Problems with out-of-sight properties

Investments are thought of as money working for you. But property investments may be one category where you end up working for the investment. Managing a property – from buying, maintaining and selling – can be a chore. More so if the property is located far away from where you live.

It is possible that you bought the property and moved to a different country or city; or you own an ancestral asset in your hometown; sometimes good opportunities come up in other cities and you may have invested in it for income or capital gains.

No matter how you ended up with ownership of a property far from where you live, it is essential to realize the problems it may come with. You can then decide if the asset is worth the hassles and if so, what help to take to manage these.

Regular expenses
Unlike financial assets, property ownership may entail active management and hence expenses. Taxes have to be paid to the local authorities periodically. If the property is a home, regular maintenance – painting, structural checks to verify there are no damages, plumbing related work to ensure there are no leaks or blocks in the system – are needed from time to time to maintain asset value.

Finding someone to handle these or taking time to travel, locating reliable local help to get these done can be a hassle for many home owners. It helps to take the help of professional agencies to supplement support from friends, relatives and neighbours.

Tenant troubles
Some of the problems in maintenance can be sorted easily if the home is rented out and the care is left in the hands of tenants. You can entrust the occupant to pay taxes and ensure good upkeep.

But having a tenant can cut both ways. Tenants themselves may raise many maintenance demands or increase the need for upkeep. For instance, a tenant may not be open to doing simple things such as fixing a faulty electrical outlet and demand your intervention, urgently. Or they may damage wood work and want you to remedy it. They may also create other disturbances and you may have to answer neighbours on the troubles and inconveniences created by your tenant.

Often, there is also a time factor constraint in getting fixes done. Broken water pipes cannot wait for few days that will take you to come to the site. So owners may find managing urgent fixes to be quite stressful. And when tenants refuse to pay their regularly, confronting them and ensuring payment is not easy remotely.

And when the tenant vacates, ensuring the house is handed over properly, cleaning up to make it ready for occupation, finding a new tenant and executing the rental agreement also require time and effort and often physical presence.

There are many professional agencies that can help with tenant management, starting from fixing up the house, tenant screening and ongoing support such as rent collection and regular checks while the house is rented. Fees may range upto 10 per cent of rent and extra charges for additional services.

Plot problems

If a home ownership comes with one set of problems, having a land comes with another. An unfenced plot can be a ripe target for encroachment. Fencing may still not eliminate risks if you don’t visit the site regularly. There are also taxes to pay to local authorities for the plot.

Another risk is Government take-over for infrastructure development. While there is not much one can do about this, handling the authorities remotely may not be easy. If there are legal disputes in the land that were missed during purchase, the pain of handling it may be worse when trying to handle it from a far away place.

Still, in spite of the many hassles, diversification beyond one’s place of residence does have its benefits. Buyers must however think through the likely problems based on the type, age and purpose of the property they want to won and put a plan in place to handle issues that may arise.

Three property risks beyond your control

Investment risks may give us jitters but they apply to all asset classes. As they say a butterfly fluttering its wings in China may set off a tornado elsewhere, sinking many a carefully-laid profit plan. Some risks are controllable to a lesser or larger degree but some are usually beyond the control of investors.

For example, when buying a property you can mitigate developer issues, legal problems and agreement trouble to a large extent through due diligence. But not all risks can be foreseen and even if it can be, prevented. This is true not just in property investments but in all asset classes. It is therefore important for investors to know some of the perils one may not have control over.

Government policy
Government, at various levels, can be a real wild card as their policies have a big impact on property investments. For example, a road project that would have greatly enhanced connectivity and boosted growth in a locality may be shelved or stalled when there is a change of power. A new project may be taken up and authorities may acquire land and want to demolish other property in an area. Owners may only get rates below the market rate and are forced to sell if they had intended it to hold it for the long term; worse, even these payments end up being stuck for years on end due to delays or litigations.

Policy changes may also play truant with investments. Adding extra layers of clearances in approval process or any ambiguities in a new procedure may lead to projects getting stuck with the local authorities. New objections may be raised on approvals already given, setting back the clock on completion and hand-over. Buyers and builders do not much recourse in these cases.

Macro changes
Events that impact the larger economy – nationally and globally – are another category of risk over which investors have no control. The global financial crisis sapped liquidity and changed central bank policies and economic growth trajectory globally for many years. The slowdown in China has affected commodity-centric economies around the world. In an inter-connected world, where money flows freely to pockets of opportunities and leaves quickly, sentiments shift suddenly.

