Real estate or equities?

I agree that real estate has some advantages. But it is not true that it is a totally safe investment option or that its price never drops, I said. Like other assets,I said,real estate too witnesses bull and bear cycles. However,since the price of our apartment,unlike that of stocks,is not reported in the newspapers,we are unaware of the day-to-day price fluctuations. Due to this lack of information one lives under the illusion that the price of real estate is stable or has moved up. It is only when one actually tries to sell a property that one discovers its true value. This is because no two properties are identical one may have a better view while the other may have better water supply. These dissimilarities make it difficult to gauge the market price of a property. Since most of us remain under the illusion that the price is appreciating,we are able to sleep well at night and hold on to a property for a number of years. It is quite likely,although not guaranteed,that over a 10-year period the price of the property will be higher than what one had bought it for. But a similar effect would be seen in equities if one had the stomach to hold it for so long. However the daily or the minute-to-minute price quotations in stocks cause sleepless nights to some. If only they could ignore the short-term price volatility of stocks and hold on to them for the long term,they would reap good rewards there too. Thus,I concluded,investing in real estate is just as risky,if not more,than investing in stocks.

Unforeseen risks in realty

Take the example of Arun Jain. His father was in government service. Upon retirement the father bought an acre of land on the outskirts of the city. He built a small house and lived there. After about 15 years the city had grown so much that his plot was now very much a part of the city. It was now surrounded by highrise buildings. Everyone told him that the price of his plot was now Rs 5 crore. Jains father had no interest in selling it and continued to live there. A few years later,Jain Senior passed away. Arun,who had by then settled in the US,decided to sell off the property. He got offers worth Rs 50 lakh. Arun was shocked and enquired why the expected price of Rs 5 crore was not being offered to him. He learnt that the government had deemed the land to be covered under the hill tops and hill slopes regulation. This meant that no construction was allowed on that plot of land. But there are buildings all around our plot, he protested. He was informed that they had come up before the new rule came into effect. Since no new buildings are permitted now,the value was down to just one-tenth of the earlier price.

This is a true story. I have witnessed many more such incidents, I said. I further added: This is not to say that real estate is a bad investment. Its just that it bears a certain amount of risk,just like any other investment.

Somesh was lost in thought.

What about investing in stocks? Madhav enquired.

Like real-estate,stocks also have some advantages and some disadvantages. The greatest challenge in stock market investing is choosing the right basket of stocks or mutual funds. But the advantage of stocks is that they are very liquid,one can invest small amounts at a time,and the transaction cost is low compared to real estate. The lower transaction cost is due to the absence of stamp duty and long-term capital gains tax on equities,which are applicable to real-estate transactions. Moreover,the absence of any cash component as is demanded in real-estate purchases in buying stocks means that even middle-class people can buy them.

With the launch of index funds and exchange-traded funds ETFs stock investing has been greatly simplified. It reduces stock-picking risks and assures returns that very closely replicate those from stock market indices such as the Sensex or the Nifty.

So where does one invest? asked Madhav.

A combination of both real estate and stocks is desirable, I said. As a thumb rule,for an upper middle class household,up to 50 per cent of their total wealth can be in real estate. Of the remainder of the portfolio,a percentage equal to 100 minus age should be invested in stock markets preferably index funds or index ETFs. For example,for a 30-year-old,100 8211; 30 = 70,therefore,70 per cent of non-real estate assets should be invested in equities.

Somesh was no longer lost in thought. He looked at Madhav and nodded. The conversation moved on to other subjects.

The author,a certified financial planner,is the chief executive of Sardesai Finance.

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