Thursday, November 25, 2010

Real Estate investment in India

Currently we have about 300 million people residing in Urban India – appx 30% of our population – with increasing urbanisation, we will be having close to 550 - 600 million people in urban India by 2035 -  This massive wave of urbanisation in India means that our cities will grow to almost double the size in the next 25 years – we can see this happening all around us – if we compare a 1985 vintage map of any city in India  -we would realise that the city has truly expanded to almost double the size – the same thing will repeat –at a larger scale between 2010 and 2025.
Where is the opportunity hidden in this information – if you look at a 20 year horizon, invest in a plot of land (any size that you can afford) in an upcoming gated development that is 10-15 kms away from the current city limits –in 20-25 years, this locality would be part of the city and the value would have grown tremendously. Anyone who did this in 1985 knows the value of this smart investment and the same opportunity exists even today. The key issue here is that the land must be safe from encroachment for this period of 25 years - hence it must be a gated or walled development.
Real estate investment in India offers tremendous potential to get a 20% plus returns – it is quite difficult to make a mistake if one knows the basic rules of investing in real estate. Real estate investment is like a fixed deposit with near zero risk giving atleast 15% returns per annum. Once you have about 10-15 lacs worth of assets created – make your first real estate investment –- leverage your position by putting 20% of the investment from your savings and remaining 80% through a loan. Leveraging is a commonly used technique in this area as the investments are in large chunks and the appreciation of property is normally more (15-20%) than the interest costs (10%) of the loan. My class presentation is available for you in and has some scenarios described on how leveraging works.
There are broadly five ways of investing in real estate:
·         Residential properties – flats and residences with land
·         Commercial properties – offices, shops, godowns etc
·         Urban Land – commercial, industrial, residential
·         Rural land – agricultural
·         Real Estate Investment Trusts ( REIT)
I consider the other way of investment in real estate sector through Real estate equities as not truly a real estate investment as this does not represent the true real estate risk/ reward scenario in India.
Let me elaborate on these five ways on investing:
Residential properties – contrary to popular opinion, this must ideally your second investment  -not the first investment – residential properties give you capital appreciation (10-25% pa)  and rental cash flow (2-5% pa) – the overall returns are 15% to 30% pa and I believe this will go on for at least another two decades in India due to urbanisation and economic growth. The land appreciates at a higher rate than building and hence the residences with land would show a higher appreciation than flats. However, due to good common amenities (like security and club house), the flats give a higher rental yield than residences with land. A good location, a good builder /architect, good landscaping, good common amenities will give higher ROI and hence one has to select properties based on these parameters. The minimum investment required (including loan) would be around Rs 50 lacs.
Commercial properties: This must be ideally your first investment – I have not seen too many people do this as their first investment – but those who have done it are more financially savvy. The reason for this is that, the commercial properties give the same capital appreciation of 10-25% pa as residential properties – however, they give a rental yield of 7-10% pa and that is double the rental yield of residential properties. Also the minimum investment required here is around Rs. 15-20 lacs as compared to Rs 50 lacs in residential properties. Early in life, when one wants to increase the cash flows from investment, higher rental helps – hence when compared to residential properties, we must look at investments in commercial properties early in life. Once we have become financially independent ( i.e. our cash flows from investments are more than our expenses), then we can look at residential and other investments. Go to any broker, look at the Sunday edition of Times of india and you would be surprised to see the kind of options that commercial real estate offers – however, surely do a legal check and also take advice from broker on the rental yields before investing.
Urban land – Once you have become financially independent, you must invest in urban land – land gives higher capital appreciation than buildings – my experience has been at least 20% pa – normally higher if the location is good. So after having a few rental yielding properties and after becoming financially independent – focus on urban land and keep a minimum of 5 year window for these investments – you will more than double your money.
Agricultural land – Investments in agricultural lands that are 10-15 kms from some urban area will give good appreciation over 15-20 years – however, lands that are truly rural and far away from urban areas – may not give good appreciation or rental. If you are investing in lands like these – do not expect a great appreciation unless there is some development in that area in the future.
REIT  - REIT is a good way to gain from real estate appreciation without getting into the legal and asset maintenance issues – REIT’s came in India as an investment structure in the last one decade and India REIT is the pioneer in our country. The company offering REIT takes commitments of Rs 25 lacs from investors over 2-3 years and they invest this money through well known real estate developers  in residential /commercial properties being built by them – as these properties get ready and are sold, the profits from this sale are given back to the investors  - this takes about 7-8 years to materialise – there was another flavour of this REIT before recession where the REIT company used to buy existing commercial spaces and the rental yields was given as quarterly yield, and after 5-7 years, they sold the commercial assets and returned the principle and profits from the investments. If you have 25 lacs to invest and do not want the hassles of legal work, property maintenance work, but still want the gains that one gets in real estate – REIT is highly recommended. These are closed funds and hence you will have to keep an eye for when these offers are available – ask your wealth manager and he will tell you when one comes up.
There are a few very logical, practical and doable tricks for real estate investment that I have shared in my class – these are in the ppt for you to see in slideshare.
As MBA’s starting your career, you must build your asset value of about 15 lacs in the first 3-5 years of work through equity route and then before marriage, invest in a property that yields rental plus capital appreciation – a commercial property is what I would recommend. Over the first 15 years of your career, you must own rental yielding properties worth 150 lacs  (in today’s value) – if you can do that, you will be financially independent by then– after that based on your savings, invest in land to get good appreciation.
But before all that, advice your parents to invest in an upcoming gated development that is 10-15 kms away from the current city limits in your city.

