Mutual Funds Vs Real Estate Which is better for

Investing in India?
Case 1: Real Estate Investment

Following is the data being used:

Value of Property = Rs 75 Lacs (1500 sq ft @ Rs 5000/sq ft)

Required Initial Down Payment (@20% of Property value) = Rs 15 Lacs

Loan Availed (for remaining 80%) = Rs 60 Lacs

Loan Tenure = 20 Years

Loan Interest Rate = 10.15%

Few more administrative costs are as follows:

Loan Processing Charges & Other Expenses (@2% of Property) = Rs 1.5 Lacs

Registration Fees (@10%) = Rs 7.5 Lacs

After doing some calculations which are depicted below, we arrived at quite interesting numbers.

Interest Paid over 20 Years = Rs 80.30 Lacs

And as you can see in the last column in table above, this property has also been able to generate post-tax
and expense adjusted rental income. We used a few assumptions for rental income and expense which are as
follows:
 Rentals increase by 5% every year
Rental income from property is taxed at 20%
Maintenance expenses are recurring every 5 years: Rs 1 Lac (5th year), Rs 1.5 Lac (10th year), Rs 2 Lacs (15th year)
and Rs 2 Lacs (20thyear)

All in all, these result in an amount of Rs 24.67 Lacs being generated from the property over a period of 20
years.

This means, that effectively the property costs about Rs 1.39 Crores as depicted in table below:

Now as per general perception (at somewhat backed by data too), the properties are known to appreciate in
price. But here, we are not talking about property prices doubling every 2-3 years. We are talking about
much sensible returns ranging from 9% to 12%.

Lets see what this part of the calculation leads us to:

We will evaluate 3 scenarios where property appreciation is taken as 9%, 10% and 12% continuously for 20
years. And this evaluation is depicted in table below:

To summarize the above calculations, this property initially cost Rs 75 Lacs. But since loan was taken and it also
generated rental income, the total landed cost was Rs 1.39 Crores.
Now when 3 different scenarios are considered where this property appreciates by 12%, 10% and 9%, the
expected net gains are Rs 5.1 Cr, Rs 3.4 Cr and Rs 2.75 Cr respectively.

Agreed that these are some really big numbers.

But before you start putting your hands on your mouth after reading them, lets check out the second case
where we evaluate similar investments in mutual funds.

Case 2: Mutual Fund Investment

We are using the following data for this case:

Initial lumpsum investment in MF schemes of Rs 24 Lacs. This amount is equal to the sum of Initial
Property Down Payment (Rs 15 Lacs), Registration Charges (Rs 7.5 Lacs) and Loan Processing fees (Rs 1.5
Lacs).

Now the EMI amount in earlier case was Rs 58,459. This amount in this case can be used as monthly SIP.
But we also need to consider the tax benefit of Rs 1 Lac availed on house loan investment which is to be
equated monthly. That amounts to Rs 8333 and resultant amount available for monthly SIP is Rs 50,126.

So here is the calculation sheet for two types of investment scenarios.

First one is where returns from MF move from initial 12% to 7% in later years. These are conservative
numbers when compared to returns given by really good MFs.
Second one is a slightly aggressive returns assumption based analysis. Here the returns move from 15%
initially to 7% in later years. But even then the returns of 15% are not that rare and have been achieved by
quite a few funds in India for decades.

Now what happens when these funds are sold after 20 years? There wont be any tax as long term capital
gains is not taxed in India for stock market returns.

So for an investment of Rs 1.44 Crores (lump sum + SIP of 20 years), a corpus of Rs 10.28 Crs and Rs 7.06
Crs has been achieved. And mind you, this return has been achieved despite having paid the additional tax
@ 8333/- per month for 20 years. And these numbers are substantially higher than the real estate investment
even after tax saving.

This means a net expected gain ranging from Rs 5.61 Crs to Rs 8.84 Crs.

