Whatever be your financial goals – saving for college expenses for your children, building a retirement income source, earning additional income or any other purpose – you need the right financial products to help you achieve your goal.
Very often, investors get scared of the risks associated with an investment and fail to choose the right investment option that offers good returns.
Here, in this post, we shall explain the nature of risks and returns in investments.
We will also help you understand how you can optimize the risk-reward trade off while investing in the asset class of real estate.
Risks Vs. Returns – A Starter Guide for Beginner Investors
When getting started with making investments, you come across two basic terms – risks and returns.
Here’s the basic definition of risk – Risk is the chance that your investment’s actual return will vary from what was expected. Due to risks, you have to face the possibility of losing a portion (or all) of your investments. Return, on the other hand, is the monetary gain or loss, you get from the investment.
Here’s a reality check – “All investments across different asset classes- equity, debt, cash, commodities, derivatives and real estate; carry some amount of risk. “
And, here is a myth buster- “A low level of risk does not mean the potential returns are low as well. Similarly, a higher level of risk does not mean the potential returns are high as well. It all depends on the risk-return trade-off the investment offers.”
The smart choice here to choose investment options amongst various asset classes, which have low to medium risks but offer above-market returns.
What is the Risk-Return Trade-off?
This is the balance between the lowest possible risk and the highest possible returns.
You need to keep in mind that higher risks don’t guarantee you higher returns. On the other hand, what high risk indicates is that there is a possibility for high returns, but it isn’t guaranteed. Remember that with high risks, you could also have higher potential losses.
As an investor, one of the biggest decisions, you’ll have to make is choosing investment products with the appropriate levels of risk. The appropriate level of risk that is right for you depends on several factors like your investment objectives, investment horizon, future goals, and age amongst many others.
Also, every asset class has unique characteristics offers a different risk-return tradeoff. Depending on your risk appetite, overall portfolio mix, liquidity requirements, investment objectives and return expectations, you need to choose your build your portfolio across various asset classes.
Optimizing the Risk-Reward Trade off in Your Real Estate Investments
Simply put, when investing the objective is to put your money to work today, so that you can enjoy good returns in the future.
Let’s take the example of investing in real estate as an asset class. Here, the returns or profits you make must be high enough to cover your risks, the costs you incur like property taxes, maintenance, utility bills, insurance and so on.
How to Ensure a Good Risk-Return Trade-off in real estate?
When chosen well, real-estate is a great investment, that can offer a good risk-return tradeoff in the long term. Some experts also cite that it is safer than investing in equities.
Let’s understand how you can mitigate the risks of investing in an asset class like real estate to earn a good return.
Real estate market is cyclical in nature. Hence, while investing in property its important for the investor to maintain proper cash flow. This help in funds required for renovating the house or maintaining the property or even holding it during a slump.
It’s easier to get loans for the purchase of residential property compared to commercial properties. You can avail up to 90% of the property’s value as the loan amount. Some real-estate companies make it even easier to get loans for residential flats and villas. They connect you with the right lender, and you can choose a long-term loan that suits your investment portfolio. This helps investors retain their liquidity and mitigate their financial risks.
You can also take a loan against your property if required to meet your cash flow requirements.
Further, the home loan interest rate is the lowest across the loan category when compared with the other type of loans. Moreover, these are available with the highest repayment tenure mostly up to 30 years.
Home Loan Provider | Home Loan Interest Rates | Repayment Tenure |
SBI | 8.75% onwards | up to 30 years |
HDFC Bank | 8.85% onwards | up to 30 years |
ICICI Bank | 8.95% onwards | up to 30 years |
India Bulls | 8.80% onwards | up to 25 years |
Takeaway: Consider the ease of securing loans while choosing a property for real-estate investment.
When it comes to choosing successful real-estate investments, location plays a crucial deciding factor. Property rates across metros have sky-rocketed, while the growth rate has stagnated. This has led investors to look beyond established metros at upcoming emerging micro-markets like Bhiwadi, Jodhpur, Jamshedpur and several others.
Micro-markets are upcoming locations that have huge potential. These are locations that have a rising residential population, with growing retail infrastructural development. These areas are unlikely to be affected by fluctuating market conditions, thereby are relatively lower risk.
The appreciation of prices in an upcoming micro-market offers significantly higher returns rather than investing in an established location. Additionally, it’s easy to find renters at micro-markets, due to the rising demand for housing.
Takeaway: Look beyond established locations and choose residential properties in micro-markets that have huge potential for capital appreciation.
If you are purchasing a property with the sole aim to generate rental income, then look for residential flats that come with maintenance facilities. Some realty builders offer regular maintenance of all their properties post-sale. These residential communities have various amenities like 24 x 7 CCTV security, regular groundwater supply, power backup and a wide array of other extra amenities like recreation zones, clubhouses and more.
Tenants often look for properties that are easy to maintain and offer various amenities. When you invest in such residential flats, you can get an enhanced rental value.
Takeaway: To get better rental value, make sure to keep your residential property trim, proper and appealing at all times. By choosing builders, who offer regular maintenance, you can reduce the repairs and renovations you have to spend on your rental property.
