Real estate is not our most-preferred investment asset. Nevertheless, there are some advantages of investing in real estate. Though there are several unique factors, it is important to consider the associated risks before you invest in realty.

Unique factors

Real estate refers to your investments in land and property with the intent of generating either rental income or capital appreciation. It does not, therefore, include your self-occupied house.

The following are some of the unique features associated with real-estate investment.

First, it is an investment asset that you can easily convert into a consumption asset. Suppose you buy land for capital appreciation and the price does not appreciate enough; you can build a house and gift it to your children. You would have essentially converted your investment asset into a consumption asset.

This is an important feature because it reduces your anxiety associated with the investment. Your stress levels are likely to be lower when your real-estate investment declines by 20 per cent than when with a similar decline in your equity investments.

Second, real estate gives you emotional satisfaction. True, you may be excited thinking about your wealth if you own 1,000 shares of MRF. But owning a similar value in real estate can give you greater satisfaction.

Why? For one, real estate is touch-and-feel because it is a physical asset. And two, it is less volatile than equity. A 25 per cent decline in a stock is more possible in any year than a similar decline in your property value.

Third, real estate can offer stable income, just like bonds. Of course, you also know the amount you will receive if you hold a 10-year bond or bank fixed deposit till maturity. But you do not know today how much you will receive if you sell your property 10 years hence.

Real estate, however, offers a different benefit; it gives you some protection against inflation. If the general price levels in the economy increase, your rental income could increase as well. This is an important feature for retirees who depend on rental income to support their post-retirement living.

Finally, you can use real estate as collateral to borrow money to meet large contingencies. The advantage is that the haircut or margin for real estate is lower than that on stocks. If your equity portfolio is worth ₹5 crore, you can typically borrow ₹2.5 crore, whereas you can borrow more for the same value of real estate.

That said, you must consider the following factors before you decide to invest in real estate.

Associated risks

Real estate is a lumpy investment and will constitute a significant part of your investment portfolio. This could be a problem if you believe in holding a liquid and diversified portfolio.

Also, real estate is a non-portable asset. This is especially a problem if your work requires you to move from one place to another. Your investment portfolio must be aligned with your professional work.

More the portability of your work, more should be the financial assets in your investment portfolio.

Finally, you must consider the economics of real-estate investment. Is it worth borrowing money to buy a rental property or a land for capital appreciation? Your decision to invest should not be driven by tax benefits. What if tax laws change in subsequent years even as your loan is outstanding?

That could change the expected cash flows from your investment. Also, selecting a good property is important because reversing a bad investment decision is difficult with real estate than with equity or bonds.

The writer is founder of Navera Consulting. Send your queries to portfolioideas@thehindu.co.in

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