Key takeaways
Hera are the list of potential risks or difficulties when one buys a property:
- Difficulty in determining fair price of purchase / sale
- Difficulty in ensuring clear title to property
- Large amount needed to even just get started
- High amount at stake if one makes a mistake
- Risk of buying at market peak: No SIP possible here
- Builder / Developer related risks
- Hassles of paperwork, bureaucracy & related fees
- Squatters & eviction risks
- Maintenance outflow & renovation expenses
- Liquidity issues
- Display of wealth
- Land Mafia issues
- Inheritance issues
In summary, a large number of the risks stem from the slowness / level of effectiveness of the judicial system in India. In addition, property has the hassle / risks of dealing with many agencies & people who can often be quite unscrupulous and / or untrustworthy. Lastly, there’s significantly more paperwork & bureaucracy and a lack of transparency in property. On the other hand, Mutual funds win hands down on simplicity since almost everything can now be done online in just a few clicks.
Introduction
Let me start by stating that I fully recognize that real estate is a very valid & legitimate asset class for people to invest in. I also realise that real estate is a favourite investment asset class with many people and that many people have indeed also become very rich by investing in it
However, after having invested in both real estate as well as Mutual funds over more than 20 years, I am absolutely clear that, at least for me, investing in Mutual funds is far simpler, involves much less hassle & effort and (apart from the risk of market crashes) has far lower risks or possibilities for complications. So In my personal view, Mutual funds are a hands down winner.
While there is no doubt that we all need to buy a property as our home or from which to do our work or run a business, this article looks at the potential issues / risks you run each time you buy additional property over & above that as an investment.
What I have noted here in the article is not the gospel truth by any stretch of the imagination. I am merely sharing my own personal observations based on my experience of having bought & sold a few properties as well as Mutual funds in India over the past 20 years. I would simply urge you to consider each of the points below carefully before buying an additional property as an investment. So here goes …
1. Difficulty of determining fair Price of purchase
When looking to buy a property as an investment, the first step is for you to figure out the fair price at which you can purchase it. As Robert Kiyosaki says repeatedly in many of his books, your profit is made when you buy. So if you end up paying a high price to buy, your profit or returns could end up being quite low. I’ve personally made this mistake at least a couple of times in the past.
To the best of my knowledge there is no standard or transparent way in India to determine the fair price of a property at any given point in time. It all boils down to “what people are asking / quoting” and your ability to bargain / negotiate well.
Having a truly trustworthy estate agent is therefore probably your best bet. Alternately, if you can get reliable information on recent sales in the area, that might work as well but that isn’t easy. In some places one can get access to a professional property valuer to help with this.
Exactly the same risk applies when you are trying to sell a property.
On the other hand, with mutual funds, you can be 100% sure that the price you are paying is the price everyone is paying and there is no chance of your getting a raw deal.
2. Difficulty in determining clear title to the property
While a good advocate can determine whether or not the basic required documentation is in place for a property, that’s only a technical / theoretical evaluation of the soundness of it’s title.
The real risk with evaluating title of a property in my view lies in the fact that today in India, to the best of my knowledge, we don’t have a fool proof way of knowing whether or not there is any litigation currently pending in any court against the property you are intending to purchase.
To the best of my knowledge, the way this risk is typically addressed is by getting the seller to “declare” in the agreement that there are no pending disputes. Alternately the buyer indemnifies the seller from all claims on the property. But if there is a serious dispute or claimant, they could bring injunctions or stay orders on the use of the property pending settlement of litigation. And litigation could take decades to resolve.
3. Large amounts of money needed even to get started
Unlike Mutual funds where you can start investing with as little as say Rs. 500 to Rs. 1000 per month, property requires relatively huge amounts of capital to be able to afford even a small one bedroom flat.
Although loans are available & they make it possible to buy a property with relatively affordable / manageable EMI’s one has to remember that one is indeed paying interest to have access to the large loan. That interest paid in turn eats into the returns on your property.