There are also wars and acts of terrorism that de-stabilize growth plans. Civil wars and political unrest also create ripples that may take a while to settle. Currency fluctuations, global tax low changes such as FATCA and changes for BEPS also impact the performance of various assets.

While some events such as policy shifts may unfold slowly, most events are sudden but lead to large structural shifts that are long lasting. The collapse of the twin tower in the US in 20011 is one example of a black swan event that was hard to foresee and whose impact lingers for many years.

Natural calamity
Similar to man-made disasters, nature may also wreck havoc on carefully laid investment plans. The tsunami that hit Chennai dented buyer’s appetite for coastal properties for a few years. Cyclones such as Katrina that hit New Orleans, USA may shift property buyer interest from one area to another as their priorities change after the calamity.

While floods or likelihood of water shortage can be somewhat assessed, many others are not so easy to predict. For instance, many regions may be categorised as seismic zones with a risk of earthquake occurring; but no quakes may have happened for even a century. And just when we become complacent, nature may show who is in control. Insurance policies can help with a few situations to reduce loss but the financial damage in most catastrophes is to be borne by the buyers.

So, property buyers must be aware of the worst case situations by understanding the many risks that are beyond one’s sphere of control.

Three use-cases of Property Assets

People buy land or a home not just for their own use but as an investment quite often. In these cases, property is not a consumption purchase and must be seen as a part of a portfolio of assets. When building a portfolio, real estate as an asset class can be a very helpful tool that plays a pivotal role in meeting certain financial goals. Globally, property is an accepted asset class used by financial advisors to meet investment goals of their clients.

Here are three examples of how property investments can be thought of in your portfolio to help you reach certain financial needs.

Education goal

Young parents start to worry about their children’s education early on. The struggle and high fee to get admission to a pre-school makes them wonder about college expenses, given high inflation in education costs. For those with funds available now, buying a property and holding it till the child is ready for college can be one choice to consider for parents.

Land can be a good option to consider as it enables investing a smaller sum as well as a much large sum. You can also buy in smaller quantum and add to the overall portfolio over a few years, as and when you have funds. A home is also an option and rental income can be invested in a systematic investment plan to continue building the corpus towards meeting the education expenses in the future.

Given that property markets go through cycles and selling a property may take time, you can consider selling the property a years ahead of when the funds will be needed. Invest the money in liquid investments such as fixed deposits so that you are assured of having it handy for college admissions.

Retirement income
Property can be a good asset that can provide monthly income during your retirement. This is in spite of rental yields being quite low, only about 2-3 per cent of the property value.

For example, during your working years, you may be in a high tax bracket. You can take a loan for a home that is worth say Rs 30 lakh and avail tax benefits. A second home has no restriction on the amount of interest you can deduct and the expenses you incur on the home can be set off against the tax on rental income.

Say the house price appreciates over the years by say a nominal 5 per cent. In 8 years, you may have repaid the loan (average loan tenure tends to be 8 years) and the house is worth about Rs 45 lakh. At 2 % rental yield on Rs 45 lakh, you earn Rs 7,500 per month. This can cover 10-20% of your monthly expenses which may be in the range of Rs 40,000 to Rs 75,000.

Rents also typically keep pace with inflation. If inflation is 7 % rents would increase to Rs 10,000 in about 4 years and your expenses may be Rs 50,000 to Rs 1 lakh. Rents continue to contribute 10-20% of your monthly expenses. This can be quite helpful especially if other sources of your income – fixed annuities, fixed deposit interests or fixed pension – do not keep pace with inflation.

Asset for business
Property assets can also come in handy if you intend to take some loans in the future. For instance, say you want to start a business a few years down. You can buy a home and pay off the loan while you are earning a salary. When you start a business, this will ensure that you need not have to budget cash flows for your rent. Running a business creates severe cash flow issues as there is no steady income and avoiding one big need for monthly cash can be a great source of relief.

Also, a home is an asset against which you can take loans for your business. It is good collateral, against which many banks and financial institutions lend. The rate of interest on a loan against property, about 12% currently, is also much lower than other personal loans that may be charged over 14%. Unlike gold loan, where the collateral is physically in the possession of the banks you can continue to live in a pledged home and save on rent.

Three mistakes property buyers make

Buying a property is not easy, no matter what agents and real estate advertisements want us to believe. And buyers, especially first time buyers, make umpteen mistakes in the process. Rather than paying a high price for the learning process, a few simple steps can help buyers make a good purchase. The first step to learning is to know what the mistakes are and how to rectify it.

