Real Estate Doom | Value Research Traditionally, it has always been viewed as a safe asset class. But depending on how you invest in it, it could turn out to be a risky proposition
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Real Estate Doom

Traditionally, it has always been viewed as a safe asset class. But depending on how you invest in it, it could turn out to be a risky proposition

Many of us instinctively feel that buying property is always a good, safe and sound investment. One that will eventually turn out right no matter what the future brings. Consequently, many of us are getting into serious financial trouble because of this delusion. I'm sorry to put this in such an alarmist fashion but that's exactly what my intention is.
Rising interest rates and stagnating real estate prices may be just an inconvenience for the cautious home owner but it could spell disaster for a new class of real estate investors that have come up in our cities in recent years.

The huge real estate boom that's been on for about four years now has given rise to some distinct types of buyers. At the bottom are those who have bought a house or an apartment for their own use. Depending on how much of their income goes into the EMIs of their home loan, these people will get uncomfortable (either a little or a lot) but it will work out for them in the end. At the other end are the big developers whose fate depends on their finances and their risk control.

In any case, each is a different story altogether. In the middle are the category of people who are most at risk. They have other professions and businesses but have been lured into channelising a large proportion of their money into real estate.

Unfortunately, the standard mode of 'investing' in real estate is not investing but is closer to what is called margin trading in other kinds of investing like stocks. For those unfamiliar with this activity, I'll quickly explain. Conceptually, margin trading means buying an investment on borrowed money for which the investment itself is the guarantee.

Normal (non-margin) trading works like this. If you have Rs 1 lakh and you buy shares share worth that much, you pay the broker Rs 1 lakh. If the shares go up to Rs 1.1 lakh, you've made Rs 10,000 on an investment of a lakh which is a gain of 10%. In margin trading, you would give your broker the one lakh and he would let you buy, say, Rs 10 lakh worth of shares. Basically, you would be borrowing Rs 9 lakh on the strength of the one lakh that you've put down.

You would, of course, have to pay interest and the shares would not actually be transferred to your name.

Now when the stock price rises 10%, your effective gain would be Rs one lakh on an investment of Rs 1 lakh (minus interest), a far more handsome return. But the catch is obvious. A 10% gain could double your money but a 10% loss could wipe out all your money. Margin trading is clearly a high risk-high gain activity.

Most real estate investing nowadays is actually margin trading of a kind that is even more dangerous than that in the stock markets. When real estate investors buy a property by putting down 10% or 20% of its value and borrowing the rest, then they are actually not buying anything, they are just speculating on something that the bank owns. So far, they have all been ahead of the game because prices have risen relentlessly. You put down Rs 10 lakh and buy something for a crore. A year later, the property is worth Rs 2 crore and you feel that you've made Rs 1 crore on an investment of Rs 10 lakh.

The problem is interest rates and liquidity. You've actually made a 15 or 20 year commitment which is looking increasingly dangerous the way interest rates are rising. But the bigger problem is liquidity.

In mutual funds or stocks (the bigger stocks), you can at least cut your losses at any point.

Real estate markets, however, tend not to offer liquidity in bad times. Either the prices are rising, or there are just no buyers except at distress prices. My hunch is that at least in residential property, we will enter a phase in which highly-indebted middle level amateur 'investors' will make lots of distress sales, perhaps to the benefit of the individual house owners as well as the deep-pocketed long-term developers.

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