Don’t buy an apartment for more than…
Suppose you’re considering buying an apartment that rents for ₹40K a month. Such an apartment isn’t worth paying more than 60 lac for. Why?
Because you could invest the 60 lac in a mutual fund, specifically an ultra-short-term debt fund, and earn the same 40K from it, at 8% return.
Before you make any investment — and real estate is an investment— you should look at what the alternative is, and how much that would have paid you.
For an apartment, you should pay no more than:
rent * 12 / 8
Rent is in thousands, so if you pay ₹40,000 a month, enter 40. And 8 is the interest rate you expect. The output of the formula is in lacs.
This formula considers only the rent you’ll get from real estate, not appreciation of the property value. It’s dangerous to expect appreciation since real estate is already unaffordable, with more than a lac unsold properties in Indian cities. Expecting an overpriced asset to further appreciate is a dangerous assumption.
If, instead of sticking with a safe ultra-short-term debt fund, you invested in a higher risk hybrid fund that should give you a 14% return , then the apartment is worth only 34 lac.
Again, the real point is not that the apartment is worth 34 lac, or 60 lac, but that you should evaluate the opportunity cost: if you didn’t invest in real estate, where else would you invest, and what return would that give you?
Ultra-short-term funds are generally safe — they rarely decline in value. If they do, only for a short while, like weeks or months, before they recover their value. Real estate, by contrast can decline for as long as 7 years:
If you bought a property in Hyderabad, you’d have lost money. If you thought the loss was temporary, no, you wouldn’t have recovered the money even after 7 years.
Some cities, like Bangalore, did give you a return, albeit a paltry one of 1.7%. Even a savings account would have done better.
If you choose a high-risk, low-return investment, when an alternative is available that has lower risk and higher return, you’re being irrational.
And this is not even getting into all the other costs real estate has. For example, a neighbor encroaching your plot. Physical violence. Scams where the same plot is sold to multiple people. Real-estate developers not delivering on time.
Real estate isn’t diversified, so if your city, or even your neighborhood, experiences a decline, you lose money. Whereas a mutual fund invests in dozens of companies, so a single company losing money won’t hurt you. Look again at the chart above. Some buyers in every city most probably lost money.
Real-estate requires a large investment, as opposed to a mutual fund, which lets you invest any amount any time. With real-estate, you need a loan, which limits your choices, say starting a startup or taking a different job that pays less. Investments shouldn’t control your life. It should be the other way around. You should be the master.
On top of all that, real-estate is illiquid — if you urgently need money, you can withdraw money from some mutual funds in 30 minutes, and from others in a few days, compared to the months it takes to find a buyer for a property. There are lots of transaction costs, from stamp duty, bribes, agents’ fees, and capital gains tax. And the cost of your time in dealing with sellers, buyers and tenants.
Real estate also ties you down to a city, and to a neighborhood in a city, when you’d be better off working or living elsewhere. I knew some people that would commute as much as three hours a day in Bangalore traffic, which is a waste of their life. Or maybe you want to Ooty for the better quality of life.
To compensate for all these costs, I’d expect real estate to give me a much higher return than equity funds. Since equity gives me roughly 18% a year, I’d expect 30% from real estate, before I’d buy.
If you don’t get a good enough return from real estate, don’t invest.
The point isn’t so much that you should (or shouldn’t) make a particular investment, real-estate in this case, as that you should evaluate your options rationally, consider all the options available to you, all the costs and benefits each of them comes with, and choose one with benefits commensurate with their costs.
 Assuming the fund invests 65% of its money in equity, and the rest in debt, and that the debt pays the same 8% as an ultra short-term fund.