Real estate has traditionally been an avenue for considerable investment and investment opportunity for high net-worth Individuals, financial institutions as well as individuals looking at viable alternatives for investing money among stocks, bullion, property and other avenues.
Money invested in property for its income and capital growth provides stable and predictable income returns just like bonds, offering both a regular return on investment (if the property is rented) as well as the possibility of capital appreciation.
Like all other investment options, real estate investment also has certain risks attached to it, which is quite different from other investments. The available investment opportunities can broadly be categorized into residential, commercial office space and retail sectors. For example, if someone is looking for investing in flats in Thrissur, he must know what the investment scenario is in Thrissur.
Investment scenario in real estate
Any investor before considering real estate investments should consider the risk involved in it. This investment option demands a high entry price, suffers from a lack of liquidity and an uncertain gestation period. To be illiquid, one cannot sell some units of his property (as one could have done by selling some units of equities, debts or even mutual funds) in case of urgent need of funds.
Real estate is expected to offer a good investment alternative to stocks and bonds over the coming years. This attractiveness of real estate investment would be further enhanced on account of favourable inflation and low-interest rate regime.
The rationale for real estate investment schemes
The activity of real estate includes a wide range of activities such as development and construction of townships, housing and commercial properties, maintenance of existing properties etc.
The construction sector is one of the highest employment sectors of the economy and directly or indirectly affects the fortunes of many other sectors. It provides employment to a large workforce including a substantial proportion of unskilled labour.
However, for many reasons this sector does not have smooth access to institutional finance. This is perceived as one of the reasons for the sector not performing to its potential.
Advantages of investment in real estate
The following are the advantages of investing in Real Estate Investment Schemes:-
As an asset class, the property is distinct from the other investment avenues available to a small as well as large investor. Investment in property has its own methodology, advantages, and risk factors that are unlike those for conventional investments.
A completely different set of factors, including capital formation, economic performance and supply considerations, influence the realty market, leading to a low correlation in price behaviour vis-a-vis other asset classes.
Real estate returns also show a high correlation with inflation. Therefore, real estate investments made over long periods of time provide an inflation hedge and yield real returns.
Risks of investment in real estate
The risks involved in investing in real estate are primarily to do with future rental depreciation or general property market risk, liquidity, tenancy risk and property depreciation. The fundamental factors affecting the value of a specific property are:
Location
The location of a building is crucially important and a significant factor in determining its market value. Property investment is likely to be held for several years and the attractiveness of a given location may change over the holding period, for the better or worse.
For example, part of a city may be undergoing regeneration, in which case the perception of the location is likely to improve. In contrast, a major new shopping centre development may reduce the appeal of existing peaceful, residential properties.
Tenant Credit Risk
The value of a building is a function of the rental income that you can expect to receive from owning it. If the tenant defaults then the owner loses the rental income. However, it is not just the risk of outright default that matters.
If the credit quality of the tenant were to deteriorate materially during the period of ownership then the sale value will likely be worse than it otherwise would have been.
Tax Implications
Apart from income tax which is to be paid on rental income and capital gains, there are two more levies which have to be paid by the investor i.e. property tax and stamp duty. The stamp duty and property tax differ from state to state and can impact the investment returns ones expected from a property.
Physical Characteristics
The type and utility of the building will affect its value, i.e. an office or a shop. By utility is meant the benefits an occupier gets from utilizing space within the building.
The risk factor is depreciation. All buildings suffer wear and tear but advances in building technology or the requirements of tenants may also render buildings less attractive over time. For example, the need for a large magnitude of under-floor cabling in modern city offices has changed the specifications of the required buildings’ space.
Also, a building which is designed as an office block may not be usable as a Cineplex, though Cineplex may serve better returns than office space.
High Cost Of Investment
Real Estate values are high compared to other forms of investment. This nature of real estate investment puts it out of reach of the common masses. On the other hand, stocks and bonds can now be bought in quantities as small as-one share, thus enabling diversification of the portfolio despite lower outlays. Borrowing for investment in real estate increases the risks further.
Legal Issues
While stock exchanges guarantee, to a certain extent, the legitimacy of the trade in equities or bonds and thus protect against bad delivery or fake and forged shares, no similar safety net is available in the property market.
It is also difficult to check the title of a property and requires time, money and expertise. Overall keeping an eye on market trends can reduce most of these risks. For instance, investing in properties where the rentals are at market rates, also, investing in assets that come with high-credit tenants and looking for lease lock-ins to reuse tenancy risk are simple guidelines to follow.
Future Outlook
The real estate market is witnessing a heightened activity from the year 2000 both in terms of the magnitude of space being developed as well as a rational increase in price. Easy availability of housing loans at much lesser rates has encouraged people who are small investors to buy their own house, which may well be their second home too.
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