Monday, May 07, 2007

Make property part of your investment portfolio

Circa 1999: The term 'Indian real estate' was a scary one. Investing in real estate for capital appreciation and income was unheard of.
Circa 2005: The consensus was that there is a real estate 'bubble' that can burst anytime.
Circa 2007: Real estate emerged as 'another asset class' ideal for diversification as well as in optimising returns.
This is how perceptions about investing in real estate changed over the years. With real estate markets more vibrant than ever before, and with increasing institutional participation in this market, their scope is proliferating. The result - increased investor confidence and increased investments in the sector.
Investment avenue
Over the past few years, with more investment avenues opening up and offering better returns, investment in real estate had taken a back seat. The reasons - price appreciation in real estate, and markets opening up with more sustainable demand. Half a decade ago, we did not have a vibrant rental market for retail and commercial space. With increasing demand for retail space and office space, these two segments are witnessing improved rental yields and also attractive price appreciation.
With increased buoyancy, the real estate market now falls in league with stocks, bonds, mutual funds, gold and commodities, and insurance policies as a viable investment option for investors in all categories - individuals, corporates, and funds.
Residential property offers appreciation
Residential property is a relatively simple investment route for an individual investor/buyer, who can buy properties both under construction and ready possession for capital appreciation. Returns increase if expected capital appreciation is higher than interest rates on housing loans. In such a scenario, individuals can invest in a house by borrowing from a housing finance company.
Possible returns:
Illustration 1: Returns on investment in a house
Property cost: Rs 100 Loan: Rs 85 Net investment: Rs 15 Appreciation: 15 percent Interest cost: 12 percent Holding period: Two years Net profit: Rs 7.9 Returns: 26 percent
An additional benefit is tax benefits on deduction of interest paid and repayment of loans from gross income. This increases net returns commensurately.
Commercial space
Office and retail space is a more interesting investment option for bigger investors. Here, an investor buys a property and lets it out. He earns a regular rental income and carries the benefits of price appreciation too. Rental income can range between 11 and 12 percent on investment, and there is room for capital gains. Again, investors can leverage much more efficiently by using lease rental discounting (LRD).
In another model, an investor can buy a vacant or under-construction property, invariably available at a lower price than a leased-out asset. The intention is to earn a higher rental income and a higher yield on his investment. He has to take a call on increase in prices and demand. This results in higher rentals. However, the investor undertakes the responsibility and risk of leasing it out. Eventually, basics of investing prevails - higher the risk, higher the return.
Real estate funds
The only risk that a small investor carries while investing in individual properties is risk of concentration of assets in single or few cities or single or few asset classes. An easier way to diversify one's asset portfolio and mitigate this risk is investment in real estate funds. The advantage is that professionals manage such funds - professionals who are current on market developments and who can take proper decisions immediately. Also, given a large fund size, they can diversify across asset categories. For instance, they can invest in retail, office, and residential property. This diversification reduces risk and also helps in optimising returns.
To sum up, the only real investment that one can hold in one's portfolio is real estate. Investors can look at ways and means, and evaluate options to invest in real estate. Adding realty to a portfolio that also features equities, debt, commodities, and insurance will help in diversifying it and optimising overall portfolio returns.

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