The Luck of Investing in Real Estate

India-Real-Estate-Market

When flying out of the terminal 2 at the Chatrapati Shivaji International Airport in Mumbai, I like to follow a certain routine.

This includes eating a sandwich along with a cup of coffee and watching airplanes take off and land. The entire routine lasts for around 15 minutes. And this is precisely what I was doing two days back, when I saw a person walking towards me. I wouldn’t call him a long-lost friend but he was someone I had come to know during my course of work.

Don’t we all know a bunch of people we know, but we really don’t know? So, he was one of those.

“And who have we run into,” he said, sitting down in front of me. After the mandatory hello, this gentleman got to the issue straight away. “So why are you so against investing in real estate?” he asked.

“Well, I am not against anything. I am only against things which don’t make sense to me at a certain point of time. And as of now it doesn’t make sense to invest in real estate, in my humble opinion. But if you want to buy a home to live-in, that is a different issue altogether,” I explained, extremely irritated at having been disturbed.

“Oh, you know but the value of the home I bought has gone up four times,” he said with great confidence.

This is the oldest argument made by those still confident about investing in real estate. It comes in two forms. One form was just cited above. The other form is to talk about a third person who seems to have made money by investing in real estate. This can include Sharma ji, Verma ji, Gupta ji, Mr Banerji or Mr Subramanian, one of whom lives down the road.

This argument deals in absolutes. “I bought for Rs. 10 lakh and I sold it for Rs. 50 lakh,” is how you go about selling this point. The trouble is that it doesn’t take into account any expenses incurred in between.

This includes the maintenance cost that needs to be paid to the society every month. Or the property tax that needs to be paid to the municipality every year. Or the cost of insuring the home. Or the interest on the home loan. Or the cost of buying an insurance on the home loan. On the positive side, it does not include any rent that comes in and any tax deductions that are made.

The point being that no one calculates the return on investment on investing in property. In fact, there is no such number going around. If you want to know the past returns of a stock or a mutual fund, it is very easy to find that. But if you want to know about the past returns on real estate, there are only absolute numbers going around.

There are only stories. And people like to believe in stories, not numbers.

“So when did you buy this home?” I asked the gentleman.

“Around 2005,” he replied.

“You were lucky,” I blurted out.

“What do you mean?” he asked.

I had made the proverbial mistake of attributing the success of a person to his luck. And given that I would have to explain what I meant.

“Well, if you had invested in real estate any time post 2009, there is a reasonably good chance that your investment would have ended up in a mess,” I explained.

“What do you mean?” he asked again.

“Many people who invested in real estate post 2009, still haven’t got the homes they had invested in. The builders have either run out of money or in some cases simply disappeared.”

“Oh,” he replied, rather nonchalantly.

“So, in many cases people who thought they are buying a home to live in, have had to continue paying the rent on the home that they live in, along with the EMIs.”

“Oh,” he said again.

“They are basically screwed.”

“But what are you trying to say?”

“Success in real estate investing like many other things in life is also a matter of timing. You think you have made money because you invested in 2005. Many others who invested in 2009 or after, are stuck. And unlike other forms of investing there is no exit route. Also, given that the amount involved in this case is large, there is no getting back from it,” I explained.

“Oh, but all that doesn’t apply to me,” he said rather confidently.

“Really? So, this home you bought and which has gone up four times in value, have you ever tried selling it?” I asked.

“Yes.”

“And for how long have you been trying to sell it?”

“For the last six months.”

“And you still haven’t managed to find a buyer for it?”

“No. I think it is worth a certain price. But the stupid buyers haven’t been willing to pay.”

“Ah!”

“My broker also thinks it is worth the price that I think it’s worth.”

“Oh, really. The price you and your broker have, is in your head. That is certainly not the market price, because if it was, your home would have been sold by now.”

“That is not the case,” he responded very aggressively.

“You are anchored on to a price and are not willing to sell for anything less than that price. But in the time to come, as your home continues to remain unsold, you will revise your expectations and be ready to sell at a lower price,” I said, gulped my cup of coffee, and started walking towards gate number 87 to catch my flight.