4. High amount at stake if we make a mistake
Given that even a small property typically costs tens of lakhs, the cost of recovering from any mistake with that property are that much higher. Let’s say you buy a property & later find it’s title deficient / improper or the builder goes missing / absconding or if you buy it for a higher than average price or if the property simply doesn’t appreciate much over the years. In any such case, the magnitude of the mistake is rather high with property.
On the other hand, if you buy a poorly performing mutual fund, your risk is limited to a few thousand. You could admit your mistake & exit with a small amount at stake. Alternately you could buy 3 or 4 different categories of mutual funds & spread your risk.
5. Risk of buying at market peak: No SIP possible in property
Although property prices typically don’t tend to crash like stocks do, still the chance of buying a property at a market high do exist. The consequence of this would be that your returns on that property purchase would likely be low.
Here’s a personal story to illustrate the point. Decades ago, when my dad retired from the Indian Air Force, he took a lump sum of his retirement payouts and invested it in a small shop in Pune. Why did he do that? Well because for the last several years he (and all of us) had heard of property going up in price at astronomical rates. Builders would raise prices by Rs. 50 per square foot almost every month (or at least so they would say to pressurize you into buying in a hurry) Little did he know that prices had peaked by then and that returns going forward would be relatively low. Long story short: We held the property for about 9 years and then sold it at almost the price at which we had bought it 9 years ago.
Unlike Mutual funds, while buying property, there is no way to do an SIP and average out your purchase price over market peaks & troughs.
6. Builder related issues
This one only applies if you are buying a property under construction.
The temptation to buy a property under construction is that you get to buy it at a lower rate and can also typically pay in installments as the construction progresses.
However, there are a few potential risks here.
a) Quality of materials used by the builder are sub-standard. Unless you are an expert in construction you would have a hard time catching the builder on this aspect
b) Shortcuts taken in construction processes resulting in compromised quality or safety of the property. Again, unless you are an expert in construction you would have a hard time catching the builder on this aspect
c) In the past, builders often used to pull wool over naïve buyers’ eyes by creating all sorts of area terminology like “super built-up” area which is hard to verify. So if you are not buying a brand new property (where carpet area is mandated by law) you could easily get duped on this count as well.
d) The builder delays the project & fails to meet agreed delivery timelines. In that case rent for all those months that the project is delayed is typically lost
e) However, the greatest risk is when a builder abandons the project due to financial problems or any other legal issues. Although regulations in this regard have improved the situation, the fact that the law takes very long to take effect & redress matters makes the risk very real
7. Paperwork, bureaucracy & associated fees
When dealing in property you have no choice but to deal with a range of government agencies and departments. You start with the registration office, then you need to deal with the property tax department, then the electricity department and in many states other departments for land records for things like “khatta transfer” or “patta transfer”.
When dealing with government agencies there is significant paperwork & bureaucracy. And to get past the bureaucracy & get your work done, you know what comes next. I’m sure I don’t need to spell it out. All such government & other agency “fees” further eat into your returns.
In addition there is also brokerage to be paid to an estate agent & lawyer’s fees all which of course can be well worth it if you have a trustworthy & capable person.
8. Squatters & eviction issues
Most of the time, when you buy a property as an investment, you would like to rent it out so that it generates some income. However, each time that you rent you are taking on the risk of your tenant or their maids or their caretakers squatting.
Squatters are basically people who don’t own the property yet refuse to vacate and probably don’t pay you any rent while they are illegally occupying your property.
A significant part of this risk is related to the fact that the law & courts in India take VERY long to resolve disputes. 10, 15 or 20 years for such disputes to get resolved is common.
Even if the squatter does lose the case in court finally, he / she has managed to live there for a decade or more free of cost, you didn’t get any rent & paid huge amounts in litigation fees.
9. Maintenance & renovation expenses & hassles on property
Most property requires maintenance and this entails a regular outflow of money. In addition, once every few years you might be tempted to renovate the house and this results in very significant outflows.
