Buying a house v/s Mutual fund Investment- Which one is better?

Before you read my answer look at the above image. Dream house of an small investor from redemption of SIP of just 1500 per month done in one mutual fund.

I have come across with same questions from many a client now a days. Specially mid to senior level salaried person who are not living in their home town. I trust my answer will help many to take wise decision. Since you have asked about house so i have not focusing much on aspects related to commercial property, also I have taken period of 7 to 10 years as long term-

Before Investing in residential real estate one should ask themselves following points -

Why investment in property? Is it part of retirement planning or for your own residence ? If it's for pure investment then what kind of return do you expect from residential real estate ?

Let me start with some of the facts/Characteristics of real estate as an investment-

One should have your own dream house ( of-course at a place where you are planning retirement or say at least 20–25 years of life for your own accommodation)

My experience says that investment in residential real estate ( Besides your own house for living ) never works. Now question is why ?

Here are key challenges with investment in residential real estate -

  1. Liquidity- The biggest problem with real estate is liquidity. Suppose you have bought one property for Rs. 50 Lacs few years back and now you need some money, say for daughter marriage. Can you sale the property immediately? Assuming you have a buyer and the deal is done for Rs. 80 Lacs but you only need Rs 10 Lacs for marriage. What you will going to with remaining 70 Lacs. Again buy another property ?
  2. Cash component- Its a big big issue while dealing in real estate ( perhaps the unbroken chain and main reason why people invest in real estate) . Usually In Tier II cities of India you have to pay almost ~40% in cash for investment in real estate ( Its difference between circle rate and actual deal value) So same is with the seller.
    • If you are selling your property, where will you deploy the cash part that you received in the deal. Again real estate is the only option as for all others you need white Income
    • If you are investing in real estate & under employment how you will manage the cash. Think of it.
  3. Cost of acquisition - Investors rarely think of this aspect. Among all the asset class real estate is having the highest acquisition cost. Suppose you are buying under construction apartment you have to pay close to 20% of cost of property -
    • 12% GST on value of apartment ( if it's under construction)
    • About 6% Stamp duty (Though vary state-wise In MP its 12%) of value of the property
    • 2–3% brokerage -If broker is involved
    • Legal expenses plus
    • Unlimited mental stress during the transaction period of 2–3 month ( if you are new to real estate or dealing in cash for the first time)
  4. Emotions- Because of touch and feel, society status, efforts to acquire property and time usually get people attached to real estate AND even they have bought the same for retirement planning people end up holding properties for generation and usually dies thinking of worth they have but never enjoys the same.
  5. Return on assets- Even after so much hassle overall return on real estate is not encouraging. Though we can not make generalize comment on historical return because it varies from place to place. however historically return on good mutual funds are far better than real estate over a period of 10 years. As per study average return on residential real estate is close to 10% per annum
  6. Research- Trust me the kind of efforts required to identified right property, right area, right developer and builder that too on right time is very very very high
    • Area-First you have to identify the area where you want to buy property. To generate good return it should be emerging area
    • Builder and developer- Most importantly developer of the property should be renowned and must have delivered many projects in past. Real estate industry is cyclical one and nature of developer is like gambler There is a high risk of non completion of project. Unitech, JP groups, Ansal and many more are perfect example where people have taken loan to buy their dream house while project didn't got completed, they are then impelled to live in rented house and pay EMI of the house which they are not going to get. If they don’t pay they are not going to get any loan in future- courtesy CIBIL scores
  7. Rental Income- If you are thinking of buying residential property for rental income. You must be aware that rental yield in residential property is not more than 3–4% p.a.
  8. Housing Loan for acquiring residential property- Investment in housing property ( not for your own living) by taking loan is social injustice to your retirement. You will end up paying EMI for next 20–25 years and will not get more than 10%
  9. Tax saving - Interest on housing loan is exempt u/s 24 and Principal on housing loan is covered u/s 80 (C) to the tune of 1.5 lacs p.a. but tax savings alone can not be deciding factor to investment in property.
  10. Bulk investment- You cannot invest few thousands or even some lacs in real estate, the amount required is huge at one go

Now, let us talk about Mutual funds

Mutual fund - Since we are comparing mutual fund and property for long period of 7–10 years we must see mutual fund with that view only. If you are new to mutual fund this video might help you - Do watch - Mutual funds for beginners ! What are Mutual funds?

Before I explain mutual fund let me clear you mutual funds are not risk free. It carries market risk which can be mitigated and managed by investment through SIP/STP in good multi-cap schemes and diversifying your portfolio by investing in debt/equity/gold etc.

If you are new to mutual fund this might help you. Even if you have invested in small cap mutual fund ( Riskiest one) over a period of 7 year 0% mutual funds has delivered negative return. ( this is what history says )

Now i will compare Mutual fund ( One time or SIP) on all 9 parameters/risk discussed above for real estate, so that's ahead to head comparison

  1. Liquidity- There is no liquidity problem in mutual fund. Since underlying asset is equity, you can withdraw fund in just 1 day time. Even if you have invested yesterday there is no lock in period, however if you exit within a year of purchase 1% exit load is there. Mutual fund wins here with big marks
  2. Cash component - Big no to cash - Everything is fair and transparent. Even a single penny is on paper. Problem is with those who only have cash money to invest in.
  3. Cost of acquisition- There is no acquisition cost against 20% in case of real estate. However yearly charges range from 1.5-2.25%. Again positive for MF
  4. Emotions- There is no touch and feel, so comparatively less emotions are involved. The only negative is you can track value of you investment on daily basis. Some time ( for few months or year also ) you can see bit negative return. You have to have that patience.
  5. Return on assets- Historical return in mutual fund is close to 15%, even on conservative side you can expect 12% return p.a. for next 10–20 years. This is huge over a period. Again mutual fund wins here.
  6. Below is the example of Reliance growth fund ( Now Nippon India growth fund ) Started with a NAV of just Rs.10 in Oct 1995 urrent NAV is 1186. Delivered total return of 11800% (CAGR return of 21.8% p.a.)

    If you have invested 10000 per month in SIP you will get about 1 crore after 20 years (@12%) and about 1.5 core (if return is 15%) which is reasonable expectations

  7. Research - Yes, it do require decent time for researching mutual fund or a good adviser who understand the mutual fund and equity still much lesser than real estate.
  8. Rental income- There is no rental income yes you can opt for divided option where you can get price appreciation of mutual fund on regular intervals
  9. Loan for investment in mutual fund - BIG NO, its injurious to your wealth and mental health as well. NEVER EVER THINK OF IT.
  10. Tax saving - Yes there are Tax saving mutual funds ( also called ELSS) there is lock in period of 3 years on such investment. Investment upto 1.5 lacs is allowed for deduction u/s 80 (c). Return on ELSS or tax saver mutual fund is also close to 12–15%
  11. Investment amount- You can start investment with just 500 or 1000 per month.
  12. Commercial real estate - Rental income in commercial property is bit higher and is close to 5–6%, all other aspects are similar to residential property. Now a days SEBI has allowed organised funds raising by REITs ( like an IPO for real estate property) this can be a game changer and than we can do better apple to apple comparison for mutual fund and real estate. If you a heavy investment in mutual fund and equity you can explore investment in commercial property to diversify your portfolio.

Having one dream house is okay, it's not a investment that’s a necessity. However having multiple one for generating return seems to me as inefficient capital allocation