Real estate is a popular investment choice among many. It is often believed by many people (incorrectly!) that real estate always appreciates. Consequently many of us ignore the different risks and red flags before jumping to a real estate investment. In this post I’ll be sharing some risks in real estate investment.
1 Price not appreciating
This is the obvious risk! For any investment not offering assured returns (even though some “experts” may pitch otherwise!) risk of prices not appreciating is a risk they undertake.
What makes real estate peculiar is that in addition to this, there is no universally accepted fixed price for a property. Depending upon various parameters it can be less than what the “market” views or maybe, in few cases even more!
So at any given point of time, the “price” of property has a certain degree of speculation inbuilt.
2. Skew in asset allocation
Real estate is expensive. And unlike most of the other asset classes (debt/ equity), you usually need to commit a larger amount. This can end up taking a significant proportion of net worth (more than 100% if you take home loan for it!). Thus your asset allocation gets skewed towards real estate.
In this case case you become excessively dependent upon one asset class to grow your investment value. And it it doesn’t, like in several markets of late, you are stuck (unless you are willing to sell for loss).
3. Liquidity issues in an illiquid asset
Real estate is a highly illiquid asset. You can’t redeem that for cash immediately when required The process usually takes time, usually in months.
This is unlike investments like equities, mutual funds or fixed deposits – which you can redeem instantly and get money in your bank account within a matter of few hours or days! This can be really important when there is a urgent need for money.
4. Hidden costs – How do you calculate the real cost of owning real estate?
When you buy real estate, you need to pay stamp duty and registration. In some cases even GST (if you are buying under construction property in India). Add to that charges like parking, clubhouse, electrical fittings, furnishing etc, your cost can be really high.
While maintaining the house, you need to pay property tax, maintenance bills, fix issues that come on and off and deal with wear and tear as the building ages.
While selling, you may have to deal with the taxation aspect. In India, you actually make capital gains, you need to pay taxes or invest in certain predefined government bonds (which offer low rate of interest!)
These factors often make it a bit difficult to fathom the actual cost of owning a real estate investment.
There are costs, often huge, associated with owning real estate.
(I have discussed this earlier in – Real cost of buying a home for investment)
5. Risks associated with renting out
Real estate for investment is often based upon the assumption that you’ll have a rental income. While it is usually true, we often underestimate the risks associated with renting out property. In addition to rental yields not being high (typically 2-3% in India) you may also need to pay brokerage to the real estate agent who can help you rent out your property.
There maybe periods of no-occupancy, which can make your assumptions haywire. Sometimes you may have to deal with tenants who may not pay on time, refuse to vacate or create nuisance!
6. You may not always get what you are promised
Often there is a gap between what is presented in glossy brochures and what is actually delivered. So, the flat design, interiors, society, surroundings, etc. may end up being a bit different from what you would have expected.
Then there are risk of possible delays (hopefully with RERA, this will reduce substantially). Of late we have been hearing about liquidity crunch in market, which is affecting the project.
7. Reluctance to sell due to emotional attachment
Real estate is something that people often have an special affection for. It may be for many reasons – old family house, first major investment, house associated with prestige in the society etc. And this builds an inertia to sell. This becomes an hindrance if you need to sell a property and you emotions feel otherwise.
While real estate might have generated good returns for many people, it may not always be the case universally. You may also end up losing money or blocking a sizable capital. Owing to these risks in real estate investment, I would suggest to rethink before having real estate as your primary investment.
Home for your primary residence is a different case. So is investing in real estate for diversification, if you have lot of money!