Another very important factor is the delivery time in Real-Estate. Say a family living on rent of INR 40,000 per month was to be delivered their ready-to-move-in residential apartment in August. However, the possession has not been given for the past 4 months and there could be further delays. Looking at this from a financial perspective, the rental amount is lost and in addition to that the time and cost of visiting the builder’s office. Hence it is a critical factor to consider.
Real-estate is a capital intensive investment. So, you need to ensure that you have the right partner to support you. Before you choose a real-estate builder, make sure to check and review the previous projects of the company. Ask previous buyers to know their feedback regarding the property, completion time, other support from the builder and so on.
Real estate investing has a high potential to offer huge returns. To win, you need to choose the right properties, at the right time. Make sure to consider the factors listed here and start building a winning investment portfolio comprising of different asset classes, including real estate.
Real-estate is a long term purchase and choosing the right builder is a very important decision. It is of utmost importance that builders have a customer-centric approach for a smooth investment; with a better risk-reward trade off.
Comparing Real Estate Investment versus Stocks
Would you have made a fortune if 20 years ago, you invested in shares of MRF, Reliance & other such enterprises OR would have made a fortune if 20 years ago you invested in the outskirts of Delhi, Gurugram?
As you can see, there is no clear comparison of this.
We can safely say that the returns on realty and equities mostly depend on GDP growth. Say if real GDP grows at 7.5%, real estate could give CAGR returns of 10-12%, while equities could give returns of 15-17% on an average. Let us look at how select investments and select realty in select cities have performed in the last 5 years.
Asset Class | 5 Year CAGR (%) | Initial Investment | Final Value |
SBI Blue Chip Fund | 18.04% | Rs. 1 Crore | Rs. 2.29 Crore |
Reliance Large Cap Fund | 17.86% | Rs. 1 Crore | Rs. 2.27 Crore |
DSP Opportunities Fund | 19.66% | Rs. 1 Crore | Rs. 2.45 Crore |
Property in Mumbai | 6.00% | Rs. 1 Crore | Rs. 1.76 Crore |
Property in Delhi | 12.00% | Rs. 1 Crore | Rs. 1.34 Crore |
Property in Bengaluru | 7.30% | Rs. 1 Crore | Rs. 1.42 Crore |
Source: Realty returns – economic times; MF returns – Value Research
As you can see from above, equities have clearly outperformed realty. Over longer period, equities create wealth more effectively.
But what about the taxation?
Now this is where, realty as an investment gets us better yields. The tax exemption rates are much higher for realty. You get tax exemption up to Rs 2 lakh per annum on interest on home loans under Section 24 of the Income Tax Act. There is an additional exemption under Section 80C for the principal component. You can also take the property in joint names and double the tax benefits. When the property is sold, you pay long-term capital gains (LTCG) after indexation. You can also avoid this tax through Section 54 options. Under PMAY you can save upto 2.3 lacs
Total Savings: 2.3 lacs (PMAY) + 2 lacs (80C) + 1.5 lacs (Section 24) = 5.8 lacs
Equities however do not do as well as realty when it comes to taxation as now dividends are subject to dividend distribution tax (DDT) and also taxed beyond the threshold of Rs 10 lakh. In addition, LTCG is taxable at 10% on capital gains above Rs1 lakh per year on a flat basis without indexation. This may give a minor tax edge to realty.
Suppose you are buying a property of Rs.35 lacs and made a booking down payment of 20% of the property’s value. For the rest of the 80% amount, you took a home loan which is the cheapest and the best loan amongst the rest with the least interest rate i.e 8.5%
Price of property at the time of purchase | Rs. 35,00,000 |
Booking Amount (20% of the property price) | Rs. 7,00,000 |
Loan Amount (80% of the property price) | Rs. 28,00,000 |
Based on the historical records, on an average the property is considered to be appreciated at a rate between 12% to 15% in a year. One can for sure save big by investing in real estate market and can get higher returns.
Property Price | Rs. 35,00,000 | |
Note – | Average Appreciated Property Value | 12% – 15% of the Property Price |
Add – | Appreciated Value Amount (In this case it is 12%) | Rs. 4,20,000 |
Appreciated Value of Property | Rs. 39,20,000 |
Hence you will be saving Rs.4,20,000 on the money you invested by getting the appreciating on the property you purchased. This will not only be the return amount for you but you will also be saving on the home loan amount i.e on Rs. 28,00,000 and further will explain how:
Loan Amount | Rs. 28,00,000 | |
Subtract – | Home Loan Interest Rate (8.5% of the property price) | Rs. 23,80,000 |
Add – | Appreciated Value Amount (In this case it is 12%) | Rs. 4,20,000 |
TOTAL RETURNS | Rs. 8,40,000 |
Therefore, the calculation is simple when it comes to getting better returns than any other option available to invest. The return is better than the risk.
To summarize, when choosing between real estate or stocks, there really is not a clear choice. In addition to the investment that you are considering, a lot also comes down to your situation, personality and preference. Choosing a home is not just a solid financial investment but many families prefer living in their “own” home. As they say, home is a happy place.
Ashiana, Ashiana Housing build homes. Homes surrounded by vast green spaces and fresh breeze. Homes cocooned in secured gated complexes. Homes where futures are forged and there are opportunities to grow. And Homes in environments brimming with healthy activity, trust and respect. At heart, we build communities with care.
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