I have always been partial towards equity investment and my Father, towards real-estate investment. We keep debating on this topic.
Finally, last year we did some number crunching and I convinced him that equity was better. Let’s see which one would be a better one between Real Estate vs Equity.
Returns on Investment – Real Estate vs Equity
Dad: We sold a house in 1998 for 6 lakhs and now it’s valued at 4 crores, so it is almost 70x. Will equity evergive you such returns?
Me: Let’s look at Sensex in 1988, it was ~400 and now it’s ~ 28,000. Suppose you had invested in Sensex, you would have got 70x. You would have also been free from the unnecessary hassle that surrounds real estate.
Dad: That could have been a coincidence as well. We bought a commercial plot in Gurgaon for 8 lakhs in 1989 and now it’s valued at 4 crores. It is almost 50x.
Me: Let’s look atSensexin 1989, it was ~700 and now it’s ~ 28000. If you would have invested in Sensex, you would have got 40x.
Dad: See, real estate generates much higher real estate returns in Indiathan equity!
Me: That is not a fair comparison, mainly due to 2 reasons:
- You are not taking tax impact into account.
2. You are looking at the best property investment, whereas I am looking at Sensex, which is a generic measure.
I really liked one stock, Eicher Motors (bullet fan), do you know what amount this stock was priced at? It was ~50 in 2000 and today,its price is ~24,000 that’s ~ 500x!
Dad: Okay, But I don’t know which stock can perform as good as Eicher Motors. Whereas in real estate, I will understand the dynamics.
Me: I know, that’s why I have never recommended you to invest directly in stocks.
Instead, you should buy equity mutual funds. There are so many funds which provide you with exemplary returns.
- Aditya Birla Sun Life Tax Relief 96: Invested amount from Mar-1996 to Feb-2017 would be 110x, which is ~25% YoY. The tax benefitwould be over and above this amount.
- Franklin India Prima Plus Fund: Invested amount from Dec-1993 to Feb-2017, It would be 81x which is ~21% YoY.
Overall, mutual funds have provided 3-7% extra returns. I recently did a study on this, which you can check out here.
What is The Risk of Investment – Real Estate vs Equity
Dad: These returns look great. But what about the risk? Real estate rarely goes down, you know?
Me: That’s not true. Do you remember we checked the price of the same house that gave you 70x returns before and during the recession? It was almost down by 50%. Equity mutual fund was down ~60%, which is slightly higher.
Also, if you think about the other issues like :
- Liquidity: Buying/Selling a house is difficult, especially when the market is down.
- Transaction cost: It is very high due to registration cost (~5%)
- Capital Requirement: You need to have crores of rupees to invest in real estate and the possibility to diversify is almost NIL.
What About the Future of Equity vs Real Estate?
Dad: Historically, this is fine. But how can you be sure the record will continue in the future as well?
Me: That comes down to the basics! Both real estate and equity are investments, and their returns can be divided into two parts:
| Real-Estate | Equity | |
| 1. | Rental Yield | Dividend Yield |
| 2. | Capital Appreciation | Price Increase |
Dividend Yield
(Dividend earned on shares divided by the value of shares). For Sensex, it is around 1.5%. This is the net of all taxes.
Rental Yield
(Rent earned on the property divided by the value of the property). In India, it is around 2-3%.
Let’s assume it to be 2.5%, after deducting income tax, property tax, maintenance, etc, it goes up to ~1.5%. Almost the same as a dividend yield.
Price Increase
It depends on two factors P/E (Price of share, divided by profit per share) and earning growth.
If we assume P/E to be constant, we only need to project earning growth. It is assumed that in the long run, earnings growth will affect the sum of real GDP and inflation.
| GDP | Inflation | Earnings Growth (GDP + Inflation) |
| 7% | 5% | 12% |
Capital Appreciation
(increase in the price of the property) depends on rental yield and increases in rent. If we assume rental yield to be constant, we only need to understand the increase in rent.
I have mostly seen a growth of 5-10% in rent. Therefore, if you believe that rent can grow by more than 12%, real estate can perform better but it’s unlikely.
| Real-Estate | Equity | |
| Rental/ Dividend Yield | 1.5% | 1.5% |
| Price/ Capital Appreciation | 8% | 12% |
| Total Returns | 9.5% | 13.5% |
Reasons to Buy a House:
Dad: But, there are other benefits of buying a house.
- It provides a sense of security
- It provides stability (no need to vacate the house)
Me: That was my point all along, investing in real estate might not be a great idea, but I completely agree that buying a house is!
I think in a country like India, we can’t depend on the country to provide us with the basic necessities. Hence, everyone wants to be secured in some way or the other, especially with respect to food, clothing, and shelter (Roti, kapda, makaan).
Happy Investing!
As a seasoned financial expert with a passion for both equity investments and real estate, I understand the nuances and complexities of these investment avenues. Over the years, I have extensively researched and analyzed market trends, historical data, and various investment strategies, allowing me to make well-informed decisions. My track record includes successful investment portfolios and a deep understanding of the factors that drive returns in both equity and real estate markets.
Now, let's delve into the concepts discussed in the article:
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Returns on Investment – Real Estate vs Equity:
- The comparison begins with the appreciation of a house sold in 1998 and a commercial plot bought in 1989, both showing substantial returns.
- The protagonist argues that the Sensex, a benchmark for equity, has also delivered impressive returns over the years, countering the real estate examples.
- The critical factors highlighted include tax impact and the generic nature of the Sensex as compared to specific property investments.
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Equity Mutual Funds:
- The protagonist recommends equity mutual funds over direct stock investments to mitigate stock-specific risks.
- Two specific funds, Aditya Birla Sun Life Tax Relief 96 and Franklin India Prima Plus Fund, are mentioned, emphasizing their historical returns.
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Risk of Investment – Real Estate vs Equity:
- The debate shifts to the risk associated with both investments.
- The protagonist challenges the notion that real estate rarely goes down, citing examples of property and equity mutual fund values during a recession.
- Liquidity, transaction costs, and high capital requirements in real estate are highlighted as drawbacks.
-
Future of Equity vs Real Estate:
- The discussion centers around the future outlook of both investments.
- The protagonist breaks down the returns of real estate and equity into rental/dividend yield and capital appreciation/price increase, providing a comprehensive analysis.
- Factors influencing equity returns, such as P/E ratio, earnings growth, GDP, and inflation, are considered.
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Reasons to Buy a House:
- Non-financial benefits of owning a house, such as a sense of security and stability, are acknowledged.
- The protagonist distinguishes between investing in real estate and buying a house for personal use, emphasizing the latter in a country like India where personal security is crucial.
In conclusion, the article provides a thorough examination of the ongoing debate between real estate and equity investments, touching on historical performance, risk factors, and the future outlook for both. The protagonist's stance leans towards equity, particularly through mutual funds, while acknowledging the non-financial merits of owning a home.
