When it comes to NRI investment in India and interacting regularly with NRI clients, I’ve seen a disproportionate interest in NRIs into real estate as an asset class. Today, I am presenting my view on real estate as an asset class, present market in India and whether it makes sense for NRIs to invest in real estate.
Before you read further, read this
Warren Buffet has said – “Never ask a barber whether you need a haircut”! A post like this – Should NRI invest in real estate in India – will have different conclusions depending on the occupation of the writer. If he is a financial adviser mainly advising on financial assets, he will say it is bad. If he is a chartered accountant, he will say it is good (as he will earn from tax return filing, Form 15CB etc.), if he is a builder/property broker, he will say it is good – as his income depends on people buying real estate.
In my case, I am a CA (so I do all the certification and tax return filing work I’ve mentioned above) AND I am an Investment Adviser– I leave it up to you to assess my conflicts of interest – from my end, I’ll try to be as objective in my analysis as possible:)
Reasons why NRI’s have historically invested heavily in real estate
From my personal experience interacting with NRIs, following are some of the main reasons they’ve either invested in real estate or considering a real estate investment:
#1: Promise/expectation of high returns:
How often have you heard this – “An investment in real estate can never go wrong”
Everyone knows that the period of 2002-2014 has given phenomenal returns from real estate. This is not true for every case, because a lot depends on the location and other factors, however, more often than not, the experience of investing in real estate has been a pleasant one for most NRIs.
And that pleasant experience (coupled with nature of tax breaks under Section 54 of Income Tax Act that requires a fresh investment in house property to claim exemption) has made NRIs invest a lot more.
So, when I make a financial plan for an NRI and ask for details of existing investments, it is common to see NRI having 1-2 flats in India as part of the investment portfolio.
We’ll see later in the post why the chances of this superb experience can be less in the next 10 years, due to the structural shift in real estate market in India.
#2: Push from family members/extended family
I assume you, as a reader to be around 35 years of age now. Know that the generation prior to you was exposed to real estate, bank FDs and post office investments as the only recognized investment avenues. Further, in those times, the recognition level for “owning” something was very high. The fact that you’ve built a house after 20 years of service meant that you’ve arrived. Also, for those parents who had invested out of greed in the 1992 Harshad Mehta scam, the scars are still very much fresh despite India having come a long way from those times.
Also, a male carry a very strong sub-conscious impression of their father’s ways, which includes his investing habits. So, at a dinner conversation, papa will most likely to nudge beta to consider an upcoming project from a builder known to him, rather than an investment in Infosys or Wipro shares (unless papa hadalso been into investing in stock markets from the days Dhirubhai used to book AGMs in stadiumsJ) – and that plays out subconsciously when one is forced to select options to invest his hard earned money.
After becoming an NRI, there is a certain status accorded to you within your family (I fail to understand why – just because someone crosses India’s shores, you start treating him differently) – so, an NRI is expected to have at least one, if not 3-4 properties in India and that is the consistent advice he gets from his relatives (especially the uncles and aunts) whenever they come back to India. The reactions are like: Don’t tell me you’ve been out of India for the last 10 years and don’t have a single property investment here in India?
#3: Allows you to show off your wealth:
The more “shallow” a person is, the more he needs outward crutches to establish his credentials to those he meets and interacts. In Gujrati, it is said – “vat padna chahiye”.
Real estate helps establish that vat.
If you own 3-4 properties, you can easily show off during your conversations and in social functions.
Have you seen anyone boasting that he has recently invested in 5000 shares of so and so company, or has 25000 units of Franklin India Blue chip Fund? But when it comes to real estate, its like – we just bought a 1000 sq/ feet property and I forgot to tell you, it’s a Lodha constructionJ
#4: Provides a feeling of safety and security:
We’ve come forward a lot in recent times, thanks to the information revolution. As a result, professionals have become internationally mobile and sought after across the world. They’ve got ESOPs and RSU’’s, diversified their stock investments internationally, and so on. However, as I’ve discussed in some of the deep conversations with such professionals, there is always a lingering thought in their mind – what if one day, everything comes crashing on the ground. What if I have to return back to India? Some recent examples are the Middle East Oil Crisis and the recent H1B visa crisis playing out in USA.
Also read: H1B visa issue in USA: Implications for Indian professionals
Worst case, you come to India, find a place to rent for some time and then if thought fit, buy a place by liquidating some investments.
