Home Ownership In India: A Risky Investment?

Buying a house is a dream for most people around the world. However, it is not always a good investment option. Here are some reasons why:

- Illiquidity: Real estate is difficult to sell in all markets, and the transaction costs are abnormally high (around 10% of the value).

- Low returns and high expenses: Real estate investments are known for providing low returns, often less than the rate of inflation. The rentals earned are also negligible compared to the time, money, and effort required to maintain the property.

- Lack of geographical flexibility: Buying a house forces you to settle down in one geographical area, limiting your opportunities.

- Leverage and interest: Most people buy real estate with borrowed money, paying large chunks of their income in interest. This assumes that real estate prices will rise, but if they don't, investors can lose a lot of money.

- Concentration of portfolio: Since real estate consumes most of the middle-class person's salary, it ends up consuming most of their portfolio. This lack of diversification increases risk.

High transaction costs

There are several costs to consider when purchasing a property in India, and these can add up to a significant amount. One of the major costs is the stamp duty, which is a compulsory fee paid to the State Government, ranging from 5% to 7% of the total property value, depending on the state. For example, in Karnataka, the stamp duty is 5% for properties above Rs 45 lakhs, 3% for properties up to Rs 45 lakhs, 2% for properties up to Rs 20 lakhs, and 3% for properties between Rs 20-45 lakhs. In addition to the stamp duty, there is also a cess of 10% and a surcharge of 2% for properties priced above Rs 35 lakhs in urban areas and 3% in rural areas.

Another cost to consider is the registration fee, which is typically 1% of the property value and is paid to the local court to obtain the legal document indicating the change of ownership. If you are buying an under-construction property, you will also need to factor in the Goods and Services Tax (GST) of 12%. Property inspection charges may also apply if you are obtaining a housing loan from a bank, as they will want to inspect the property to ascertain its worth and the reputation of the developer.

If you are purchasing a home with a desirable view or on a higher floor, you may be subject to a preferential location charge, which can add a significant amount to the overall cost. There are also maintenance or society security deposits to consider, which can include charges for security guards, maintenance of roads and common areas, lighting fixtures, and even club membership.

Other hidden costs may include charges for interior fittings and appliances, car parking fees, and brokerage fees if you are using a real estate agent. These brokerage fees are typically around 2% and are shared equally by the buyer and the seller.

Illiquid investment

Real estate is considered an illiquid asset because it takes more capital to acquire than stocks or precious metals, and it takes a lot longer to sell. In the case of real estate, the sale price may also be impacted by a multitude of factors, and the asset may have to be sold at a discounted price.

In India, the Bombay Stock Exchange (BSE) publishes and updates a list of illiquid securities on its website periodically.

Low returns

Real estate investments are known for providing low returns. Traditionally, the returns on real estate investments have been less than the rate of inflation. It is only in the past few years that there was a sudden spike in the capital appreciation earned on real estate. The rentals earned are also negligible. Also, in order to earn rent, a lot of time, money and effort, has to be put in. Also, many times, it is just difficult to rent out houses. Hence, there is an element of risk as well.

On the whole, the returns earned by real estate are comparable to risk-free investments even though a lot of risks has to be taken. This is what makes realty a bad bet for the middle class.

Real estate purchases are usually leveraged. This means that people are paying large chunks of their income in interest. All these payments are being made with the assumption that real estate prices will rise. The problem is that if the prices don’t rise, investors stand to lose a lot of money.

It needs to be understood that the price doesn’t need to fall in order for the investors to lose money. Even if the price stays stagnant, investors have already lost a huge chunk of their savings which they paid out in the form of interest.

High expenses

The expenses of owning a house are high. The transaction costs of buying and selling a house are very high, often around 10% of the value of the house. These costs include legal fees, brokerage, and appraisal costs. The government also takes a large sum of money from each sale. These high transaction costs make real estate illiquid, as people are often stuck with the property they purchased even if it turns out to be a mistake. Real estate is also opaque, with listed prices differing from transaction prices. This makes it difficult for buyers to know the correct buying price and leaves them vulnerable to being ripped off by unscrupulous middlemen.

In addition to the high transaction costs, there are also high ownership costs associated with real estate. These include property taxes, maintenance, and repairs. Over 30 years, these costs can add up to hundreds of thousands of dollars.

The opportunity cost of owning a house is also significant. The money that could have been invested in stocks, bonds, or other assets is instead tied up in a house, which may not provide a good return on investment.

Forces you to settle in one geographical area

Buying a house can force you to settle in one geographical area. This is because, unlike other investments, a house is a physical structure that is tied to a specific location. Once you buy a house, you are committed to living in that particular area, which can limit your mobility and flexibility.

There are several factors that contribute to this immobility. Firstly, the financial burden of owning a house can be significant. The high cost of purchasing a home often requires taking out a mortgage, which can last for decades. This long-term financial commitment can make it difficult to relocate, as selling a house may not always be feasible or timely.

Secondly, the time and effort invested in maintaining and caring for a house can create a sense of attachment and emotional connection. The process of settling into a neighbourhood, establishing relationships with neighbours, and personalising the space can make it challenging to consider moving elsewhere.

Additionally, the physical structure of a house is subject to environmental changes and settling. Over time, the weight of the house can cause the soil underneath to compress, leading to shifts in the foundation and framework. These shifts can result in cracks, sticking doors and windows, and other issues that require ongoing maintenance and repairs. Addressing these problems may involve hiring professionals, further increasing the financial burden and sense of obligation tied to the property.

Moreover, the decision to settle in a particular area is influenced by various factors such as access to resources, employment opportunities, safety, and favourable climate conditions. Individuals tend to choose locations that meet their personal and professional needs, which can vary depending on their circumstances. For example, those working in a specific industry may be drawn to cities with thriving job markets in that field.

In conclusion, buying a house can indeed force you to settle in one geographical area due to financial commitments, emotional attachments, maintenance requirements, and the influence of personal and professional factors that drive the decision to settle in a particular location. While homeownership has its advantages, it is important to carefully consider the potential limitations on mobility before making such a significant investment.

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