On a pleasant, late summer evening, Finn, Nancy and Meme catch up for dinner after work.  They meet at the newly opened Burger Palace with a seating area overlooking the beach.

Waiter: “Are you ready to order?”

Finn: “I’ll have a regular Cheeseburger, please.”

Meme: “I’ll have a Ceaser’s salad.”

Nancy: “Salad! That’s so boring! I’ll have a double-burger, please.”

Waiter: “We have an ongoing offer for a triple-burger for just a little higher price than a double. Would you want that instead perhaps?

Nancy: “Oh yes, definitely! Please also bring some extra ketchup and mayonnaise.”

Waiter: “Absolutely, ma’am. It will take about 15 minutes.”

While waiting, the conversation turns to real estate.

Finn: “Have you checked out the huge apartment complex getting built near our office building?”

Nancy: “I did and I was thinking of buying a 2 BHK there actually. But the marketing executive convinced me that it is actually a good investment idea to go for a 3 BHK.”

Meme: Why do you need a 3BHK?

Nancy:“Because I can get more rent by letting it out to a group of bachelors working in our office building. It will be cheaper for them per head, while I’ll get more rent in hand.”

Finn: “I’m surprised you are considering putting your money to good use by investing in real estate instead of wanting to spend it on a holiday to the Maldives with your boyfriend or something like that!”

Nancy: “Maybe, I have become more sensible with investing, thanks to Meme!”

Meme: “That’s funny! There’s a simple way to figure out if your investment is sensible or not. What is the rental yield you are getting on this apartment?”

Nancy: “Rental yield? What’s that?”

Meme: “Your annual rent divided by the cost of your investment.”

Nancy: “I’ve been told that I’ll get around Rs.30,000 as monthly rent. And the cost of the property is around 75 lakhs. So my rental yield is Rs. 3,60,000 divided by Rs. 75 Lakhs, which should be slightly less than… 5%! Not bad, I suppose!”

Meme:“Hold on for a minute! 75 Lakhs! How are you going to afford it?”

Nancy: “I’ll be getting a home loan of course. The Bank has offered to fund me 90% of the home price and I just have to put in a down payment of 10% to book it.”

Finn: “And you’ll be paying off the EMI for how many years?”

Nancy: “The bank representative said, I’m eligible for up to 30 years since I’m young.”

Meme: “Have you calculated how much interest you’ll be paying through these 30 years?”

Nancy: “My EMI comes to about Rs. 44,000 at 6.75% interest, but as I’ll get Rs. 30,000 as rent, I’ll only have to pay Rs. 14,000 as EMI from my pocket.”

Meme: “That wasn’t my question. Your EMI includes Principal and Interest to the bank. Over 30 years, you will be paying nearly 1.6 Crores as EMI of which, 90 Lakhs is just as interest.”

Finn: “Phew! That’s a lot! This is why I don’t prefer to take any loans!”

Meme: “And you said the rental yield is 5% – which is something you can get even with FDs at today’s rates. And the money will be liquid, whereas you cannot sell your house immediately if you are in urgent need of money for something. And most importantly, you need to include the cost of money, that is, including interest, in the cost of your house acquisition / investment. So, your yield is not 4.8% but 2.3% if you take 1.6 Crores as the total cost of your apartment including interest!”

Nancy: “Calm down, guys. Aren’t you forgetting that the price of the apartment is also likely to go up in 30 years?”

Meme:“Firstly, the real value of your investment is in the land, not the built-up construction. For which you need to look at the proportion of UDS (undivided share of land) that you own as part of this apartment complex. While the land price might appreciate, the cost of your apartment as it gets older will depreciate since a 30-year-old building will need a lot of maintenance. Also, in India, currently supply far exceeds demand. I would prefer to buy a brand-new apartment over a 30-year-old flat in resale.”

Nancy: “But… but…, don’t real estate prices always keep going up?”

Meme: “Firstly, they don’t *always* go up! Prices have been stagnant in India since 2013. But yes, over a long period of time, they tend to go up, considering the number of first time home buyers in our country uplifted by the economic opportunities.  However, as an investment, you need to consider the rate at which your investment is able to compound.”

Finn: “I know of a relative, who bought an apartment for Rs. 15 Lakhs in 2003 and sold it for Rs.1.5 Crores in 2013. Isn’t that a good 25% annual growth rate?”