Compare these numbers with those of Real Estate case and you will understand what this article is trying to
point you towards.

Why do People Invest in Real Estate?

We have tried to list down a few reasons which we though people have for investing in real estate. And here
were are not talking about the 1st House but about the 2nd property, which is treated as an investment:

1. There is mental comfort in buying a hard asset that you can see and feel (also applicable to gold).
2. It is an asset that can be funded largely through long-term debt (75% Funded by banks). No other asset
provides such a benefit.
3. It is a big asset, which you can acquire and then comfortably pay back via monthly payments (EMIs) over a
very long period of time. Once again, no other asset provides this benefit.
 4. The comfort we get by doing mental accounting about tax savings in real estate investments. One always
feels happier when one is told that they dont need to pay tax or no money would be deducted from salary,
because of tax savings due to loan-funded real estate investment.
5. Second income from spouse, which can be used to get additional tax benefits (by being a 1sthome loan for
the spouse) by taking a home loan.
6. Comfort of getting a stream of rental income. An income, which you get without working for passive
income. But most of the times, people forget about the linked expenses.
7. General opinion that it is a hedge against inflation.
8. Mental fix that there is Zero Risk in real estate purchases (in reality, there are more risk than most other
investments like gold and mutual funds).
9. Justification that it is an investment for the next generation(s).
10. High return expectations due to the recent past records (say last 15 Years).
11. Black money at work!!
12. Pride of owning multiple real estate investment and being known as the Landlord.
13. As there is no daily ticker, the daily mental valuation of the asset does not take place.
14. Mental satisfaction and happiness when disclosing to others that you own multiple properties.
15. The perception that since everyone is investing in real estate and profiting from it, even I should do the same
and make easy money.
16. You always hear story from neighbors that they bought a flat for Rs 900 / sq ft 15 years ago and now it is
worth Rs 5000 / sq ft. Here mental maths comes into picture. Mentally you might think that this 900 to 5000
appreciation is more than 5 times and a very profitable one. But neighbors comfortably forget to tell you
about the expenses they incurred in these 15 years or in repaying loans. Actual returns are always calculated
net of expenses. Its neighbors envy and owners pride (copied from an old Onida TV advertisement). For
those who want to turn Rs 900 to Rs 5000 in 15 years, its not that tough. You can do it at 12.1% per year.

Why Dont People Invest in Mutual Funds?

Since you are reading Stable Investor, chances are high that you would be a mutual fund investor. But there
are many who avoid mutual funds to invest in real estate. Lets see what are the possible reasons for them to
do so:

1. Lack of knowledge about mutual funds and equity markets.

2. Lack of understanding about the power of compounding, the power of equity as an asset class and clear
knowledge of wealth building via SIP.
3. Lack of knowledge about asset allocation.
4. Risk and loss aversion.
5. Unable to determine financial goals and estimate the amount required.
6. They have already utilized all the tax benefits available to them because of home loan. Now they have no
tax-incentive to invest in mutual funds. And hence they dont do it!
7. Bad past experiences. And these are primarily due to wrong fund selection or wrong time horizon or wrong
advice (like combining insurance and investment or wrong thinking that saving and investing are same).
8. As daily price movement of MF through NAVs is available, the daily mental valuation of the asset, forces one
to take frequent buy and sell related decisions. This is driven by general lack of patience in investors.
9. Mutual Funds cannot be funded through Black Money.
10. Unlike real estate, no long-term loans are available for investments in mutual funds.
11. More people talk about losses made by investing in funds (for whatever reasons) and very few people talk
about their success in meeting financial goals through funds.
12. Mental fixation with recent huge loss events (like 2000, 2009, 2013 etc.)
13. A major chunk of saved money has already gone into real estate, which leaves almost no money to invest in
mutual funds.
14. And as substantial money is not invested regularly in mutual funds, one does not feel that substantial money
can be made through mutual funds.
15. You dont get to hear every day that a fund having a NAV of Rs 28 has grown after 15 years to Rs 805 a
return of 25% per year (Check Reliance Growth Fund). Such returns are very high ones and rare and cannot
be matched by real estate investment or investments in other asset classes.
Now lets test your memory

Do you remember how much did petrol cost in the year 2000?

