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Builders & Real Estate Bulls Theory Proved Wrong

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Builders & Real Estate Bulls Theory Proved Wrong

Last updated: November 1 2016
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  • Re : Builders & Real Estate Bulls Theory Proved Wrong

    I actually am staying on rent, waiting for the price : rent ratio to turn favorable. In Dahanukar Colony, Kothrud, current prices for a 1 BHK are 40L, rent is 10k per month.

    EMI for a 40L flat would be 32k per month. So I need to invest the extra 22k per month which I am saving by staying on rent. This saving adds up while waiting for either rents to go up or prices to go down.

    Case 1: Rents go up, price remains constant. So a 1 bhk flat rent becomes 20k per month, price 40L. Now the rent : price ratio becomes 1 : 200, which is decent enough for buying.

    Case 2: Prices crash, which I dont think will happen in Dahanukar colony, Kothrud.

    In case 1, if it takes 5 years for rent to reach 20k, then I am saving on an average 17k per month. Investing this at 15% p.a. will give me 16L, and the 8L downpayment which I already have will become 16L in 5 years.

    So waiting on rent gives me a downpayment of 32L, and need to take a home loan of 8L only, at the end of 5 years.

    The other pain in a rented flat is only that you need to shift periodically. I think this is more of an urban myth. If you have a decent landlord, and you are a decent tenant, every landlord will prefer to keep on extending the tenure with you rather than find a new tenant every 3 years.

    In rental properties, a known devil (tenant) is always better than an unknown one. Nowadays, with leave and licence agreement, a tenant never gets a right on the property.

    Comment


    • Re : Builders & Real Estate Bulls Theory Proved Wrong

      Where do you invest for 15% pa returns?

      Comment


      • Re : Builders & Real Estate Bulls Theory Proved Wrong

        Applying DCF model to Real Estate

        What if we apply the DCF (Discounted Cash Flow) model to RE?

        In simple words, DCF states that

        intrinsic value of an asset is equal to the sum of all future income expected from the asset. The future income has to be expressed in today's currency.

        Let us take a plain vanila example - a 2 BHK 1000 sqft flat in Kharadi.

        Since we are talking about "all future", we have to make several assumptions.

        1. Life of building is 100 years.

        2. Rent will be in sync with the inflation. (so that a neutral analysis can be arrived at. bulls and bears can adjust it as per their taste)

        3. After 100 years, the building will be demolished free of cost. The owner will retain the land share. The pricing of the land share is complex - will look at it later.

        4. Maintenance cost per year from owner's pocket = 1 month rent.

        5. Vacancy = 1 month/year. No brokerage paid.

        6. The inflation figure will be used to as a discount factor.

        -----------------------------------------------------------------------
        Current Rent = 12k

        Using points 4 and 5 above, yearly rental income = 1.2 Lakh

        using points 2 and 6, yearly rent remains constant. So

        total rental yield = 100 * 1.2L = 120L

        Suppose the price of land also increases only in sync with the inflation. So the price of land in todays currency remains constant.

        If built-up area is 90%, the land share of the flat will be about 900 sqft, as FSI(FAR) in Pune is 1. With very conservative pricing, it can be valued at 3000 psf.

        land price = 3000 * 900 = 27L

        Total Intrinsic Value of the Flat = 120L + 27L = 147L.

        One big omission from the calculations is Property tax. I don't know how this tax is charged. Applying it to the aboce calculation would give a more reasonable result.
        -----------------------------------------------------------------------

        I know several people would disagree with/laugh at/ridicule the assumptions mentioned. Even I have not put a lot of thought while penning them down. his is just a method, and people can choose the variables according to their wisdom and aggressive/conservative feeling.

        Before property tax is considered, the formula for intrinsic value is:

        Intrinsic Value = (Life of property in years) * (yearly rental income) + present market value of land share.

        Comment


        • Re : Builders & Real Estate Bulls Theory Proved Wrong

          Mutual funds below:

          HDFC Equity
          IDFC Premier Equity Plan A
          Franklin Templeton Prima Plus
          Birla Sunlife Dividend Yield Plus
          Quantum Long Term Equity
          ICICI Pru Discovery Fund

          All SIPs, no trading.

          Comment


          • Re : Builders & Real Estate Bulls Theory Proved Wrong

            Originally posted by fatichar View Post
            Total Intrinsic Value of the Flat = 120L + 27L = 147L.
            So you would be willing to pay for next 100 years rent income in advance today, in today's money? Not me.

            Way I would look at it: Rent today already takes into account all economic opportunities available for the tenant who is ready to stay in that flat.

            So a rent of 12k per month would make this flat worth max 30L. Now lets look at the dilemma of the tenant.
            He wants to buy this same flat, but today it is available for 50L. Should he pay a premium of 20L or wait on rent and save the difference?

            Suppose in 5 years, rents rise to 20k. Rents rise only when disposable incomes go up. So the tenants income is also going up correspondingly, and percentage of income he spends on rent remains constant.

            Also, keep in mind that tenant is not "compromising" on his today's lifestyle in any manner. He is living in a posh 2 bhk flat in new society with all amenities, and no maintenance headache.
            Also he has to keep investing the difference between rent and EMI to build a lumpsum.

            If this decision has to be taken by an "investor" and not a "home owner", all value considerations go out of the window and what remains is speculation.