Meme:“Yes, but that depends on location and a bit of luck. You need to understand how value accretes in real estate. When you have a piece of agricultural land and you sell it to a developer, there’s some addition of value when he builds multiple apartments on that land. When there are highways and other industries developing in that area, it makes the location more valuable, causing some more addition of value. As the area becomes densely inhabited with stores, schools and other amenities available nearby, there’s more demand for housing in the area, causing additional price appreciation. This used to happen in earlier decades quite a bit. But today, the value addition from the earlier phases has already happened in most locations. Only the last phase is pending in many locations. So, you may still see real estate prices appreciate but you are unlikely to see the kind of real estate price boom as you saw from 2003 – 2008.”

Finn: “What happened in 2003 – 2008?”

Meme: “2003-2008 was a boom period for the global economy on the back of the new found corporate profitability arising out of globalization and outsourcing. At that time, almost every investment – stocks, bonds, real estate, gold, had a booming period as there was more investible surplus in people’s hands and consumption was quite high. Today, with more protectionism, the aftermath of the 2008 financial crises and the 2020 pandemic, the situation is very different. And in India, developers are struggling due to unsold inventories due to the crackdown on black money and introduction of the RERA act, but unwilling (or unable) to reduce the prices from the elevated levels of 2013. So, the golden period of 2003-2008 and earlier decades is unlikely to repeat itself.”

Nancy: “Are you saying no one should buy a house in this climate?”

Meme: “No, not at all. I’m merely pointing out the risks in considering a house as an investment, especially when you take home loans with the expectation of windfall gains due to property appreciation.

Nancy: “So what should I do instead?”

Meme: “If you are not going to live in this house and you are buying this just as an investment, you are better off investing in equity and debt mutual funds, as they are more liquid, and can be easily sold for cash, in times of emergencies, and you are likely to get better returns of around 8-10% in the long run instead of a 2-4% rental yield.”

Nancy: “And if I’m planning to buy a house for living on my own?”

Meme: “If you are planning to live in this house, then by all means buy it. But do so, after careful consideration of your long-term financial goals. Firstly, ensure you have 6-12 months expenses put away as emergency expenses – a sort of safety buffer. Secondly, consider money needed for retirement and financial independence. Our parents’ generation had a secure government job and a life-long pension. We don’t. We will need to invest today to ensure we have a corpus to draw money from when our jobs stop – either due to regular retirement or if we are forced out of the job, as it happened during Covid. Until then, there is no harm in staying on rent. In the long term, renting is cheaper than paying home loan interest. After you have put together an investment plan for your long-term financial needs, if you still have money left over for EMI that doesn’t affect your lifestyle expenses, then you can go ahead.

Nancy: “Makes sense. You are recommending prioritizing liquid investments over real estate which is illiquid, correct?”

Meme: “Exactly. There are many people, who are well educated and earning top-notch salaries in my circle, whose financial situation has spiraled down rapidly after getting affected by Covid. They had barely 1-2 months expenses in their bank and the rest of their assets were sunk heavily in real estate, which they cannot sell at a moment’s notice to pay off a large hospital bill for example.”

Nancy: “I understand. Basically, you are saying don’t compromise on your long-term financial goals by getting stuck with a home loan liability. Now, let’s say I’m investing systematically for my long-term goals and I have money left over for a home loan EMI with a 30 year tenure, can I go ahead?”

Meme: You can, but do bear in mind that  as the tenure increases, the amount of interest you pay to the bank increases quite a bit. For your example, a 15-year tenure of your loan will bring your interest down from 90 Lakhs to 40 Lakhs.”

Nancy: “Whoa! That’s a lot, but I can’t afford a 15-year EMI now. What if I take a 30-year loan, but pre-pay earlier in 15 years?”

Meme: “That would also reduce your interest outgo in proportion to how much you have pre-paid. Again, this is fine as long as you have not compromised on your other long-term financial goals. It’s a balance that only you can figure out.”

Nancy: “Fair enough!”

Meanwhile, the burgers arrived and all three jumped right into their plates.

Finn: “This Cheese burger is really tasty!”

Meme: “I’m loving this salad as well!”

Nancy just mumbled something inaudible with a mouthful of the triple burger, which the boys assumed to mean she was enjoying it as well. Suddenly, Nancy started to choke and gag.

Finn: “Nancy, are you okay?”

Meme: Give her a pat on the back, Finn!”

And just like that, Nancy spat out everything in one big cough.

Nancy: “I’m alright. Thanks guys!”

Meme: “This is why they say, ‘Don’t bite off more than you can chew’”

Nancy: “Are you talking about my burger or home loans?”

Meme (chuckling): “Well, maybe there’s more than one lesson here!” 😉

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