To conclude, if you are unable to sell a house that you had bought as an investment, that doesn’t make the buyer stupid.

The column originally appeared in Vivek Kaul’s Diary on October 26, 2016

Why Capitalism Won

Âûñòóïàåò Ãåíåðàëüíûé ñåêðåòàðü ÖÊ ÊÏÑÑ Ìèõàèë Ñåðãååâè÷ Ãîðáà÷åâ. XX ñúåçä ÂËÊÑÌ. Êðåìëåâñêèé Äâîðåö ñúåçäîâ.

After the end of the Second World War, the Soviet inspired communism and socialism started to spread through large parts of the world.

Some of it (the communism bit) was pushed by the Soviets themselves with the weight of their big army. And some of it (the socialism bit) the countries adopted on their own. India is a good example of the latter trend.

In fact, for a very long time, the bet was that the Soviets would win and the Soviet economy would become larger than the American one. But that never materialised. In fact, this idea was even a part of the most read economics text book during those days, written by the American economist Paul Samuelson.

As Daniel Acemoglu and James A. Robinson write in Why Nations Fail – The Origins of Power, Prosperity and Poverty: “In the 1961 edition, Samuelson predicted that Soviet national income would overtake that of the United States possibly by 1984, but probably by 1997. In the 1980 edition there was little change in the analysis, though the two dates were delayed to 2002 and 2012.”

But nothing like that happened. By the time Mikhail Gorbachev became the General Secretary of the Soviet Union in 1985, the Americans and the rest of the West, had won. Gorbachev was more practical than the previous Soviet leaders and even launched the policies of glasnost (“openness”) and perestroika (“restructuring”) to get the moribund Soviet economy going.

The story goes (and it is perhaps apocryphal) that Gorbachev sent a key aide to London to learn a thing or two about what the British were doing well, which the Soviets clearly weren’t.

The British played good hosts and Gorbachev’s aide was taken for a tour of the city with places like the London Stock Exchange and the London School of Economics being on the itinerary.

As Yuval Noah Harari writes in Homo Deus—A Brief History of Tomorrow: “After a few hours, the Soviet expert burst out: ‘Just one moment, please… We have been going back and forth across London for a whole day now, and there’s one thing I cannot understand. Back in Moscow, our finest minds are working on the bread supply system, and yet there are such long queues in every bakery and grocery store.”

Gorbachev’s aide was surprised that in London there were no lines in front of supermarkets and shops for bread, even though millions of people lived in the city. The aide ended up saying: “I haven’t seen a single bread queue. Please take me to meet the person in charge of supplying bread to London. I must learn his secret.”

Of course, it need not be said, there was no one in charge for supplying bread to the city of London. And this is precisely why there were no queues. As Donald J. Boudreaux writes in The Essential Hayek: “There is no overarching—no “central”—plan for the whole…That larger outcome is… spontaneously ordered.”

This is precisely the secret of success of capitalism. Unlike in communism there was no central processing unit to supply bread to the city of London. As Harari writes: “The information flows freely between millions of consumers and producers, bakers and tycoons, farmers and scientists. Market forces determine the price of bread, the number of loaves baked each day and the research-and-development priorities.”

And this is why capitalism won at the end of the day. As Harari puts it: “Distributed data processing works better than centralised data processing, at least in periods of accelerating technological changes…When all the data is accumulated in one secret bunker, and all important decisions are taken by a group of elderly apparatchiks, you can produce nuclear bombs by the cartload, but you won’t get an Apple of a Wikipedia.”

Or even a Facebook for that matter.

The column originally appeared in Bangalore Mirror on October 26, 2016

 

Why Tata Fired Mistry

(This is a spoof and a work of fiction. Any resemblance to actual persons, living or dead, or places or actual events is purely coincidental)

Office of a digital publication

“Oh Shit!,” yelled the young intern, who had been asked to keep a tab on what was happening in the world at large.

