Real Estate vs Mutual Funds

Its not an apple to apples comparison !

POINT 1: House Return = Residential property Return + Your house Buying Skill

Let’s first start comparing Real Estate Return with Broad stock market Return

I have written few answers on this ,how the end results is determined by many factors

Without Leverage

Real Estate Return = Capital Appreciation + Rental yield.

we know rental yield is approx 3% for residential house.

So 8–9% is the approx return you need to make to beat a 12% Mutual Fund CAGR.

While 12% is the return of Nifty Index means that you could have blindly bought Nifty and made 12% but for a house a major part of Return is because of your skills:

  • selecting properties
  • Selecting Location
  • negotiation for price as there is no universal price.
  • Tenants you select.
  • How the area develops in the future .

Therefore buying a house is like buying a single stock which will go up or down based on how you selection skill and also on luck.

Here I have compared how buying House in Noida was disaster but Gurgaon a great deal even though both cities are in NCR

Rohan Rautela’s answer to Is buying a flat in India at a price of 50 lakh or more investment or liability?

POINT 2 : Leverage Play an important Role in delivering high Return or Losses.

With Leverage

Real Estate Return = Leverage * ( Capital Appreciation + Rental yield – Interest Cost)

Leverage Magnifies everything : Interest Cost impact, Rental yield Impact and Capital Appreciation Impact

I will show you how slight change in any factor can make one look more profitable than other:

Assume cost of house is 50 lakh,80% is loan at 8% Interest

Case 1: House appreciation is 10% per annum, Rental yield is 2.5%, Mutual fund gives 15% return in 20 years,tax saving is included ( we reinvest rental income and tax saved in mutual funds monthly)

So my property in 20 years grew to 3.66 Cr

Rental money and saved tax grew to 4.46

Mutual fund gave 7.14( includes 10 lakh upfront too invested at 15%)

property beats mutual fund by 1 cr

Case 2:House appreciation is 8% per annum, Rental yield is 3 .5%, Mutual fund gives 15% return in 20 years,tax saving is included ( we reinvest rental income and tax saved in mutual funds monthly)

What happened now???

because how appreciation dipped to 8% I am making net loss if mutual funds gave 15% return.

Bottom Line is if you leverage and things work out perfectly then you can call yourself to be smart else blame your luck.

POINT 3 : Real Estate is a killer of asset allocation for most people.

People are always worried about asset allocation and firm believer not to keep all eggs in one basket.

They will do endless research on the best mutual fund, best stock ,best debt etc.

Now look at the reality.

Mr X has 25 Lakh Corpus. Buys a home for 1 Cr, Put 20 Lakh upfront and rest 5 lakh is in mutual fund.

This is how asset allocation looks like:

Mutual funds: 20%

Real Estate : 400%

If real estate drops by just 10% you will lose 40%!!!!!!!!! but most people are not worried why??

Because you cant see the daily Mark to market value on the computer screen every day. Nifty you can see everyday so cant take that leverage.

Your parents made money because of Loan Leverage. If they would have bought Nifty Futures and rolled it for 20 Years They would have made more money!!

Conclusion : Should you buy a Flat or Mutual Funds ?

  • You should have exposure to both. If you have 10 Crore in your account you can buy 1 Cr house but if you have 20 Lakh in account and want to buy 1 Cr then be aware of the risk you are taking.
  • Even if you are really bullish on real estate and want to take a loan which is significant compared to net worth ensure that interest servicing is a small part of your monthly salary and you would be able to service it even without a job for 8–9 months.
  • If you want to live in the house and its your dream then buy it for that , don’t fool yourself that you are doing it for investment
  • Buying a house is also a skill like picking a stock. If you think you have it then buy it ,don’t buy it because everybody does.
  • If you just want to take real estate exposure for diversification which is a good thing you can do it through REIT which has diversified commercial rental properties as underlying
  • Even if you have money you can still leverage for better optimisation of funds and tax benefit. Taking Loan should be used as an advantage not a dire need.


Leave a Comment

Subscribe to the newsletter to get the latest information on Alternative Investments