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Risk of going overboard on real estate


Risk of going overboard on real estate

Last updated: October 22 2012
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  • Risk of going overboard on real estate

    Property investment has seen a big spurt in recent years in India. After the initial euphoria cooled off a bit with the crisis in 2008, interest in properties as an investment picked up again in 2010-11 and continues. Property has given fabulous returns in the last decade or so and in many geography prices have gone up by anything from 3-4 times to 10 times.

    In today’s environment when other asset classes like equities, debt, gold etc all have their own set of problems and there is significant risk associated with many of them, property has once again emerged as the preferred investment option. It’s not uncommon to find investor portfolios carrying 70-80 per cent weight in real estate.

    There has been low investor interest in equities as it has not given good returns over the last two years. For people looking for safe investments, debt is a good option but returns are almost negligible, net of inflation. Gold has lost some shine due to very uncharacteristic volatility seen over last few years.

    Hence, there is a natural attraction towards properties. It seems to give high returns while being very safe. But is it really as safe as it seems to be? Is it a good time toinvest in properties?

    Many people are not asking these questions today, which to my mind is quite relevant and must be asked. Historically, any asset class that sees a huge rise goes through a phase of correction and real estate is no exception. Sub-prime crisis has seen meltdown of real estate prices at its core. Similarly, be it the 1997 Asian crisis or the more recent problem with Bankia in Spain, bursting of real estate bubble has been the prime driver in many financial contagions in the past.

    But isn’t India different? With a huge unmet demand for housing and growing urbanisation and affordability, why should property prices go down for another 10 years? Its not an easy question to answer. Let’s look at some recent trends. Property prices have gone to dizzying levels in Mumbai and have stagnated for about a year now. Overall, the number of transactions has remained slack and seems investors are sitting on the fence waiting for the prices to correct. In places like Gurgaon, almost 40 per cent of ready apartments are lying unoccupied as they have been bought by investors who don’t want to go through the hassle of renting them out. Affordability in Delhi, Bangalore and Gurgaon is certainly becoming as issue for most of the people who live in these cities.

    Between Q1 FY10 and Q3 FY12, FDI in real estate declined by 92 per cent and its share in total FDI shrunk from 6.83 to 1.94 per cent.

    On the other hand, falling rupee has made property more affordable for NRIs. It’s quite logical to expect heightened interest amongst NRIs to invest more in properties now.

    The answer for an investor probably lies in the time tested process of diversification of risk and proper asset allocation. Going by the examples of property prices collapse in numerous countries globally in the recent past, it will not be prudent to assume there is no inherent risk in properties. Like any other asset class, real estate also comes with its set of risks.

    Best way of managing this risk is by ensuring you don’t go overboard by putting all your eggs in one basket by investing only in real estate. To ensure this, it’s critical to avoid significant leverage in your real estate investments. If prices were to come down by 10-20 per cent, you should not go bankrupt or get severely stressed. By keeping these points in mind, one can gain from the potential upside in property prices which still seems very much there and at the same time manage risk by diversifying adequately.

    Risk of going overboard on real estate
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