greater stability. Property historically appreciates in value without many violent downswings. It can be purchased on a down payment of 1/5th of its total value, and the remainder can be financed by a bank. Financial institutions will lend money to a real estate buyer more easily than to stock market investors.
Real estate prices tend to sink far slower than they rise, since property owners are more hesitant to sell in a downturn. Property investment also helps in diversification, hedging inflation and yield enrichment.
Realty stocks allow investors to participate in large-scale real estate projects without having to inject massive amounts into non-liquid investments. They also circumvent the inherent complexities of real estate development in the country and give average investors access to a large array of office, retail and hospitality real estate projects which would otherwise be out of their reach.
Moreover, the investor does not have to actively manage any properties. For someone looking for a passive real estate investment with the added benefits of portfolio diversification and liquidity, an investment into a realty stock is certainly a good option. Real estate development companies with realistic projections and predictable incomes are far less volatile than most stocks. However, investors need ensure that the company is professionally managed and that investment decisions taken with circumspection.
Obviously, there is a direct link between the stock and real estate markets. In an escalating stock market, the profits find real estate the best place for reinvesting funds, leading to escalation in property prices. By the same coin, the gradual collapse of stock markets reflect visibly on real estate markets.
Both markets represent the two major asset classes for growth investing. Both allow investors to participate in long-term appreciation of values. Both asset classes should be included in a balanced investment portfolio depending on the risk-return profile and in-depth understanding of the particular asset class.
The author, Ramesh Nair, is Managing Director – West India, Jones Lang LaSalle India