It was around Rs 25. As of today, it is about Rs 66. Now suppose you had invested that Rs 25 in real estate,
which grew at 12.1% as mentioned few paragraphs earlier. This would have grown to Rs 139. Enough to
buy 2 liters of petrol today. Now if this was invested in a mutual fund, which somehow could manage 25%
return, it would have grown to Rs 711. Enough to buy at least 11 liters of petrol.

That is how equities work. That is how compounding works. That is how value of your money is
preserved and increased by investing in right asset class for long periods of time.

Concluding Thoughts

And this is a repetition of earlier statement. One should not give any second thought about buying
your 1st property for self-occupancy, whether it is with or without tax benefits.

However, based on our comparative analysis above (and estimated returns), one should think twice (or even
ten times) before buying a second home for investment purpose. One should carefully weigh all the
available data and then take a wise call. Just because your friend or family member is investing in real estate
does not mean that you should also do it. You should evaluate your own financial goals and think about how
you plan to achieve it, and then decide whether you want to invest in real estate or not.

A hard and physical asset will always give a huge mental comfort and satisfaction over other financial assets
like mutual funds. But it is also true that it may not always be the best available investment option. In fact,
investing in house funded through loan, is a huge long-term liability which chokes the ability of the person
to save and invest in other right instruments for future.

Why Equity Funds Don't Beat Real Estate

Too much churn
Going by the point-to-point returns on equity funds over the last five or ten years, it is quite difficult to see
how any investor could have lost money if he bought an equity fund and simply held onto it till date.

Even the worst diversified equity fund has delivered a ten-year CAGR of 10 per cent and the best one is at
20 per cent. But most people don't make this return in practice because they try too hard to 'time' their equity
investments. When equity markets are booming, they invest large lump sums or start SIPs in equity funds in
the hope of high returns. When equity markets slump, not only do they struggle to retain the conviction to
continue SIPs, they even get tempted to pull out.

Thus, the investor experience with equity funds tends to be poor because people view funds as an
opportunistic investment - they invest when markets are peaking and usually exit when markets are low.

If they did the same with real estate, they would make losses. But the truth is that they usually do the
opposite with real estate. First, you don't try to time your property purchases when prices are zooming. You
buy property when you feel the need. Nor would you rush to dump your property when the market is in a
downturn. If there's a downturn on, investors would wait to get a better price for it.

What aggravates this behavioural bias against equity funds is that with these funds you can actually track
your everyday returns. When you see your equity fund NAV sinking by the day, it's hard not to act and get
rid of the fund. With property, unless you make a transaction, you don't get to know how much prices have
fallen. So you have the conviction to hold on through a downturn.
 Too small to matter
The second reason why no one ever seems to have become a millionaire investing in equity funds (while
they do with property) is that they simply don't invest enough.

Ask people around you what sums they are investing in equity fund SIPs - you'll find sums like R1,000,
R2,000 or R5,000 being bandied about. But ask about their home loan EMIs and the big numbers come
tumbling out. They're committing R25,000, R50,000 or even R70,000 on their property investment, a good
portion of their monthly pay cheque. How can an SIP investment of R5,000 a month match up a R50,000
EMI? If you invest less, you are bound to make less.

Power of leverage
That's not all. When we buy property, our conviction in the asset is so strong that we are willing to leverage
our savings to make a really big bet on this one investment. Therefore, if you have `20 lakh worth of your
own savings, you're willing to take on a R80 lakh home loan and pay a monthly EMI of R88,000 so that you
can buy a R1 crore flat.