Though this reasoning is quite straightforward, it does not easily cut ice given the deep subconscious need to have a “home” back in India. It gives them comfort and stability that worst come if something unfortunate happens, the bird can return to its OWN nest.
#5: Fear due to lack of knowledge on how to invest in equity or how to handle short term volatility:
It is my strong belief that many a times, people invest in real estate because of FEAR – they fear volatility in equity markets, or have burnt hands by having unrealistic expectations or consulting the wrong people and hence that FEAR of not knowing where to invest leads them to “BLOCK” their money in real estate. I’ve captured more on this in this post: Middle class families: Read this before you invest in real estate!
Structural shift in real estate market in India & why NRI should know about it
If you’re an NRI and do not actively track Indian markets, let me tell you that Indian real estate market has, since the last 2-3 years, started to undergo a deep structural shift which is short term negative and long term positive for the stakeholder, which includes you as an existing or a prospective investor.
Real estate is different from equity markets in terms of the cycles. While a bull or a bear cycle in stock market is 2-0 years, in real estate, it is 10-15 years. In equity markets, you get a situation where Brexit leads to equity markets down 1500 points, and it is all over the newspapers (adjectives like mayhem, bloodbath etc.) and panic all across, in real estate is it a very very slow process. In equity markets, you see a price correction, in real estate (especially metros); you see a TIME correction and very little price correction.
Real estate had a large bull run in 2000-2014 period which was primarily fuelled by black money and lack of proper regulatory oversight on source of funds and hence the supernormal returns.
However, things have taken a turn now.
Over time, what happened was that the real estate prices in India crossed the affordability limits of most families so the end user demand stopped. Investors who aim to invest in real estate also realized that due to almost nil demand, the opportunity of making a killing in this sector is very less so they also went away. There was a situation by last year whereby I’ve seen registrar’s offices in Mumbai almost empty. Brokers started shutting shop or doing other side businesses to survive. People who wanted to sell their property could not find genuine buyers after waiting for a full year.
All this is a reversal of excesses that happened during 2000 – 2014. And a big reason is the intent and resolve by the new government to eradicate black money.
Some of the developments that are bringing a structural shift in the real estate sector are as follows:
Greater tax scrutiny on real estate transactions:
Earlier, it was easier to invest a good component in “black” – even genuine people had to pay in black, because only this way would builder get hard cash to pay for black component for a purchase of land and pay bribes to municipal and governmental officials.
Lot has changed now.
Rule 114B of Income Tax Rules now requires PAN to be quoted in any any sale/purchase of property exceeding INR 10 lacs & to be reported by Sub-Registrar’s office to the Income Tax Department as part of Annual Information Return.
Section 194 IA was introduced on 1/4/2013 that requires any buyer of immovable property not less than INR 50 lacs to deduct 1% TDS from payment made to a resident seller.
Then, in Nov. 2013, we’ve had changes to Benami Prohibition Act that gives wide powers to the Income Tax Department to confiscate benami property irrespective of the amount
Also read: Benami Prohibition Act: An Analysis
Demonetisation:
On November 8, 2016, the Indian Government banned 500/1000 notes. While I am not very much in favour of this move (for “why”, I will have to write another post), the positive effect of it is that it has created a shock value in the minds of various stakeholders.
On that date, you had the builder or seller who had collected cash from the buyer, and buyer who had kept cash ready for handing over to the seller/builder, all got stuck. No complaints possible. Difficult situation.
It is widely expected that post demonetisation, the cash component will not go away but reduce considerably. And property prices in secondary sale market should correct to the extent of the prevailing black component.
Real Estate Regulation Act (RERA):
Till now, surprisingly, there was NO regulator for an asset class in which families invested their lifelong earnings. Result? Delays by builders, cheating and fraud incidents and the recourse was only a court and that is why people opted to resolve it out of court by taking help of mafia, goons, politicians and so on.
RERA, according to me, is a great step by this government that brings a lot of sanity and transparency to the sector. Now, real estate projects will come into the purview of this Act.
By virtue of this Act, Consumer gets the right to get information about the project and raise grievances to the regulator. Builders can no longer misuse the funds received for a project and will have to put it in a separate bank account.
These developments are a big time negative for the builder community and a long term positive for the entire real estate industry.
