Which One Fares Better? – Forbes Advisor INDIA

Investments in real estate have traditionally been made by constructing buildings and renting them out. While most of these investments have been in the residential sector, some individual investors have also ventured into commercial buildings through retail space and small warehouses.

However, for the average private investor, real estate investment opportunities were not viable prior to the advent of Real Estate Investment Trusts (REITs) and fractional ownership. Both allow retail investors to invest in commercial real estate, which is a much more stable asset than residential real estate. Importantly, people are becoming increasingly interested in the commercial real estate sector while also having assets such as gold, mutual funds and time deposits in their investment portfolios. So does this mean that real estate can be viewed as a substitute for others or vice versa? Let’s understand in detail.

Regardless of the type of investment, several factors must be considered before investing in any asset. Be it instruments like stocks, mutual funds (MF), gold, fixed deposits (FD), real estate and others. Aside from the risk-reward matrix involved, investors need to be clear about their investment goals and the time in which they can invest their money.

What is a real estate investment?

Traditionally, buying property and owning it until it increases in value is the most basic form of investing known to most retail investors. The better the connection to the property via roads and bus/train lines, the higher the appreciation over time. There are factors such as demand and supply, as well as economic activity in the area, that add value, but the general rule of thumb remains the same.

Residential and/or commercial space is only available to a limited extent and is becoming less every day. Those that are better connected and closer to other commercial/residential centers have a higher likelihood of being in demand and are therefore appreciated more quickly. Unlike a vacant lot, a constructed building somewhat limits the options for the initial investor.

The building must not be preferred by a new buyer/tenant because of its construction or design, it must not serve the intended purpose of the prospective buyer/tenant. Regardless of these factors, once owned real estate is an asset that rarely faces major problems. Regarding buildings, maintenance and upkeep are the minimum costs that an investor has to bear.

Options like REITs and fractional ownership are making it much easier for individual investors to invest in real estate — more specifically, commercial real estate. Why is commercial real estate preferred over residential real estate? The long lease periods offer a better opportunity for value appreciation, and because the tenants are corporate, they tend to be more stable in their tenancy compared to apartment tenants. In general, commercial properties include retail, office and storage space and can have lease terms of five to 20 years with minimum vesting periods of two to three years. This presents a nice opportunity for an investor to be assured of returns from the asset over a long period of time.

real estate for gold

Gold and FDs are both the preferred investment options of the average investor who doesn’t want to get involved in stocks, shares and the like. Paper gold has made it even easier for people to invest in gold at will.

In 2010, the value of 24k gold for 100 grams was about INR 1.85,000. From May 5, 2022, the same 100 grams will be worth INR 5,12,800. That’s quite an increase in investment in just a decade. But one should also look at the fluctuations in the price of gold over the past six to seven months.

Incidentally, the availability of gold as a natural resource is also decreasing day by day, so it is natural for the value to increase. What is not healthy is the volatility that the asset faces due to its demand and supply matrix. Since fluctuations only occur over a period of months, it becomes difficult for even long-term investors to determine when would be the best time to liquidate the asset.

Let’s summarize what investing in gold can mean for you –

  • Holding gold offers no tax benefits.
  • Finding the best price to sell gold could be difficult as yields are cyclical.
  • Not everyone is interested in buying gold, much less when it comes to the actual metal, low liquidity.
  • Unless investing in paper gold, transparency is low and ornaments involve fees that cannot be included in the investment amount.
  • As an investment, gold’s only potential is the appreciation it can experience. There are no other income opportunities.
  • The devaluation of paper money is one of the reasons gold is appreciating in value. This makes every win very nominal.
  • Interestingly, gold deposits of more than half a kg may be subject to income tax under the gold monetization scheme.