            Comment


            • Re : Builders & Real Estate Bulls Theory Proved Wrong

              Originally posted by abeerbagul View Post
              Mutual funds below:

              HDFC Equity
              IDFC Premier Equity Plan A
              Franklin Templeton Prima Plus
              Birla Sunlife Dividend Yield Plus
              Quantum Long Term Equity
              ICICI Pru Discovery Fund

              All SIPs, no trading.
              Are you sure these will give you 15% pa?

              Comment


              • Re : Builders & Real Estate Bulls Theory Proved Wrong

                1. We can't talk about 'today's money', that factor is already taken in to account.

                e.g., todays rent is 12k. Next year rent is 13.2k. Inflation is 10%. So after applying discount factor of 10%, we have added next year's rent as 12k only, not 13.2k.

                This is the way CF model works. It is obviously one model out of several possible ones, none of which are perfect. But the beauty of this model is that it can be applied across the asses classes.

                Whether one is willing to pay that price is subject to one's capability. If a car is offered to me at 1L while it can be rented at 10k pm, it makes sense to buy it. But if one doesn't have money to buy, renting is the only option. Now I am not saying that you don't have money. It is just that you are believing a different model of finding the intrinsic value.

                Could you tell me the rationale behind choosing 250 as multiplication factor? Why not 200? or 300?

                Originally posted by abeerbagul View Post
                So you would be willing to pay for next 100 years rent income in advance today, in today's money? Not me.

                Way I would look at it: Rent today already takes into account all economic opportunities available for the tenant who is ready to stay in that flat.

                So a rent of 12k per month would make this flat worth max 30L. Now lets look at the dilemma of the tenant.
                He wants to buy this same flat, but today it is available for 50L. Should he pay a premium of 20L or wait on rent and save the difference?

                Suppose in 5 years, rents rise to 20k. Rents rise only when disposable incomes go up. So the tenants income is also going up correspondingly, and percentage of income he spends on rent remains constant.

                Also, keep in mind that tenant is not "compromising" on his today's lifestyle in any manner. He is living in a posh 2 bhk flat in new society with all amenities, and no maintenance headache.
                Also he has to keep investing the difference between rent and EMI to build a lumpsum.

                If this decision has to be taken by an "investor" and not a "home owner", all value considerations go out of the window and what remains is speculation.

                Comment


                • Re : Builders & Real Estate Bulls Theory Proved Wrong

                  Reason for the 1:250 ratio

                  I believe real estate is always cyclical. If there is a boom today, there will be a bust tomorrow. It might be in inflation adjusted terms, not absolute terms.

                  So a 50L flat might not go down to 30L, but it might remain at 50L for 5 years, in which case inflation is eroding its value.

                  Bubble is when price : rent ratio starts going above 1 : 300, bust is when price : rent ratio starts going below 1 : 200.

                  E.g. If a flat is worth 50L and rent for the same is 30k per month, it is a definite buy scenario. Because rents will keep increasing 10% per year.
                  If a flat is worth 50L and rent is 12k, it is a definite rent scenario.

                  The grey zone is in between, i.e. a 50L flat gets 18k rent.

                  I would prefer to wait till the cycle swings over into bust, when people suddenly discover that real estate is flat for a couple of years. In such cases, usually external environment is blamed such as political unstability (e.g. Telangana in Hyderabad). In such cases people ignore that rental demand is strong and rents are high.

                  At this time, banks have very stringent finance requirements and cash is king. If you have more than 50% downpayment, then you can get big size flats 3 bhk or 4 bhk at very low prices.

                  Demand for small flats is always constant, but demand for big flats and penthouses is very volatile.

                  Comment


                  • Re : Builders & Real Estate Bulls Theory Proved Wrong

                    Some of my friends told that even Kerala market is dead for past 3 years.
                    Last edited by abc111; December 25 2012, 04:03 PM.

                    Comment


                    • Re : Builders & Real Estate Bulls Theory Proved Wrong

                      Originally posted by abeerbagul View Post
                      I actually am staying on rent, waiting for the price : rent ratio to turn favorable. In Dahanukar Colony, Kothrud, current prices for a 1 BHK are 40L, rent is 10k per month.

                      EMI for a 40L flat would be 32k per month. So I need to invest the extra 22k per month which I am saving by staying on rent. This saving adds up while waiting for either rents to go up or prices to go down.

                      Case 1: Rents go up, price remains constant. So a 1 bhk flat rent becomes 20k per month, price 40L. Now the rent : price ratio becomes 1 : 200, which is decent enough for buying.

                      Case 2: Prices crash, which I dont think will happen in Dahanukar colony, Kothrud.

                      In case 1, if it takes 5 years for rent to reach 20k, then I am saving on an average 17k per month. Investing this at 15% p.a. will give me 16L, and the 8L downpayment which I already have will become 16L in 5 years.

                      So waiting on rent gives me a downpayment of 32L, and need to take a home loan of 8L only, at the end of 5 years.

                      The other pain in a rented flat is only that you need to shift periodically. I think this is more of an urban myth. If you have a decent landlord, and you are a decent tenant, every landlord will prefer to keep on extending the tenure with you rather than find a new tenant every 3 years.

                      In rental properties, a known devil (tenant) is always better than an unknown one. Nowadays, with leave and licence agreement, a tenant never gets a right on the property.

                      Abeer sir,
                      Price of the flat will also go up in these 5 years.

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