“What happened?” asked the senior desk hand sitting next to him.

“Tata has fired Mistry,” said the intern, in an excited state.

“What?” screamed the editor from across the bay.

“Yes,” said the senior desk hand who had checked out the news by then.

“Okay. Shouted the editor. Let’s get working on this.”

“Yes Sir!” said the intern.

“I want you guys to start working on Five Reasons Why Tata Said Bye Bye to Mistry.”

“But Sir so soon?” asked a confused intern.

“Yes goddamit. We are a website and not the Economic & Political Weekly, which can take six years to figure out what really happened. If you hadn’t been asking questions you would have already figured out two and a half reasons by now.”

“Sir, five reasons won’t work,” screamed the senior desk hand.

“Oh, but why?”

“While we were talking, another website has already come with Five Reasons Why Tata Said Bye Bye to Mistry.”

“Oh, then let’s use six.”

“Sir, the numbers six to 77 have already been taken.”

“What?”

“Yes Sir.”

“Let’s do 78 then.”

“78?” asked the intern again. “How do we come with 78 Reasons Why Tata Said Bye Bye to Mistry?”

“Oh that’s simple,” said the senior desk hand. “We just ask a question on Facebook and Twitter to the people.”

“What question?” asked the bewildered intern again.

“We ask the readers why do you think Tata fired Mistry,” said the senior desk hand patiently. “Take those reasons and turn them into 78 Reasons Why Tata Said Bye Bye to Mistry.”

“But how will the readers know, if we don’t know?” asked the intern, rather innocently.

“Well. The readers don’t know. But every reader on the social media thinks that he knows. So, we just cash in on that.”

“Ah. Like that,” said the intern, finally figuring out what was happening.

By now, the editor had totally lost patience. “Let’s get cracking. This is a part of our strategy of building direct reader connect. If readers generate their own content they feel more connected with it. We also don’t need to spend money on generating content.”

All this left the intern wondering: “Does the nation really want to know?”

Meanwhile in a business TV studio.

“I want you guys to get cracking on this,” shouted Maureen.

“Yes Mam,” came the reply from the young reporters.

Two minutes later Maureen was on air, explaining the development to the audience which was watching the news on mute.

“Why do you think Tata fired Mistry?” she asked the reporter.

“Sources close to sources said that the sources have no idea behind the mystery of the mysterious sacking of Mr Mistry…” the reporter explained, speaking at breakneck speed.

“Ah. Thank you for giving us that exclusive breaking news. Remember you heard it here first,” said Maureen. “And now it’s time to take a break.”

“Good show girl,” Maureen told the reporter. “I love it when you speak so confidently. After all that is what TV is all about.”

Meanwhile at a Hindi news channel.

“So what angle do we take?” the editor asked the reporter.

“Sir, aap jo bole wo angle le lenge (Sir, whatever angle you ask we will take),” the reporter replied.

The reporter up until two minutes back had been covering politics and suddenly he was now being asked to turn himself into a business journalist.

“Hmmm…Let’s take the Mulayam angle,” the editor suggested.

“Mulayam?” asked the reporter, totally stumped.

“Yes. Arre, Mulayam could have fired Akhilesh but he hasn’t. He has managed to postpone the problem for another day,” explained the editor. “Also, there is a family angle. Ratan’s brother is married to Mistry’s sister. So,  we can compare it to Mulayam. To chal jaega (It will do).”

“Yes Sir. Yes Sir,” agreed the reporter, thanking the Gods. At least, he would be able to speak something on this.

Meanwhile at one of India’s leading pink papers…

“What have we got?” asked the editor leaning back on his chair and trying to blow imaginary smoke rings into the air. This was something he used to love to do all day in his office for real, until the no smoking policy became the order of the day. Now he could only smoke in the office loo.

Six Reasons Why Tata Said Bye Bye to Mistry,” explained the corporate editor.

“Ah. You wrote it so fast Mr Matthew,” said the editor.

“Yes. Mr Chakraborty.”