You may not notice it. But by committing R88,000 a month over a period of 15 years, you're actually
investing R1.54 crore in that flat (considering both your interest and principal repayment). If the value of
that property rises fivefold to R5 crore by the time you pay off your loan, you are mighty pleased. That's a
sum that can make a big difference to your wealth!

In contrast, people seldom take loans to make equity-fund investments (it's not a great idea anyway). So if
you continue with a R5,000 SIP for 15 years, you would have invested a mere R9 lakh. At the end of the
period, you'll be left with R33.4 lakh even at a 15 per cent CAGR. That won't seem like much, simply
because the investment you made is one-twentieth of the sum you had invested in the flat.

No like-to-like comparison
A final reason why most people believe they've scored big with real estate but not with equity funds is that
they don't really compare the returns from the two assets on an annualised basis. If a `1 crore flat appreciates
to `5 crore in 15 years, people think it's a fabulous return. But for the record, that's just an 11.3 per cent
CAGR.

Now, if an equity fund reports an 11.3 per cent CAGR over 15 years, people will write it off as a laggard,
because they expect equities to earn a much higher return.

Overall, maybe what you need to do to earn a real estate-like return from your equity funds is the following:

1. Buy your equity funds when you have sufficient savings and not when the 'time' is right.
2. Sell them only if you need the money or your goal is met.
3. Don't be stingy with your SIPs. Think of the terminal value that can make a big difference to your wealth
and back-work to get to your SIP amount.

Don't redeem your fund just because you think its relative returns (compared to the top fund or the category)
are low. As long as it's beating your other investments over the long term, it is good enough for you.

Comparisons:
Real estate investment has very poor liquidity and capital gains are taxable . It is difficult to monitor
properties at different locations . Most of business done in cash which is biggest risk and generates black
money . Property tax NA Tax enchroachment are problems with real estate and long term compounded
returns are less compared to equity . Equity investment no tax after 1 year highly liquid long term income
will give you huge returns which are tax free . You cant sale real estate partially when you need small
amount of money but equity you can redeem partialy and use money . 100 % transactions through bank so
you can use this money for your business or foreign tours
All transactions are transparent and no risk of theft and not visible to people. You cannot plan retirement on
basis of real estate because it cant give you systematic monthly income .Real estate gives good returns but
donot invest everything in real estate Asset Allocation is very important you can invest 40% in real estate
and 30% in short term assets bank fds liquid funds and 30 % in equity mutual funds debt funds.

Real estate in big cities is a good and risk free investment because of the ever growing population. More and
more people migrate to cities and need to find a place. Hence a flat or land parcel in a big India city will
never reduce in value. Coupled with this lack of risk , real estate also has an advantage that banks give loan
and government gives tax soaps.

One of the big benefits of equity investment is high liquidity. And most of the times this great feature gets
utilised in wrong ways. As the author rightly pointed out, most investors invest during peaks and exit during
bad times. If RE also had such liquidity, we would have probably done the same but unfortunately RE is
poor on liquidity and ticket size is big. It gets compounded by the problem of cash dealings in almost all RE
deals.

One big benefit of RE is the sense of belonging. If one owns 3 houses he/she can boast of it in society but
unfortunately it cant be done for equity.

People don't add the headache, time spent, maintenance & repair costs etc while computing their total cost in real
estate.
Human beings are never rational and mathematical. They rely on emotions and perceptions.

I have been pondering over this equity vs Real estate comparison quite some time.
My own experiences :

1. My Grandfather had bought a house in Mumbai for 35k in 1965 , which is now 3.30 Cr.
The CAGR is only 14%
If we factor in the renovations and maintenance , it will come still lower.
Also when we sell @ 3.30 crore , we pay capital gains tax , so still lower.

Yes but from selling perspective, RE may take months if not years to find the right buyer for the "right" price. Equity,
the price is always "right" (as seen on exchange) and sale money generally comes in 2 days.