Bad advice
Promotions and opinions disguised as advice is rampant and we tend to go by into it. Imagine this. A medical student tells you a great story on how a complicated heart surgery can be performed. Would you trust him to do it for it? Would you take the advice of your car cleaning person to replace the engine? Hopefully you said no (if you said yes, I have a great scheme designed for gullible people. Please call me!). But we buy on advice from friends and relatives without doing our homework.

Misleading testimonials and anecdotal evidence are rife and often buyers are influenced by the images or promises. They do not dig for the truth as unbiased independent information is not readily available. Free advice is only worth what you pay for it.

So before buying, see advice from trusted sources on developer credentials, neighbourhood intelligence, project features, total all-inclusive costs and legal aspects. Talk with credible folks and seek data and the source of the information and avoid opinion based conclusions or gut feeling alone. The data you must go by should be based on your purpose in buying the asset – is it for a primary residence, rental property or an investment. The parameters you weigh would be different in these cases.

High expectations
Buyers get taken-in by grand visions of development that is projected to unfold and make the locality nothing short of heaven-on-earth. Above all, hope that the property will give double the investment return within a year or even six months, if lucky. Often these expectations are formed by anecdotal evidence from a friend-of-a-friend who made windfall gains with a ‘timely’ investment.

Sadly though, our stars are never that lucky. Investors are disappointed if price appreciates slowly and end-users are frustrated with lack of even basic amenities such as water and drainage even after a few years of moving into a new area. What about the highway project and the IT park development that was going to come up?

The fact is that given the way our governments (don’t) work, it is not wise to bet on immediate sure-fire growth, unless you want to speculate. It helps if you have a realistic assessment of when infrastructure projects may start and complete and the timeframe for the other growth drivers to play out.

Low diligence
Property owners may also get into trouble as they forget the simple warning – buyers beware. Misplaced trust – on intermediaries such as property agents and developers – can lead to a lot of pain. Hurrying into an agreement without thorough checks and not bothering to read the fine print often leads to regretting in leisure.
Legal checks on the property and ensuring the agreement is not one sided may seem like basic things buyers must do, but they often skip these and trust that other buyers would have done it. You can be the one-eyed person who wants to verify everything when others are being blindly trusting. Do not be naïve, it is ok to dig deep, ask a lot of questions to assure yourself that there are no legal issues in the purchase.

Knowing the common but critical mistakes in property purchase can make you aware of what you need to do and gain knowledge to do the right things. Property purchases are big ticket buys and it pays to be sure and not take any short-cuts.

The Psychology behind Property Investments

In a world of multiple investment choices, ever wonder why the old asset class of property continues to be a popular choice globally? The answer may lie in the nature of property as an asset class and psychology of investors.

The problems in property assets are well known – illiquidity, lack of information, high transaction costs – to name a few. These may well be the reasons that make it a good choice in the eyes of many. Property is easier to hold over the long-term because of how the human mind works.

Long-term value
If you look at the key secret that successful investors such as Warren Buffet share, it is quite simple – do not be carried away by short term sentiments. One must keep their eye on the long-term intrinsic value and ignore the cyclical fluctuations that kindle fear or greed in our mind.

This overarchingly simple lesson is however difficult to follow. Humans are, by nature, short-term focused, possibly being trained from pre-historic times to worry about the next meal and not far beyond. The immediate pain also usually over-rides considerations of future benefits.

To illustrate, consider you have a corpus of Rs 50 lakh and you buy stocks for Rs 50,000 (1% of your funds). The stock loses 20% in a short period, setting you back by Rs 10,000. When the stock price rebounds and your portfolio is worth Rs 50,000, it is likely that you are tempted to close your position. The loss aversion feeling is more acute if the investment amount is a larger share of your total portfolio or the dip was higher than 20 per cent or the period of paper-loss was longer. Just seeing the portfolio in the red day after day makes you want to avoid this pain. And in the process we may forget the long-term value of holding-on.

Curse of liquidity
Liquidity is generally a benefit in investments as you can exit a position quickly. Investments such as stocks and mutual funds have their prices updated daily as it is traded actively in the market. This constant price movement can also be a source of discomfort due to information availability.

Seasoned investors are able to ignore the manic-depressive tendencies of the market and focus on long-term value. But many of us are not blessed with such intelligence-filters and hence worry about volatility.