“But that will be published on the web. What do we do for tomorrow morning?”

“Yes Sir!” explained the corporate editor, who had already put in all the spin he could think of into the Six Reasons piece.

“Let’s do something conceptual.”

“As in?”

Sabka badla lega tera faijal,” explained the editor, leaving everyone totally flummoxed for a moment. For a Bong he did watch a lot of Hindi cinema.

“As in?” the corporate editor asked again.

“Let’s call it Gangs of Bombay House. You know a play on Gangs of Wasseypur, with the Tata camp taking on the Mistry camp.”

“Wonderful idea Sir. Should take care of tomorrow’s page and hopefully by tomorrow we should be able to figure out what really happened.”

“Ah. Tomorrow we need to come with more reasons behind what really happened. Day after, a few more. We need to keep coming up with reasons behind what really happened. It doesn’t matter what really happened because nobody knows what really happened,” said the editor, as he made his way towards the loo, having gotten done with his share of philosophy for the day.

“What is the truth?” asked the corporate editor, imagining, he had an audience around him. “No one really knows. Everyone has their own version.”

And then he wondered “Where had he heard that before?” “Or I am getting better and better at writing fiction?”

The article originally appeared in Vivek Kaul’s Diary on October 25, 2016

A Small Thought Experiment on Made in China

 

china

In the recent past, there have been calls for boycotting Chinese goods. The question is: Whether this can be executed? Or to put it more specifically, whether it can be executed by a middle class Indian?

Consider my personal situation. I am writing this column on a Lenovo laptop, which is Made in China.

The Kindle book reader which I use to refer to many books that I quote in my regular columns, was assembled in China.

My internet connection is provided by Reliance 4G Wi-Pod. The device has been made by the ZTE Corporation, which is based out of Shenzhen in China.

I use the Moto g4 PLUS mobile phone, which is Made in China.

I own the most basic model of a Hewlett Packard printer, which is Made in China.

I own a Toshiba television, which also happens to be Made in China.

This shouldn’t be so surprising. In 2015-2016, 36.6 per cent of Indian imports from China constituted of electronic products. Engineering goods came in second at 28.9 per cent and chemicals came in third at 18.4 per cent.

So, basically if we want to hurt China, then these are the goods which we should not be importing from them. In total, they formed close to 84 per cent of Indian imports from China.

So far so good.

How realistic is this? Here’s a thought experiment I did in order to figure this out.

So let’s say you want to go out somewhere. You decide to call an Ola or an Uber taxi. There is a very good chance that you do this using a Made in China phone. In 2015-2016, 16.3 per cent of Indian imports from China were telecom instruments.

Even if you manage to avoid that, chances are that some component of the phone would be Made in China. You have no way of knowing. Why do I say this? This is primarily because MNCs these days manufacture products using global supply chains.

As the World Trade Report for 2013 points out: “A central feature of this… age of globalisation is the rise of multinational corporations and the explosion of foreign direct investment (FDI)… Upwards of two-thirds of world trade now takes place within multinational companies or their suppliers – underlining the growing importance of global supply chains.” This is something that India has clearly missed out on due to a whole host of reasons, which are beyond the scope of this column.

Further, the battery of the phone used to call the taxi, is charged through electricity. Chances are the electricity that you are using has been produced using equipment imported from China, using loans provided by the Chinese banks. Electrical machinery formed 4.4 per cent of Indian imports from China in 2015-2016.

You avoid thinking about this rather esoteric point and get back to calling for the cab. You need to go out after all. And in order to do that, you need to call an Ola or an Uber taxi. If you call Ola, you need to know that Ola is in alliance with Didi Chuxing, a Chinese taxi-company. They have entered into a non-compete clause.

If you call Uber you are going to use Paytm to pay the taxi driver. The Chinese company Alibaba is the major investor in Paytm. So that rules out paying electronically.

So you need cash. You go to withdraw cash from an ATM. Chances are the ATM will be in Made in China.

