This article describes real estate as an asset class, and talks about the different avenues of investment possible in real estate.
Real estate is hot these days – the prices of land and properties have been rising for years now, just like our stock markets. Many of us have benefited from this increase in property prices.
But at the same time, many of us have been only on the sidelines, and want to take advantage of this boom now. So, let’s understand what real estate is as an asset class, and how you can invest in real estate.
What is Real Estate?
By Real Estate, we refer to various fixed assets. It can be divided into three classes:
- Residential Property: It includes flats, apartments, bungalows and row houses
- Commercial Property: It includes shops, offices and godowns
- Land: It includes farmhouse plots, industrial plots, and agricultural and non-agricultural land.
Investment in Real Estate
Investment in any of above mentioned items can be termed as an investment in Real Estate.
Usually, residential and commercial property is given out on rent, so that you get a recurring rental yield over and above the capital appreciation in the price of the property. Land is usually held for a long term, and the only purpose of an investment in land is to get capital appreciation.
Please note that buying a property for your own use doesn’t count as real estate investment. Thus, buying a house for your own stay is not a real estate investment. Although it can make your investment grow on paper (that is, notionally), it is not something that you can sell and earn a profit. Therefore, it is not an investment in real estate.
Trends in Real Estate Investment
- Historically, it has been observed that investments in land have given far superior returns compared to investment in developed property. But investment in land comes with its own risk – it is far easier for someone to illegally occupy your land compared to occupying an apartment or office. Therefore, you need to be very cautious and vigilant while investing in Land.
- The rental yield offered by commercial property is higher than the rental yield from residential property. While the rental yield from commercial property is usually 8-12%, the yield from residential property is in the range of 5-6%.But at the same time, it should also be noted that the rates of commercial property are far higher – usually 2 to 3 times – than the rates of residential property.
Characteristics of Real Estate Investments
Large Investment Needed
Investment in real estate requires a very large corpus. Even a small apartment in a small city doesn’t cost less than Rs. 10 lakhs these days.Thus, you need a lot of money to invest even in a single property. And if you want to properly diversify, you need to have a lot more invested in other asset classes like equities, debt and gold.
Therefore, direct real estate investment is not for small investors.
But there is a way small investors can invest in real estate – using Real Estate Investment Trusts. Please read “Real Estate Investment Trusts (REITs)” to know more about it.
Illiquid Investment
The investment in real estate is illiquid – you can’t sell it in a short time in case you need the money, or in case you need to book profit.
Stocks and mutual funds can be bought and sold in an instant on the stock exchanges. Therefore, you can take quick decisions.
But there is no such ready marketplace for real estate. Both the purchase and sale of property involves lengthy discussions, and can consume a lot of time. Hurrying the process would only mean that you get an unfavourable rate!
Price Discovery
The lack of a proper marketplace for property also means that price discovery is that much more difficult.
The only way to find out the price is to enquire in the market and find out the prevailing rate! At times, you would get rates of deals that have happened 4-5 months back, and you would have to arrive at a proper rate on your own.
For developed property (that is, commercial and residential real estate), the price of property in the same locality also varies from builder to builder. Builders having a good reputation and track record command a premium. You would need to factor in this while calculating the price for a property.
The age of the property is also important in deciding its price – a newer property has a higher price than an older property.
But the most important factor in a property’s price is its location – as a rule of thumb, the more accessible the property is, the higher would be its price.
Legal Issues
It is very important to verify the title of the property – this means that you need to ensure that the seller is indeed the owner of the property, and has the right to sell it.
You also need to ensure that the property is not mortgaged to a bank. You should also duly register the sale deed.
Failure to take care of these things can result in legal issues at a later stage.
Income Tax Treatment
Recurring income (rent) from residential property is treated as “Income from House Property”. It is therefore clubbed with your income, and is taxed at the prevailing rates.
Recurring income (rent) from commercial property is treated as “Other Income”. It is also clubbed with your income, and is taxed at the prevailing rates.
Capital gain from residential property, commercial property or land is treated as long-term gain if the property is held for more than 36 months. In this case, the gain is taxed at the rate of 20%.
If the property is held for less than 36 months, the gain is treated as short term. It is clubbed with your income, and is taxed at the prevailing rates.
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