Mr. Gerard Colaco's Insights & Wisdom

Question: Housing is an important step in Personal Financial Planning, and for those who can block the money for at least 10 years, real estate is a good investment. So taking into consideration of needs and returns of investors, can we expect some excellent insights about real estate from you?

When it comes the factor of risks of ownership in real estate, we can shift it to an insurance company by purchasing 'Title Insurance'. So kindly advice me on the importance and use of title insurance.

The Personal Financial Planning says that, "additional real estate investments may be undertaken only if the individual has specialized knowledge and a talent for real estate investments". But what about the common person or investor who can afford to block a reasonable amount for more than 10 years?

Mr. Gerard Colaco: One need to realise that in India at least, investing in real estate is totally different from investing in stocks, equity mutual funds or debt investments. Let me see if I can help increase your client understanding of this subject, even though I am not an expert in real estate. It is absolutely true that equity and real estate are the only two avenues of investment that offer genuine, inflation-beating and wealth-enhancing returns over their respective time horizons or slightly longer. But, there is a huge difference between these two investment avenues when it comes to practically investing money in them.

In India, equity has evolved with stunning rapidity over the last 3 decades. Today, in stock market trading and settlement systems, we have achieved world standards. Computerised trading, settlement and holding systems are in place throughout India for stock market transactions. Market integrity is taken for granted where equity and equity mutual funds are concerned. No investor who has opened an account with a member of the Bombay Stock Exchange (BSE) & National Stock Exchange (NSE) needs to bother about verification of title of shares purchased.

However, the same cannot be said about real estate. As Mr. Sandeep Vaswani has very correctly pointed out, the acquisition of a house should not be confused with acquisition of real estate as an investment. Real estate suffers from several drawbacks, such as:

• Poor liquidity
• Difficulties in verification of title
• Requirement of large amounts of capital for even a single purchase
• Requirement of large amounts to make additional purchases when prices drop
• Presence of black money in real estate transactions
• High stamp duties on real estate purchases
• Cumbersome purchase and sale formalities
• Administrative difficulties - squatters, the land mafia, expenses involved upkeep & maintenance, etc.
• Absence of efficient, continuous and fluid market in real estate
• Absence of a well regulated, institutionalised mechanism of price discovery in the real estate market

That is why I do not agree with the statement of your client that, "for those who can block money for at least 10 years, real estate is a good investment". Real estate is a good investment for investors with necessary knowledge, expertise and interest in real estate, who have money that can invested for ten years or more. Real estate is not for those who do not have this skill and knowledge and only the money that can be blocked for ten years.

There are several investors with the interest, knowledge and expertise for real estate investment. These individuals can certainly go ahead with their real estate investments. For the rest of us, the best advice I have received is to own only such real estate investment as we have a use for. One use that is universal is housing and so everyone must try to acquire her/his dwelling place. People like you who are financial advisers need both a residence and on office. You must try to eventually own both.

One more example I can give is of a person who designs and sells furniture. Such as person must make efforts to eventually own a house, a factory/old house/industrial shed where the furniture can be designed and manufactured and a posh showroom in a prominent location to display and sell the furniture. It is not that all three pieces of real estate must be acquired simultaneously. They can be acquired one by one, over several years/decades.

So when we advise about real estate investment, we are conscious of the fact that there are two categories of people - the first category that has interest, knowledge and expertise in real estate and a second category (yours truly is in the second category, Sandeep Vaswani in the first!) that may just have a passing acquaintance with real estate.

The first category can actively pursue real estate investments. The second category would do well to only acquire such real estate as it has a use for. If a decision is taken about real estate, then the money blocked in real estate should be money that is not needed for at least 10 years. We must respect the investment time horizon.

Finally, when deciding about whether a price of real estate is fair or not, there is nothing as good as Burton Malkiel's principle for determining what a fair price is. Malkiel states that when you purchase a home, factors like location, facilities, neighbourhood, conveniences and the opinion about other members of the family about the proposed home, are important.

But when purchasing real estate as an investment, the most important factor is that the rental yield on the property must be equal to or greater than the yield on short-term government bonds. Let me give you a an example of Mangalore, which I am familiar with. A really good two-bedroom apartment in a prime location would cost approximately Rs. 50 lakhs. The rent that you can earn on this apartment would be Rs. 12,000/- per month or Rs. 1.44 lakhs per annum, giving you a rental yield of 2.88% per annum. This is well below the yield on short-term government bonds, which is approximately 6.5% today. Hence it is okay to purchase this type of an apartment as your home. But it is best avoided as an investment.

On the other hand, Sandeep Vaswani knows how to identify commercial properties in Mumbai where the rental yields are approximately 8% per annum, significantly higher than the present yields on short-term bonds. These would be superb investments. But the discovery of such opportunities and the acquisition and the structuring of these properties to achieve the desired investment returns would require specialised talent, skill and knowledge. It is clearly not for everyone, regardless of whether they have the money to invest for 10 years.

These are the best insights that I have received on real estate for residential and investment purpose. Your client's mention about title insurance may be relevant to the US, but there is no title insurance available in India. All I know is that a few insurance companies have filed for approval of title insurance in India, but I have not heard of any actual title insurance products available in the market. Even if such products come along, I will not jump at them until I see what sort of experiences the insured have in the settlement of their claims.

The best title insurance is ruthless title investigation, with the help of lawyers, the city corporation authorities and real estate experts. In Mangalore, buyers sometimes even release advertisements about their intended purchases, calling for objections or claims if any, prior to their purchases, after informing the sellers about the fact that they are going to release such advertisements. So, your client must realise that you are all alone when you venture into real estate. In equity, you have a lot of systemic and regulatory organisation and protection. I sincerely hope that this kind of much safer environment will be available to the common investor through genuine real estate mutual funds before long, like the REITs in the US.

I was somewhat uncomfortable answering this mail because I am no expert in real estate. I just shared the little knowledge I have, based on my experience in investment in general, rather than real estate specifically. Also, I did not want to leave an investor query unanswered. So your client may be well advised to read and be guided by Sandeep Vaswani's reply, rather than mine.