Recent tax changes:
No government in India can afford to let the real estate market crash. This is simply due to the fact that banks have lent big time to these builders. So, a sub-prime like crisis that happened in USA does not look possible in India.
Having said that, the focus of this new government is to nudge people to move from real assets (viz. real estate and gold) to financial assets like equity.
It is evident from the proposal of the Finance Bill 2017 to restrict set-off of loss from house property to INR 2L. Also, government is planning to increase Section 54EC options to make it easier for consumers to move away from real estate.
Also read: Analysis of Finance Bill 2017 & Implications for NRI
How far this leads to demand slowdown I do not know, but the intentions of this government seem to be clear – less real estate, more financial investments.
Most important question while buying real estate
There is a big difference between buying real estate for residential purpose or investment purpose.
When you buy it for residential purpose, the amenities etc. are far more important than the price (and returns do not matter because you’re not going to sell it
When you buy it for investment purpose, it is always your return on investment that matters. And ROI greatly depends on the location. Good location, and you can pre-pone your retirement by a few years and a bad investment, you are stuck with a lousy asset.
So, first question you need to ask yourself –are you considering real estate for residential purpose or investment.
Risk in real estate as an investment avenue
People say equity is risky, I say real estate is far more risky than equity. Then you have some people invest in real estate because they are under an impression that it is a risk free investment. For others, according to me, there are some considerable risks that one needs to be aware of and factor in, BEFORE taking any investment decision.
Liquidity Risk:
In my view, liquidity is the biggest risk that one faces when one invests in real estate. Once you’ve invested in real estate, it is not easy to liquidate it. Imagine you having invested in a 3 BHK flat in Mumbai for INR 1.5 CR. Now, when you need funds either in case of an emergency or to meet a financial goal, first thing is that unlike equity shares where you can sell a part, you cannot sell one bedroom – you will have to sell complete property. Second and more important, at the point of sale, you need a buyer who is going to pay you the prevailing market price in full. In the real estate market today where transactions have almost gone to zero, people who’ve faced difficulty selling property would know the emotional pain of delayed sale of property.
Timing risk:
With equity, if you’re buying outright, what you do is that you TIME a big chunk of your investment. If the timing is wrong, you’re dumped especially because real estate, unlike equity, has long bull and bear cycles that last even a decade. So, you’ve to be very careful not to invest at the end of a bull run because the next 10 year returns may not then even match the one you would have got from an FD.
Location Risk:
Consider a 1CR flat in Mumbai which you put on rent at INR 20,000 per month. In this case, rental yield is a mere 2.4% (compare this with a savings bank account that gives 6%). So, it is a given that property prices in India are still the costliest in the world and reeling from the excesses in 2000-2014 period. In this backdrop, a big component of your ROI expectation comes from capital appreciation possibility of the said property when you sell it later, and not the rental income.
Now, when you talk about capital appreciation, everything is about location, location, location. If you are able to get it right, you can even get a jackpot but if you’re not that lucky, you are left with a dud investment. The worst thing is that unlike equity, you cannot just sell a share and buy another one in a few clicks. The sheer effort & expense of time and money keep people from selling off the flat.
Maintenance risk:
This risk is particularly important for NRIs who are away from India. A plot of land left unoccupied or a flat left vacant can be encroached upon easily and given the justice system in India; it can take years to restore possession of the flat.
Another point is on maintenance and upkeep of flat – be it regular maintenance charges paid to housing society or periodic repair/renovation/whitewash expenses, these expenses need to be taken into account while arriving at the ROI.
Litigation Risk:
Unlike other assets for which regulatory bodies are there to protect the investor, in case of real estate the only recourse till some time back was a court of law. Given the delay in justice system, people used to settle the case outside court. However, this risk should reduce with the enactment of RERA and hopefully regulatory body and appellate tribunals under RERA will help in steady Redressal of investor grievances.
Repatriation risk:
For NRI’s who do not plan to return back to India, very few know that there is a limit under FEMA for repatriation of proceeds of sale of house property up to max. 2 residential house properties only. And this is supposed to be a lifetime limit. Also understand that the repatriation can be done of the amount contributed for purchase, not of the capital gain.
Also read:
FEMA Implications on acquisition of property in India
Remittance facilities to NRI & Expats under FEMA
Note: There are so many other risks like emotional attachment, possibility of family split/disputes, unreasonable paperwork, title issues etc. which I am not taking up here for brevity sake.
