Buying Property

Some time back Sushanta had asked me to write something about buying property. As luck would have it I was contemplating buying a house in Mumbai at around that same time, but dropped the idea. Not because the price was outside my comfort zone but mainly due to the fact that it clashed with my firm belief to buy houses only after they are nearly complete. I haven’t purchased any house which is “under construction” or “proposed construction” till date. I personally know of friends and colleagues who have been stuck with housing loans where they have started paying the interest component on the loan but the building is far from getting completed. This is the worst possible situation one can be in since the principal stands as it is and you only service the interest component. Many young families give in to the lure of booking property the moment it is conceived on the drawing boards of the architects since these are usually offered at a discount to the current market prices prevailing in the locality. The rate in one of Mumbai’s suburbs where I stay is c 10,000 /per sq feet ( ~1 lakh /sq.m ~USD 2,500/sq.m) and in this particular case I was being offered a flat @ 8,000 psf which would get ready in end 2012. The builder would have to be paid in installments (as and when the plinth, slabs, etc.) get ready. The builder is well known, location of the property is sexy and the future piece was being offered at a discount of 20% to current prices. I would effectively be giving a loan to the developer. Assumming that prices in that area escalate by 10% per annum (they have actually compounded up ~15%  in the past couple of years), it would mean a completion price of c 12,000 psf. I pay 8,000 today and get back 12,000 in 2 years time! I would effectively be lending money to the builder at > 22%! (It’s actually greater than 22% since I would paying for the flat in installments). Makes you wonder what kind of loony builder is this? Well, not quite for I think that Pareto’s rule applies in the housing construction acitivity as well. Close to 80% of the actual costs of a building are incurred during the last 20% of the construction acitivity. Fittings, lifts, floor work, workers wages, permits etc. are what consume up a lot of cash but are needed much later – therefore the builder enjoys the float till that time.

Anyways, given my personal situation I figured out that I’d have to take out a loan for 50% of the amount ( = 4,000/-). and shell out an interest @ Rs. 40 psf. Moreover there is always a chance that the builder over leverages himself and is unable to complete a project (or cuts corners). Idea dropped – I would be happy to deploy that capital in the capital markets and expect a modest 15% annualised return instead. At least I’d have near instant liquidity and can always withdraw in case the need for a house becomes a painful obsession later.

Here’s my two cents worth regarding home buying: 

1. Decide if you want to rent or buy. pre-tax rental yields are in the range of 2% – 4% in the suburbs of urban India (my hunch). Which means its a pretty stupid business to let out flats which logically means that it must be quite smart to rent. But young families need to build assets and there’s tremendous social pressure to own a house, and therefore we feel the need to move down the list.
2. There are three main things that one should consider when buying property. These are A) Location, B) Location and C) Location.
3. Stay within your means. Do not extrapolate salaries into the future and do not overextend in the present. Who knows the tide might just turn and all outsourced jobs might get sucked back into the countries of their origin.
4. Do not buy property which you cannot touch and see. Period. The risk of promises being broken is high.
5. If you are a young family and are renting it – then buy a house subject to above 4 constraints.
6. If you are a young family and are staying with your parents and have no house of your own – then buy (again subject to points 2 – 4 above)
7. If you are any kind of family and already own houses (my category) buy your next one at outright cash as far as possible and only for portfolio diversification. Which means you’d already have mountains of wealth in other asset classes (not my category!). Unless of course, you can afford the additional leverage.

Taking point 7 forward, I’ve never been too much of a fan of the adage, “make money on Wall Street and bury it on main street”. Many of the visitors to my site would never have made enough money on Dalal Street anyways.

In case you get stuck at point 1 above and keep staying in rented places (many people I know do this), then please ensure that the notional excess of cash at hand is deployed wisely. Hard nut to crack for most. Especially for young Indians whose parents come from the boring mileau of the license raj and Hindu rates of growth. The earning generation’s distinguishing identity seems to be today’s conspicous consumption habits. If you have the fortitude to resist the temptation of “keeping up with the Junejas” and deploy the money in (>> inflation) longer term, boring occupations, then please – do drop off the list at point 1 itself.

An extension of point 2 above is a heads up: just because you have to buy a house, do not pick one up in too remote location/city however attractive the price would be. The risk of buying houses/land in remote cities and localities is that prices remain stuck for ages and the trigger may not come in the current generation (i.e. yours). Can you say with certainty where your kids will be once they are old enough to understand website posts like this? And that they will not curse you for buying assets which they have no interest in at all.

Another problem many non-native families to Mumbai (or any other city for that matter) face is their aversion to taking up residence at the periphery of the city center or further away from their workplaces. It may be difficult forgoing easy accessibility of all the interesting sights and sounds and tastes but the outwardly radial move is well worth it – you save money. Beyond a certain point the convenience factor of being in the center of the city is taken for granted and the irritation of staying in an outpost starts to wane. Logic would dictate that a cannily chosen outpost would appreciate faster than a much discovered nerve center. Something like mid-caps vs. large caps.

Does that mean that I do not personally prefer being long on property (other than the one where I reside)? I do – that’s the reason why I’ve sunk in some amount of money in Godrej Industries Ltd. (though not directly into Godrej Properties)