Investment Blog

Real Estate investment never leads to losses.

I have heard this from many investors. Is it true?

Generally, people look at losses with reference to their initial purchase price. If the investment is sold below the purchase price, it is a loss. If the investment is sold above the purchase price, it is a gain.

So, when real estate prices go down, people tend to hold on to their investments and don’t sell them. This gives them comfort that they have not suffered any losses.

People continue to hold on to their real estate investments until they receive a sale price equal to or higher than the purchase price. And this makes them believe that there is no loss in real estate investments.

Interestingly, most people do not account for the loss of opportunity cost which could run in huge amounts.

Let me explain with an example:

A friend of mine was getting price quotes for his property in the range of Rs. 4.25-4.5 Crores but he was adamant not to sell it below Rs. 5 Crores. He held the property for 5 years and finally sold it at Rs. 5 Crores. Although he got the price he wanted originally, he is still in a big loss.

Had he taken the deal 5 years ago at 4.5 Crores and just invested in an FD at 7.50% returns, his investment value would be worth Rs. 6.46 Crores. Therefore, he suffered an opportunity cost of Rs. 1.46 Crores.

Had he invested the amount in a portfolio of mutual funds generating 12% per annum, his losses due to opportunity cost would have been Rs. 2.93 Crores!

This loss is due to the time value of money. The worth of Rs 5 Crore has also gone down in 5 years. Adjusted for inflation, Rs. 5 Crore after 5 years, is worth Rs. 3.56 Crores (at 7% inflation rate).

Therefore, even if the investors have not suffered a loss in price value, they have suffered a loss in time value. Any asset can go through a price correction or time correction or both. An astute investor is mindful of these calculations.

One of my clients sold his apartment built by the largest & premium real estate developer in Delhi NCR at Rs. 90 lakhs after losing patience. He purchased the property at Rs. 1.05 Crores 8 years ago. It’s not that there are no absolute losses in real estate. Had he held the property for 2 more years, he could have sold it at Rs. 1.30 Crores. This translates to annualized returns of 2% over 10 years period.

Thus, the price at which you purchase becomes very important to determine the gains on your investments. It makes the utmost sense to diversify your investments across asset classes like equity, debt, gold, and real estate. And NEVER over-expose your investments to an asset class that is being chased by everyone. High chance, that the prices are already very expensive.

Originally posted on LinkedIn: www.linkedin.com

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