The myth of safe realty versus risky equities

Low liquidity in the realty market, combined with its non-transparency, means investors are often unaware of the loss in capital value they have suffered during downturns

When I met Sushil, a prospective client, for the first time, I was surprised by the near absence of equity-related investments in his portfolio, despite its size (running into double-digit crores). His primary investments included an office property and a residential flat, besides bank fixed deposits and tax-free bonds.

When I enquired about this, Sushil said he had burnt his fingers in the 2008 equity meltdown when his portfolio value had plummeted to less than 50 per cent of its peak level. This had spooked him so badly that he had exited equities entirely and vowed never to touch them again.

I then asked Sushil about the best investment he had ever made. He mentioned a residential property purchased in 2009 from the money redeemed from the equity markets. He had sold it in 2015 at double its purchase price, thereby recouping his losses in equities in 2008.

When I enquired if any of his realty investments had gone wrong, he pointed to his current holdings. The office property’s value had not risen at all in around 10 years. It had been without a tenant for quite some time and attempts to sell it had been unsuccessful.

The residential property bought to shield the capital gains arising from the “excellent property investment” made in 2009 had also proved a disappointment. Possession had been delayed by over five years. Its price too was at almost the same level as in 2015. Despite these experiences, Sushil was inclined to stick to “safe” real estate and avoid “risky” equities, since the former at least offered capital protection.

I asked Sushil to check what his equity portfolio’s value would have been if he had held on to it. Between 2009 and 2015, while his real estate holdings had doubled, the Nifty had almost tripled – from around 3,000 in 2009 to around 8,500 in 2015.  It had doubled again to around 17,000 currently. His residential property’s value had remained flat all this while.

Sushil’s mistake was to compare returns from equities during a severe downturn (2008) with the returns from real estate during relatively good times (2009 to 2015). The moment he compared returns over a similar and sufficiently long duration (2009-2015), equity returns no longer looked bad.

Equity prices do fluctuate more than that of real estate. But they also provide higher returns provided one holds them for a sufficiently long time and doesn’t get spooked into selling at a loss. 

Next, I addressed the myth of capital protection that Sushil harboured about real estate, especially the office property. Firstly, even if he managed to sell it at cost price, he would make losses in inflation-adjusted terms. Secondly, his inability to sell it even at purchase price indicated that its current price was even lower than what he had paid 10 years ago. The inability to sell real estate (liquidity risk), combined with the non-transparent manner in which this market works, means investors are oblivious to the loss in capital value during downturns in that market. Equity prices and mutual fund net asset values, by contrast, are available daily, reinforcing the sense of capital losses during equity market downturns. 

All investments must be analysed on three parameters – risk, return and liquidity. One can’t earn high returns without investing in higher-risk investments. As was said in the web series Scam 1992, “Risk hai to ishk hai”. Truth be told, while investors want both high returns and capital protection, no magic formula exists that can ensure this in real life.

The writer heads Fee-Only Investment Advisors LLP, a Sebi-registered investment advisor. Twitter: @harshroongta