Less is more
One way to avoid over-reactions is to not check portfolio value often. Property markets interestingly offer this filter automatically. Prices are not flashed across our screens all day long. Price data is available based on transactions and is made available maybe only every quarter or so. Also each property is unique and the quoted price may not be indicative of the price for your specific property. For example, the rate per sq ft in a locality would be different between projects based on amenities, in the same project depending on the size, location and customizations.

Selling a property is also not instantaneous. Finding the price, a buyer and going through the process involves time and some amount of effort. And if the market is soft, there may be even more delays and price discovery may be an iterative process.

While the lack of price discovery and possible illiquidity is a problem for efficient market operation in general, it has its benefits. One, owners do not panic as much and get in and out of investments. Two, property is out of sight and hence tends to be out of your mind. Three, even if a price is given, due to the uniqueness of each property, investors are able to filter out information as it may not be indicative of what they would get. These help them to hold on, while the same investor may have sold out of stocks or bonds.

To build wealth, investors have to create a portfolio with many asset classes. The assets must have different risk, return and time horizon characteristics. And property investments differ from stocks and bonds and other alternate assets such as gold, making it an important tool in diversification and long-term wealth creation.

Bring down Property Prices, says Governor Rajan

Bring down property prices, says Governor Rajan

He is perhaps the only governor of the Reserve Bank of India with the looks of a rock-star. Flamboyant and fearless, he is today known amongst school kids as well, given the way he makes his presence felt. The IIT-IIM alumnus, Raghuram Rajan, who had the audience eating from his hands, with his dosanomics that gave a new spin to economics has something to say about realty prices.
In the last 18-months the RBI has lowered interest rates by 150 basis points and it today sits at 6.5 percent. This drop is to encourage consumers to purchase homes and revive the falling real estate sector.
Earlier, Rajan had asked realty developers to bring down prices instead of piling up inventory. With property prices soaring up, the demand is trailing supply. People will get to invest if prices stabilise.
On their part real estate developers have asked for reducing the interest rate on home loans to encourage real estate business grow to which the governor responded saying he does not want to inflate the property prices by a cut in the interest rate of home loans. In vintage Rajan-style, he crunched the discussion with numbers. As of June 2015, home loans disposed of grew by 15.6 percent to Rs.6, 53,400 crores as against the previous year when it by 17.1 percent to Rs 5,65,000 crores. In contrast, the overall lending by banks grew by 12.8 percent in June 2014 and 7.3 percent in June 2015. His argument: the overall credit growth crashed with a brisk increase in home loans.
He further added that home loans given amount to 12.7 percent and 12.2 percent of the total loans in 2014 and 2013 respectively. The increase in home loans has not lead to a decrease in the stock of unsold homes. This shows that the growth in property prices plays the dominant role in unsold home stock.
Rajan sternly believes the central bank can identify a bubble while his US counterpart Alan Greenspan held bubbles are perceptible only after the fact. Rajan says the surging property prices are a bubble, and it needs to fall for the people to buy homes.
Knight Frank India, a real estate consultancy firm, argue that developers cannot drop down prices since the input costs, including the cost of land, have gone up significantly.

Recently Rajan again appealed to real estate developers to adjust property prices. He stressed there should be more transparency on land acquisition, construction, and sales, adding the building of houses and roads is a sign of growth for a developing economy like India.
Rajan cautioned that while there is a difference in how market and developer view the prices, it the situation continues, the real estate sector will be in a holy mess, as buyers will stay away, and sellers will pile stocks. Hence, the best solution will be to reduce the home prices for the market to function. QED.

The many perils in Land Investment

Land as an investment option is quite popular. One reason is that it can fit a wide range of budgets. A small plot in tier 2/3 cities or in the suburbs can be suitable for someone with a small budget of under Rs 20 lakhs. Large tract of land or plots in prime locations can be bought for budgets of Rs 1 crore or more.

Another reason is the appreciation potential. Buildings lose value over time as it tends to depreciates. But land retains value and price appreciates as it is a limited resource. Anecdotal evidence shows that land prices have appreciated at double digit rates annually in the last three decades or so.

But while the high returns and investment size may be attractive, land investments come with many risks. One, a good deal of legal due diligence has to be conducted on land. There may be issues in ownership, access and approvals. So the investor has to tread with caution to avoid the various legal traps.

