Real estate as an investment option

Recently my friend Rocky wanted to know how I feel about a matter that has been in his mind for some time. He has a flat in Panaji purchased 12 years back for about Rs 9 lakhs (Rs 2 lakh of own and rest loan). He has moved out of it to a bigger place as his requirements now have outgrown the 90m2 space. He expects to get around Rs 54 lakhs for the old flat which amount he plans to utilize to buy another flat. He feels this could be a good investment as the real estate prices in Panaji may double or triple in the next ten years. What do you feel about it?

Let me break down the matter into smaller bites to assess the pros and cons of each of the two components of Rocky’s plan. First is the sale of the old flat. How much gain is that transaction returning to Rocky? To work that out let us put his inflow and outflow of cash over the last 12 years in a table.

The table shows us that he has earned from his investment in the flat about 19 per cent per annum over the last 12 years. This is definitely a good return. Had he put the same money in a bank FD, he would have earned around 10 per cent. Of course had he invested in equity (shares) either directly or via an MF equity scheme he would have earned as much. The average returns from equity over the last 12 years have been about 11 per cent. That takes us to the second part of Rocky’s plan to invest in a new flat. The gain from the sale of the old flat gives Rocky the confidence to assume that real estate prices in Panaji may double or triple in the next ten years. Are they likely to?

Rocky had bought his old flat around 2003 and now we are in 2015. In these twelve years

Panaji has undergone a lot of change. It is more crowded. Its infrastructure has further

crumbled. If this process continues what will be its state over the next ten years?

The real estate prices in a city depend entirely on the demand for and supply of real estate in that city. Yes, the supply of real estate in and around Panaji cannot grow much.

But will the demand grow, or even sustain over the next ten years?

Though it is still not showing in the prices there is a glut for real estate in and around Panaji. One reason is the deteriorating urban infrastructure transport, garbage disposal, water supply, power, etc. Personal safety and governance in Goa’s urban areas and tourist areas has been deteriorating day by day. Equally important is the fading attraction of Goa as a tourist destination – for the same reasons. We have got to understand that more than half of the demand for real estate in and around Panaji, and for that matter in entire Goa comes from those who look upon Goa as a holiday destination. If this demand begins to whither, the real estate prices in this urbs prima cannot be obviously sustained.

So looking from all angles, expectation of a high return from real estate in Panaji cannot be justified. Real estate prices in Panaji can now be expected to keep pace with the general inflation rate. Age is another reason why investment in real estate may not be the best option for Rocky.  He is already in his early fifties. Now he does not have with him the time to grow value in his real estate as he had twelve years back. At that time he could easily weather a ten year cycle in real estate prices. Now he is close to retirement. He needs to keep the investment sufficiently liquid to enjoy its fruit. Locking it up in an illiquid asset like a flat is obviously not the best thing to do at this stage.

So, keeping in mind the total situation it may be advisable for Rocky to go for some investment options which can give superior returns and which are more liquid. Of course, if Rocky is looking at saving tax on capital gains from the sale proceeds of his old flat under section 54, then the whole cost-benefit equation changes.