So what do you do now? You go to a bank branch and withdraw money. Chances are the computer used by the teller to give you cash is also Made in China.

So what do you do?  You think chuck it, let’s not go out anywhere because we don’t want to encourage Made in China. Let’s order a Pizza. Ah, a perfectly American Pizza. Uncle Sam can have my money but I am not going to give it to China.

What do you think Uncle Sam will do with that money? Order goods from China.

But that is a second-order effect. So you ignore that and curse that MBA degree that makes you think so much.

Nevertheless, Pizza has cheese. And cheese is made from milk. In 2015-2016, industrial machinery for dairies formed 4.7 per cent of Indian imports from China. Oh then, it’s quite possible that cheese also has Made in China inputs.

What is a Pizza without cheese? But you compromise and decide to go get Pizza bases from the market and make one for yourself at home with tomato ketchup.

Wait, wait, wait! What is a Pizza base made of? Wheat. And farmers use a lot of fertilizer to grow wheat and other food grains. In 2015-2016, fertilizers formed 5.25 per cent of Indian imports from China.

India is dependent on imports in the case of phosphatic and potassic fertilizers. As far as phosphatic fertilizers are concerned, almost 90 per cent of it is imported. With no known commercially exploitable source of potash in India, the country is totally dependent on imports for potassic fertilizers.

You decide not to think so much and just to order and eat the Pizza. After eating the Pizza you feel a little queasy. You decide to pop a tablet. Wait, wait, wait. Medicinal and pharmaceuticals formed 3.8 per cent of Indian imports from China in 2015-2016. Bulk drugs and formulations formed a major part of this. In 2015-2016, bulk drugs and formulations formed around 3.7 per cent of Indian imports from China.

So chances are that the drugs that have gone into the making of the tablet have been imported from China. Even if they haven’t, there is no way for you to figure out.

How do we go we genuinely go about avoiding Made in China? Let’s say we boycott Chinese brands. You don’t buy a Moto G phone but an Apple iPhone. While iPhones are also assembled in China, a large part of the money will go to Apple, which basically seems like an American company.

Interesting. But the moment you buy Apple, you pay more. This leaves you with lesser money to buy everything else and in the process Indian manufacturers lose out.

Hence, Apple is not worth the trouble.

Okay, so you buy a Samsung phone. Samsung is a Korean brand. But they also make stuff in China. If more and more people buy Samsung phones (and not Moto G) that in turn will also benefit Chinese companies. What they lose out on Moto G they will possibly make up from Samsung.

So where does that leave us? It leaves us with crackers. Yes. Diwali crackers. Make sure you buy Indian brands this year. Made in Sivakasi. And not Made in China. And in the process keep encouraging regular fires in Sivakasi.

And forget about the fact that there have been cases of Sivakasi fire cracker entrepreneurs also getting their stuff Made in China. You will only know once you open the packet.

And how much will a boycott of crackers hurt the Chinese? Perhaps a little. But not something that they can’t manage. Fire crackers are low value products at the end of the day.

So how is it possible to really hurt China? The way out is to ensure that the government creates an environment where Indian manufacturers can compete with the Chinese ones. And that is easier said than done.

The column originally appeared in Vivek Kaul’s Diary on October 21, 2016

The Greater Fool Theory of Real Estate

India-Real-Estate-Market

Some regular readers of the Diary have been asking on the social media as to why I have stopped writing on real estate.

Actually, I haven’t, it’s just when it comes to real estate, I have had nothing new to say for a while. But today’s piece is about real estate. Not that this has something very new to say, but the story that I came across was interesting enough to be discussed in detail.

First and foremost, I would like to thank Pune based Ashish Deshpande, Director, Paradigm Wealth Managers, for bringing this to my notice. So here is the story.

On the insistence of a friend, Deshpande went to check out a new real estate development in Wadala in Mumbai.

His friend could only afford the one bed room hall kitchen (BHK) that was on offer. And how much did it cost? Rs 1.8 crore. Deshpande got chatting to the builder’s sales guy and asked him, how many end users were actually buying the one BHK apartments. The sales guy, not surprisingly, answered 90 per cent. I mean, what else could he have said. He is expected to sell apartments not philosophise about them.