Two, land may be taken over by the government for infrastructure projects. Land investments may be in less developed areas and road projects or industrial areas may come up in these locations. The new land acquisition Bill requires paying two-four times the circle rate for the land taken up, but it is often the case that the land owner has paid over the prevailing rates and may not enjoy price gains. Not just that, the payment process may face inordinate delays due to issues raised by other land owners.

Related to this is the issue of land encroachments. As land tends to be in undeveloped areas, it must be well secured with a fence and visited upon often to avoid someone claiming ownership. The owner has to go through long legal process and suffer stress when their land is encroached upon.

Three, there are also price appreciation risks. For example, while the land may have been bought on hopes of certain infrastructure coming up, it may not happen, as government development plans may change; this can dampen returns. Also, when development talks happen there tends to be rampant speculation, which boosts land prices in the short term. When things return to normal, there may be price corrections if there is over supply. We see this when talks of the new capital city’s location was in the process of being finalised in Telengana. Prices shot up and then crash landed.

So it is important to understand the many risks in land as an asset class. The high returns come with unique risks depending on the location and the investor must be knowledgeable to evaluate them. While the success stories of land price doubling may be tempting, it is best not be carried away; it is best to only enter an investment after knowing the flip side and the probability of negative developments.

Else, you can consider other alternatives. Property backed financial instruments may be one option to provide liquidity and reduce risks. Returns can also be enhanced as experts are involved in managing the operations. Investments can be in small or large sizes, providing some of the benefits of investment such as land while also lowering risks.

New age of Property Investments in India

New age of property investments in India

Real estate as an investment option is falling out of favour. While a few factors such as the black money bill may be cited as a reason for the cyclical downturn, fundamentally property as an asset class is maturing in the country. From being a opaque system with many inefficiencies, the industry has been changing in the last decade as institutional capital is bringing more professionalism and transparency.

In the past, homes were built for consumption only and not as an investment. Homes were also self-constructed and there were no large scale projects. With real estate industry picking up, there was a need for capital. Property developers looked to investors to raise money, as traditional funding sources such as banks and NBFCs were not always willing to lend to, especially during the early stages of a project.

As an alternative to money lenders, larger developers went with real estate private equity funds. They were all the rage in the mid 2000s and many foreign and local funds were launched. They offered funding in two models – equity and debt. Equity oriented funds provide money in the early stage and when the property is sold, get their returns by way of price appreciation. Debt oriented funds offer loans in any stage to be repaid with interest (ranging from 18 to 25 per cent annually) after a certain period. There are also hybrid funds where the developer pays an assured minimum return plus a share of the price appreciation.

While it was a good deal for developers, many foreign funds and those that invested in commercial property such as office buildings, malls and retail space were stuck as they could not sell their stake. There was a shake up and many funds shut shop – the number of funds is now down to about 10, from 50 in the go-go days of 2007.

Among those left standing are local funds with a focus on residential real estate. Their strengths include offering thorough diligence on the builder and the project. They also monitor progress, put in systems to ensure quality and on-time delivery – all to ensure they can earn their return. Home buyers and developers also benefit in this bargain.

These methods have worked and the funds have been able to earn healthy returns even when the market was beaten down. The case in point is ASK Investment, a real estate private equity fund. They had at least four exits from the residential segment investments at multiples of 2.25 to 2.5 times in about four years. These work out to annual returns of 20 to 25 per cent – not a bad deal for any investment.

So while investors who bought physical property were stuck with low returns and inability to exit, wealthy investors who took the financial ownership route through real estate PE funds were laughing on their way to the bank. Real estate PE funds also offer diversification benefits as they invest in different geographies. Based on the risks assessed for the project and developer, the returns are set and systems are put in place to reduce issues.

The main disadvantage of the PE funds however is that they need a large corpus – the minimum investment is Rs 1 crore, as per SEBI regulations. Money flow to these funds increased over 20 per cent in 2015, after doubling in 2014.

In many developed countries, there are more avenues available for smaller investors to also benefit from economic ownership of property, rather than physical ownership. These include real estate investment trusts (REITs) which are entities that can invest in under-construction and completed properties – both commercial and residential.
REITs in India are however limited to income generating commercial properties. And worse, there has not been a single REIT announced, nearly 18 months* after the rules were clarified for launch.

Financial instruments backed by physical assets such as property offer retail investors a way to invest in property while eliminating the hassles with physical ownership. The cost of capital for developers is also reduced thanks to the additional funding source; this in turn could make homes more affordable for the end user. Making the residential property market more institutionalised – with more economic ownership choices for investors big and small – will only help the system further.