Real Estate and the Stock Market

Indians are generally fascinated investing in Land and Gold and financial advisers generally try the hell out to make it seem like they are making bad investments out there and how if the same were invested in the equity markets, the returns would / could be much more than either of the two above. But how far is those statements true.

When advisers want to showcase the lower returns by Real Estate for example, most try to chose the one that did not grow. For example, one of the examples that is given to justify that real estate investments aren’t as good as anecdote holds is about how prices in Nariman Point have actually gone down over X years which is Selection Bias at its worst.

Bangalore Development Authority (BDA for short) recently called for applications for allotment of sites and while the response has not been to the extent that it used to get earlier (biggest reason being the higher cost of land this time around), it still will be able to sell off without much of a trouble.

This frenzy to buy even though the layout it developed before this is still entangled in a mess of issues and the fact that they cannot sell for at least 10 years (a kind of lock-in) made me wonder whether people were just investing due to the herd mentality or was there something we really are missing when we recommend investing in stocks vs other asset classes like Real Estate.

Most investors / general public are thought to be financially illiterate though evidence has repeatedly shown that they aren’t the fools that most academicians / advisers think them to be. For instance, if you were to analyse mutual funds and rank them based on their last 5 year returns, just 6% of the AUM resides in those funds that come in the 4th quartile. Some illiteracy that has to be.

So, when investors rush to invest in Land (sites), I wondered whether there was a foundation to the thesis of it being a good asset class to invest. I started off inquiring the returns generated by friends and family on their investments in real estate and while on the extreme short term, returns seem to be plateauing a bit, the longer one goes back, the better the returns it has been.

A investment in 1964 for instance as on date has achieved a CAGR return of 21% while those who invested in the 80’s and 90’s have achieved returns of 20 – 25%. Higher returns have been generated by those who were lucky to invest just before the current bull market in real estate started (pre 2005) with some able to generate >40% CAGR over more than a decade.

Now, if you are a investor / trader in the market, you may think that if the same guy had invested in stocks such as Eicher or Page or whatever is the currently fancied ones, the returns would have been much higher. After all, has not even the greatest investor in India, the big bull Rakesh Jhunjhunwala showcased how he lost a lot of money by selling stock and investing in buying a property (Link).

Rather than compare against stocks, I decided to compare against the benchmark. While Sensex has a longer history, with data of its earlier years being suspect, I decided to use Nifty 50. I could have used Nifty 50 Total Returns Index but did not due to

1. The length of its history is much smaller than what Nifty 50 provides
2. Its end of the day, a index that cannot be traded / invested and its assumptions (re-investing for example) cannot be done as easily as its done academically.

To make the comparisons a even keel, I assumed that a investor can only put 20% of the value today and draws the rest from Bank Loans.

Periodicity of the Loan was assumed at 15 Years and Interest rate used was 11% per annum. Since we have a loan of 15 years, I calculate the probable returns of Nifty at end of 15 years. I did this by taking the long term average return over 15 years and then using Standard Deviation to look at both sides of the equation.

For Real Estate, I simply calculated end returns if it grew at X% per annum. As you can see, there are quite some assumptions out here, but the idea was to make the whole process easy. 15 years is a pretty long time and one honestly doesn’t know what the future unfolds, so why complicate when we are looking at understanding whether one asset class is better than the other.

The results were pretty interesting. If markets went up at the average rate they have and real estate prices grew less than 10%, investing in equity was a no-brainer. But if real estate prices grew higher, it would need a stretched returns to generate similar returns from the markets (and the only times we have had that growth is if you have invested just after a bust).

This post is not about convincing you to invest in real estate. Rather, the idea is to open your mind to the fact that blind dismissal of other asset classes may not be a good idea. As a famous quote goes, ” In God we trust; all others bring data – W. Edwards Deming”

The excel file with my workings can be accessed here (Link). I did not use Mutual funds since they too have not enough data and add to it suffer from Survivor Bias. Looking at only the surviving funds can give you a very wrong idea on what the future expected returns can be.

By using Nifty 50, I am missing out on Dividend Reinvesting which should add a bit more to the return, but when was the last time you used dividends to buy additional shares of the company? If you did not, that is one more data that is not accurate in real life.

And before I conclude, above thesis is for guys who aren’t knowledgeable about market and not full time pro’s for whom Nifty is not the right benchmark anyways.