Of course, like a good sales guy, he was lying. Deshpande then asked the sales manager to imagine the profile of the guy who would in a position to pay Rs 1.8 crore to buy an apartment to live in it. Let’s do a little maths to get into a little more detail here.

A bank or a housing finance company would finance up to 80 per cent of the value of the apartment. This means a home loan of Rs 1.44 crore (80 per cent of Rs 1.8 crore). Let’s say the individual who wants to buy this apartment goes to the State Bank of India. He takes on a twenty-year home loan at 9.25 per cent per year.

How much does the EMI on this amount to? Rs 1,31,885 per month. How much does a person need to earn per month for the bank or the housing finance company, to give him the required home loan? Assuming around 40 per cent of the salary goes towards the EMI, the monthly salary would have to be around Rs 3.3 lakh. This would mean an annual pay of around Rs 40 lakh.

How many people actually earn that kind of money? Further, the individual would also have to arrange for a downpayment of Rs 36 lakh (Rs 1.8 crore – Rs 1.44 crore). How many people have such a saving? Also, would you expect someone earning as much as Rs 40 lakh per year to live in a one BHK apartment? Would take a very desperate person to do that.

Deshpande offered this logic to the sales manager (not in as much detail). Then the manager let the cat out of the bag and said that most of the people purchasing one BHKs were buying it as a second home. People buy second homes typically to put it on rent to make a regular income, avail of the huge tax deduction that is available or to simply invest money and stay put. Or they simply have some money lying around and they don’t know what to do with it.

Rental yields (annual rent divided by the market price of the apartment) are currently around 2 per cent. So why would anyone in their right mind buy a home to put it on rent? Even after tax returns on fixed deposits, for those in the 30 per cent tax bracket work out to around 5 per cent.

When it comes to saving tax, the strategy perhaps makes some sense. In case of a second home loan (and third and fourth and so on) the entire interest paid on a home loan is tax-deductible as long as a notional rent is added to the income.

But what complicates matters in this case is that the delivery of the apartment is not scheduled up until 2020. That essentially increases the risk given that there are a whole host of under construction properties that haven’t been delivered over the last few years.

Also, the apartment comes with the condition that it cannot be sold before possession is granted. So this basically means that it is a five-year investment and can be sold only by around 2021. So what is a reasonable rate of return for an investor to expect in this case? Deshpande works with a simple rate of return (and not compounded) of 8 per cent per year. This would mean an absolute rate of return of 40 per cent over a period of five-year.

This basically means that five years later the apartment should be worth at least Rs 2.5 crore (actually Rs 2.52 crore to be very precise). If we include stamp duty and other charges (which also need to be recovered) the apartment should fetch at least Rs 2.75 crore in 2021.

A simple rate of return of 8 per cent per year might just work in this case because the buyer is also getting a huge deduction for the interest that he pays on the home loan. But what if someone is looking at least at a compounded rate of return of 10 per cent per year? Then the price of the apartment has to be around Rs 2.9 crore in 2021. And this is without taking the stamp duty into account.

Now, imagine one BHK apartments selling for Rs 3 crore in 2021? These are the numbers we are looking at. What if there are no buyers? As Deshpande puts it: “in the absence of an end user your investment becomes a fixed deposit fetching 2% return annually with principal not in sight or at least at big risk.”

So where does that leave us? It brings us back to the Greater Fool Theory of Real Estate. Or the theory on the basis of which people are still betting on real estate. The expectation is that at the end of the holding period of five years (in this specific case) one will always be able to find a greater fool who is willing to buy real estate at an even higher price. In more general cases, the expectation is to find a greater fool who is willing to buy.

If that is how you like to invest, then all I can say is best of luck. Or maybe you have a lot of black money lying around. And there is still no place better than real estate to launder it.

The column originally appeared in Vivek Kaul’s Diary on October 19, 2016