Tuesday, November 9, 2010

Insurance as an investment vehicle

After a break of one month, I would like to restart and share details on Insurance products available in India and what products you must use in your quest to create wealth. My presentation of this session can be downloaded from
Insurance is designed to protect the financial well-being of an individual, company or other entity in the case of unexpected loss. Agreeing to the terms of an insurance policy creates a contract between the insured and the insurer. In exchange for payments from the insured (called premiums), the insurer agrees to pay the policy holder a sum of money upon the occurrence of a specific event.
In other words, Insurance is a promise made by the insurance company to pay a certain sum of money at some future date or on the happening of an unfortunate event.
The concept behind insurance is that a group of people exposed to similar risk come together and make contributions towards formation of a pool of funds. In case a person actually suffers a loss on account of such risk, he is compensated out of the same pool of funds. Contribution to the pool is made by a group of people sharing common risks and collected by the insurance companies in the form of premiums.
There are three broad categories of insurance –
1.       Non life or General insurance - that insures against the loss of assets like house, car, factory etc.
2.       Health insurance – that insures against loss of health.
3.       Life insurance – that insures against the loss of life.
As we discuss wealth management, the only area where insurance is relevant is
·         When we are insuring the assets that we have created; or
·         When we are insuring our family against loss of life or health; or
·         When we have a liability like a home loan or a car loan, then we need to insure against the risk of loss of life of the primary wage earner for the amount of loan taken.
·         Another relevant area where risk mitigation is necessary is when one lives longer than normal and needs to fund the old age.
However, no discussion in wealth management goes without discussing insurance as a wealth management tool – this is because there are various offerings by insurance companies that mix this risk mitigation strategy with investment strategy. As customers, we are not able to differentiate between the cost of risk mitigation and the investment returns that these insurance companies are committing. So let me describe the basic four types of insurance and share my views:
1.       Term insurance –in this type of policy, the policy holder pays a premium and get insured against death for a particular term – in case of the unfortunate event of his/her demise during that term, the insurance company would pay to his/her nominee the amount insured. If there is no demise, the policy holder does not get any returns. The annual premium for someone aged 25 years for a sum assured of Rs 100 lacs for 20 years term is only around Rs 10,000. This means, if you take this policy, you will need to pay Rs 10,000 per year for the next 20 years and during this period, if you lose your life, your nominee would get Rs 100 lacs. This is a pure risk mitigation policy that I recommend that each one of you take –the earlier the better.
2.       Whole life insurance – this policy runs as long as the policy holder is alive. The policy holder pays a premium every year for a period of 15 to 20 years and that will assure the nominee the insured amount plus bonuses on the death of the policy holder. In some cases, if the policy holder lives up to 85th year, then the company would pay the insured amount plus bonus to the policy holder itself.  The premiums here are high and part of the premium is invested and another part goes towards risk mitigation from death. For example a well known insurance company offers for 25 year olds, a premium of 2.66 lacs per year to be paid for 20 years for a sum assured of Rs 100 lacs – which will be paid along with bonuses either on death of the policy holder or on his/her 85th birthday. As you can see, 60 years is a long time and the returns are not good enough for a payment of 2.66 lacs per year for 20 years. Hence such policies are not recommended - instead take a pure term policy (which costs Rs 10000 per annum) and invest the remaining 2.56 lacs yourself – the returns will be better.
3.       Endowment policies – These policies are designed to provide a benefit to the policy holder at a stage of life when a lumpsum of money is required – like marriage of daughter or college education of kids or retirement time. Plus there is a benefit in case of death. For example a well known insurance company offers for 25 year olds, for a premium of Rs. 10.94 lacs per year, to be paid for 5 years, a sum assured of Rs 100 lacs for 30 years – this 100 lacs will be paid along with bonuses either on death of the policy holder or on his/her 55th birthday (pre-retirement amount). As you can see, the policy holder is paying almost 55 lacs for the first 5 years and gets a term policy that he can get by paying 10,000 per year plus Rs 100 lacs plus bonuses after 30 years – it does not take too long to understand that this too is not an optimum investment strategy and we could do better by taking a term insurance and then investing the remaining amount directly. The endowment policies come in various forms and all of them have an investment /returns angle and an added death benefit. Unit linked insurance plans go further where they declare the value of units just like NAV’s in Mutual funds. Also in these policies, there are quite a few charges that the insurance companies charge – premium allocation charge, mortality charge, fund management fee, administration charge, surrender charge and fund switching charge. These charges are much more than what one would be charged by fund managers for managing your funds in wealth management companies. Hence it is far better to manage your own funds than use these endowment policies.
4.       Pension plans or Annuities – these policies cover the risk of living too long (unlike the risk of dying too early) – here you pay one single lumpsum or pay a premium for a few years now and in return get an assured pension after a particular age (normally retirement age). For example, a well known insurance company offers for people in their 50th year, for a one time premium of 1000, a pension of Rs 42.79 per year for as long as he/she lives. As you can see, it comes to an ROI of 4.27%. We can do better than this simply by investing in a bank FD. Hence this too is not recommended.
As you can see, Insurance is a good wealth creation vehicle – not for you – but for the insurance company– hence it is better just to take pure term insurance and manage your investments directly or through a wealth manager.