Re-emerging real estate sector of India is hungry for investments

By Indra Giri on September 27, 2016

According to market experts, the bubble in the real estate sector has burst. The prices of the real estate have decreased rapidly. Similarly, the gap between the supply and demand has increased significantly in recent times (KPMG, 2014).

However, on the other hand, the statistics show a different picture altogether. According to KPMG, India has the potential to become one of the leading destinations in the real estate sector. This is not just a hypothetical assumption but based on facts. The total value of the real estate sector in India is expected to increase to $676 billion by the end of 2025 (pwc, 2014).

Other than real estate sector there are various other investment opportunities available. In this article, the investment and their return on other assets such as equity, term deposits and gold have been compared with the investment in the real estate sector. The comparison is based on the returns on these assets over the period of time and future growth opportunities.

Volatile return in equity versus the stable return in the real estate sector

When it comes to the investment the only thing the investor is concerned is the return from his assets. An investment is profitable if the return on the investment is higher than the cost of the investment. In India, most of the investors invest either in the real estate or in equity. In the recent time, it has been seen that the returns on the real estate is lower as compared to the return on equity. However, this is only the short-term phenomenon.

Yearly return in Nifty % 1994- 2014
Yearly return in Nifty % 1994- 2014 (Source: NSE India, 2016).

In long-term investments, the real estate sector has been offering higher returns in India. In the last two decades, the average return from the real estate was 20%. On the other hand, the average return on equity for the same time period was 15.5 % (CIANS Analytics, 2014).

Apart from higher returns, the real estate sector also provides more stable returns as compared to equity. As shown in the above figure, annual return on Nifty is highly volatile. Even though both real estate and the equity market is affected by the macroeconomic environment of the country. However, the equity market response is much faster than the real estate. Looking at the current global economic situation, where most of the developed nations have not fully recovered from the crisis of 2007-08. Investment in the equity market may give lower returns or negative returns. Thus, for the risk-averse investor real estate can provide both stability and return (The Economic Times, 2014). Consequently, the housing prices in India have declined in the past few years. However, with increasing population and rural-urban migration, the housing prices are ever rising.

Declining return on term deposits

Apart from equity and real estate another popular form of investment is the term deposits or the fixed deposits (FD). In such cases, an investor deposits money with the bank for a specified time period. In return, the investor is subject to a specified amount of interest on maturity.

Term Deposits in India since liberalisation in %
Term Deposits in India since liberalisation in % (Source: Handbook of Statistics : RBI, 2016)

For most of the investors in India term deposit is one of the safest investment. However, the returns on such deposits have been declining. As the above figure shows the average interest rate on term deposits was near to 12% in 1991 which has declined to less than 8% in 2016 (Handbook of Statistics : RBI, 2016). With an increasing level of inflation and declining interest rate, the real return on term deposits is low.

For example, in a case where the rate of interest on a term deposit is 8% and the inflation rate is 7% (at the time of maturity), the real rate of return is 1%. In a worse case, if the inflation exceeds the rate of interest, then there is a negative return.

On the other hand, the average return on the real estate sector has been increasing over a period of time. Even though the real estate sector is not offering a high return, as compared to earlier years, the sector is expected to grow rapidly in future.

Increasing prices and declining return on Gold

Price of Gold (per 10 gram) since 1991
Price of Gold (per 10 gram) since 1991 (Source: Bloomberg, 2015).

There is a general consensus among the population of India that since the price of gold is increasing every year, it is profitable to invest in gold. Among the two proposition, only one of them is true i.e the price of gold has increased continuously.

Return on Gold in last five years
Return on Gold in the last five years (Source: Bloomberg, 2015)

However, the return from gold has declined in recent years. For the last three years, the returns are negative. To make the Gold investment more attractive the Government of India introduced the Gold Monetization scheme in 2015. However the return on such scheme range from 2.25% to 2.50% per year (Bloomberg, 2015).

A right time to invest in the real estate sector

Return on Various assets including the real estate sector since 2011 in %
Return on Various assets since 2011 in % (Source: Bloomberg, 2015)

The above figure shows that in the last five years there has been significant volatility in the returns of cash, gold, debt and equity. Return on gold and return on equity, which are the most common investments is in negative. In this scenario, the real estate sector emerges as the most attractive investment for the long term. There are various reasons which make the investment in the real estate sector more attractive and shows great potential to grow.

Return on various assets from 1996 – 2013
Return on various assets from 1996 – 2013 (Source: The Economic Times, 2014).

Despite the economic recession around the world, India has shown impressive growth and recently it has surpassed China as the fastest growing major economy (The Telegraph, 2016). With the increase in economic growth, the per capita income has also increased. With increasing population and rising income, demand for housing is certainly on the rise.

The advantage of a lower interest rate

The Reserve Bank of India has reduced the interest rate by 150 basis point since 2015 (one basis point is the 100th of a percentage point) (The Economic Times, 2016). Reduction in the interest rate has a dual effect, both of which can lead to higher investments in the real estate sector. Firstly, the decline in interest rate means the lower interest rate on the savings. This means a decline in return on savings and term deposits makes real estate more attractive option for investment.

Secondly, a lower interest rate means the availability of cheaper loans from the bank. However, investments in the equity market are possible with personal loans, which is not a rational decision for a risk-averse investor. Consequently, banks provide a home loan at a much lower rate of interest in compared to personal loans.

Thus, on the basis of the analysis on various investment options and their current and past record of returns, it would not be wrong to say that investment in the real estate sector is an appropriate option.  Various government initiatives such as the introduction of the Real Estate Regulation Act (RERA), Real estate Investment Trust (REIT) and Smart cities project are expected to revive the real estate sector.



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