Real Estate Vs FDs

Fixed-term deposits (FDs) are the most basic forms of investment vehicle to access early in life. The highest possible interest rates on FDs were somewhere in the 90’s with a whopping 13% yield on deposits of three years, five years or more. Those days are long gone, and after the basic investing thumb, you should be looking at your real rate of return, not the nominal rate of return that investment plans tend to advertise. It’s a simple calculation using the formula:

Real rate of return = (1+nominal interest rate)/(1+inflation rate) – 1

From June 2022, the RBI increased the repo rate by 50 basis points, which should prompt many banks to increase their FD rates as well. But will this affect your investments in any way? The FD rates available from May 2022 are between 3 and 6%. Use the calculator and understand if this is the return you want on your investments.

In the case of real estate in the classic sense, contracts can be concluded that allow a steady increase in rental prices for residential buildings from year to year. In the case of commercial properties, a similar structure is always signed by the tenants. An added benefit of commercial real estate is that it never loses its purpose.

Residential buildings can be based on the tenant’s personal preference, but commercial buildings are chosen based on their location and the viability of the business. For example, companies renting out commercial real estate know that they need to have a local presence for certain financial, regulatory, and logistical advantages.

Real Estate vs Mutual Funds

As an investment, real estate also carries risks, but market volatility is not one of them. While mutual funds that operate on stocks and shares involve significant market risk. The table below can give you a clear idea of ​​the differences between mutual funds and traditional real estate investments –

Note that many of the problems with traditional real estate investing have been alleviated by REITs and fractional ownership. Fractional ownership platforms and REITs will be regulated by SEBI from the Union budget of 2022, allowing for much better transparency in real estate investments. Such models have also significantly reduced the volume of investments, making it much easier for private investors to enter the world of real estate investing.

risk factor

Risk factors for real estate, whether commercial or private, are low. It’s an asset with a rent-paying tenant, and neither will go away overnight. A property can be flipped, multi-purposed and is just one of those things that will always be there. Mutual funds can be risky depending on the type of funds that make up the plan you’re investing in. Stock-centric plans offer the best returns, but they can also be quite volatile.

While funds that focus on government bonds offer more stability at the cost of lower yields — sometimes lower than those that offer real estate. Real estate risks can be eliminated simply by choosing a good location. If you choose fractional ownership or REITs, the preliminary work has already been done by the investment company and all you have to do is choose the asset or the time from which you want to start investing.

perfomance

Achievement can mean different things to different people. Residential real estate is not only an investment opportunity, but also a roof over your head. Policy changes at the state and national level can also affect the behavior of real estate. Recent announcements in the 2022 Union budget with an increased focus on real estate and infrastructure have given a boost to commercial real estate in many regions despite the pandemic aftermath.

Returns

Yields are consistent with real estate, although they may not be very high. The consistency factor plays a very important role in commercial real estate, as lease terms can be up to 20 years. For someone looking to have a passive income stream and a long-term investment goal, the value proposition of real estate cannot be ignored.

liquidity

Most investment decisions are subject to an invisible liquidity constraint. People may not discuss it, but it stays in the back of their minds. When you invest, you also want access to your money when you need it, preferably as quickly as possible. While mutual funds are easy to liquidate and can be converted into cash in up to a day, the same is not true for real estate. Even with models like REITs and fractional ownership, you have to plan how to get out of the investment in a timely manner.

tax exemption

Both real estate investments and mutual funds can give you tax exemptions. The tax exemption for mutual funds is higher and why it is a preferred investment category. Under Section 80C of the Income Tax 1961 you are entitled to a tax exemption of up to INR 1.5 lakh. Indexing can also help you save on taxes on real estate, but certainly not on the same level as mutual funds.

What works and what doesn’t

As an investor, your investment goals may not be the same as others. But you can certainly see similarities in the investment portfolios of people around you. Real estate is a typical long-term investment that allows for steady wealth accumulation through rental income and capital appreciation. Compare this to the following before making a choice:

  • Fixed-term deposits are low-risk instruments that provide a safe place to park money that you don’t want to use anytime soon but don’t want to put at risk.
  • The value of gold as an investment option has changed quite drastically over the years, but there are still some who vouch for it.
  • Mutual funds are generally good for those looking to make short- to medium-term investments. As previously mentioned, investment options may vary with your investment goals. It is not necessary to swap one instrument for another, while it should matter how much weight you give to a particular investment in your portfolio.

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