Taxation of real estate for NRI vis a vis other investment avenues
For an NRI, real estate is HIGHLY tax inefficient as compared to equity and NRE fixed deposits.
Under the Indian Income Tax law, NRI can claim TAX FREE long term capital gain from equity shares/MF. Also, interest from NRE FD is tax free for an NRI.
However, in case of rental income, it is taxable at slab rates (of course, it counts within qualifying exemption limit of INR 2.5 lacs). Long term capital gain is taxable at 20% with indexation.
An argument can be made that real estate is also exempt if exemption is sought. Here, my view is that for exemption, I am again require you to either purchase a fresh residential house property (Section 54) or investment in certain bonds (Section 54EC) which require you to stay locked at 6% taxable interest for 3 years. So, exemption is a conditional exemption and you do not have very much a choice but to invest again in illiquid and tax inefficient avenues to claim it. And the cycle goes on and on and on.
Apart from taxation, the TDS procedures are onerous for NRI not only for rental income but also sale proceeds of property. If NRI is unable to get lower TDS certificate in India, a significant chunk can get blocked.
Also read: TDS Deposit and Return Filing Procedures in Property Transactions
On rental income, recently there has been a very clear judgement which says rental income from a vacant property will be taxable in India on a notional basis. This is another pain for NRI to ensure that lease agreements are renewed in time and flat is never vacant. Read: NRI having vacant property in India, pl. read this [2016 Sushma Singla HC]
Should you buy real estate for residential purpose?
If you’re clear that you wish to buy for living purpose, my next question is – what are your plans to return back to India?
If you are not sure when, if you buy a property in Bangalore and don’t return back for next 10 years, do you understand the pain of finding tenants and putting it on rent every year? Do you understand the risk of leaving property vacant in India? And after you return, what assurance is there that your job is in Bangalore and not anywhere else? In that case, will you live in a rented property elsewhere and keep this on rent?
In such a case, my suggestion will be to drop the idea of buying real estate despite everyone (read: builder/broker/your extended family members) crying that real estate prices will always rise in India.
In such a case, my suggestion is to create fund for buying a home without a loan as a DEDICATED financial goal. Ensure that by the time you are back and in a position to buy, you do not have to take a bank loan for it. Invest aggressively into equities and start reducing equity exposure
If you’re sure to return to India in next few years, even then my suggestion is to create a fund for buying a home without a loan as a DEDICATED financial goal. When you return to India, stay in that locality on rent for at least a year and in that time, you will be able to do better on the ground research of property prices, amenities, schooling etc. rather than relying on the word of a broker or a friend and hence will be in a much better position to take your property purchase decision.
Also read: Returning NRI Property Purchase in India – A Checklist
Should NRI buy real estate in India for investment?
In my experience as an Investment Adviser, I’ve learned the hard way – when it comes to real estate, you cannot argue logically beyond a point with a client who is hell bent on real estate. If a person has made up his mind to invest in real estate, or if he has affinity with real estate, ghoom phir ke he will invest in real estate only and no amount of logic will change his mind. In fact such clients will even prefer to have a “yes man” investment adviser who agrees with his point of view J (in behavioural finance terminology, this tendency is known as “confirmation bias”)
So, answer will depend from person to person – his attitude towards risk, affinity with real estate, past experiences, sub-conscious patterns etc.
If you ask me, my answer is a flat NO.
If I assume myself to be an NRI, till India gives me a completely TAX FREE way to plan my financial goals via equity MF and NRE FD, why will I look somewhere else? As the LIC pitch goes – toh kahi aur kyu jaana? 🙂
Further, for me, investing my lifetime of earnings in real estate in view of the underlying peculiar risks feels almost like a gamble. I am prepared to live with the short term volatility that comes with equity but for real estate, sorry, I am not ready.
Yes, as far as diversification is concerned, within the growth assets component of the asset allocation, I WILL want to diversify the investment by investing some part in real estate. And to do that, the space I am watching out is “REAL ESTATE INVESTMENT TRUSTS (REIT)” – REIT is basically a “financial” instrument that derives its value from underlying real estate can be traded freely on stock exchange like an ETF. It has still not gone live in India as of now but as and when it comes, I would strongly want to evaluate it for my NRI clients’ investment portfolios.
So, there is NO RIGHT ANSWER here – it depends.
Hope this post has been of service to you. Thank you.