So from an investment perspective, a property almost always entails expenses that eat into your returns. Often people are not diligent in tracking what they spend on property maintenance & as a result do not have an accurate figure on what their real returns are.
In addition, one has the hassle of dealing with issues with apartment association rules & bureaucracy and potentially cranky neighbours while undertaking renovation of one’s property
On the other hand a simple Index Mutual fund has expenses of just about 0.2%
10. Liquidity
Liquidity is a word used to describe how quickly you can sell an asset so that you can get cash in hand.
Liquidity is typically helpful in case of an emergency. Alternately, it could also be helpful if there is a brief opportunity to invest in something else. For example, if there’s a market crash & you want to capitalize on that opportunity, selling a property & buying stocks at low values is not very practical because of how long it takes to sell a property.
With real estate my experience has been that it typically takes 3 to 6 months to sell a property. With a mutual fund, you can have the money in your account in 2 to 3 working days.
11. Display of wealth
When you buy a property a fair number of people inevitably get to know about the purchase and then word spreads among friends, family, colleagues & acquaintances. So in some ways, buying property inadvertently becomes a public display of your wealth. It’s like having flashy & expensive cars or wearing lots of expensive jewellery.
If a person’s temperament or nature is such that they would prefer to remain less conspicuous or would like to remain under the radar so to speak, then property sure isn’t the right sort of investment for them. Mutual funds are much better
12. Land mafia issues
This potential risk only comes into play when you own Prime property or very large property. We know of people who have owned prime property that drew the attention of land mafia. In most cases, the land mafia have strong political connections that force you to sell your property to them at a price that they dictate or else they start to harass the owners in various ways to force them into selling their property.
13. Inheritance issues
The most common issue is that most people don’t create a Will clearly specifying who they want to leave their property / properties to & detailing out each person’s share.
Even if people do leave a Will, given that property is not easily divisible, I have observed that many families with property get into legal disputes. This typically happens when one or more of the parents leave a single property to more than one of their children or relatives. Each of the children have different opinions on what share they are entitled to or what they want to do with the property. E.g. whether to sell it, rent it etc.
All of this gets addressed in a very simple manner in the case of Mutual fund investments by way of each investment needing a nominee to be named. One can easily divide one’s mutual fund investments into separate folios & amounts that one wants to leave to each child or relative by proving a clear nominee for each investment.
Summary
In summary, while there are many risks associated with investing in real estate, my view is that the greatest risks of investing in real estate all stem from the fundamental root cause of the difficulty & excessively long time (decades) needed to to get issues addressed by the judicial system.
That apart, property has the hassle / risks of dealing with many agencies & people who can often be quite unscrupulous and / or untrustworthy
In addition, the general number of hassles like paperwork & bureaucracy that one has to go through when investing in real estate are many.
On the other hand, the simplicity of investing in Mutual Funds (and Index funds in particular) is a HUGE advantage because almost everything can be done in just a few clicks online. This way, it frees up lots of your time to do what you love to do instead.
The picture below is based on data from the US but provides an interesting insight into how much less hassle one needs to endure when one invests in Mutual funds
Disclaimer: I am not a financial advisor. My articles are meant for people who are not savvy or well versed with personal finance and investing and find it difficult to grasp all the jargon typically used when discussing such topics. I hope to be able to demystify investing and make it as simple as possible for everyone. I’ve invested in Mutual funds for approx. 24 years. I’ve also been a diligent student of the subject of investing over the past 24 years learning & applying the writings of luminaries in the field. In these articles I’m merely sharing my experience & learning from that investing journey and the books of luminaries in the field in the hope that it might help others in some way. I am in no way directly or indirectly claiming to be a hot shot investor who has generated exceptional or even above average returns during my investment journey. However, I am quite confident that even if all you do is learn from my mistakes, educate yourself on sound investment principles & develop good financial habits you will benefit greatly. Please ensure that you consult a financial advisor before taking any decisions or actions concerning your personal finances or investments. I shall not be liable.