People may have different points of view about the effectiveness of a real estate investment. However, the facts remain the same. Real estate sector has been one of the most volatile if the past five decades or so are considered. The age-old saying of “safe as houses” does not seem to be applicable any longer.

In this article, we will hypothesize that this boom-bust cycle in real estate is being caused by the availability of easy financing or its lack thereof.

Easy Financing

Real estate boom in almost every country has been the result of the availability of easy financing. This is truer in the case of developing nations like India. In these countries, there was no mortgage system till the late 80’s and the early 90’s. Houses had to be brought on cash. As such, only people who had a significant amount of money could afford to buy houses.

This changed with the entry of multinationals in the Indian market. The Indian economy grew by leaps and bounds, and the banking system had to evolve to keep pace with it. Banks started providing easy financing on real estate. People could put down a mere 10% or so and pay the balance in easy installments. This created a massive crowd of people who were willing to buy homes vis-a-vis a limited supply of homes. As time passed, prices started spiraling out of control and have ended up in a property bubble. Today, the cost of an apartment in Mumbai is about the same as an apartment in London. However, the salaries drawn by Mumbai residents are less than a fifth of the salaries being drawn by London residents.

This signals the massive boom that the Indian real estate market is in. For the past five years or so, the nominal prices have remained unchanged. This means that the real prices have reduced by almost 30% when inflation is taken into account.

Securitization

A similar case of increasing real estate prices was seen in the United States. The United States is not a developing country like India. It has had a flourishing real estate market for a very long time, and financing systems are well developed and stable. However, in the early 2000’s they introduced a new form of financing.

They securitized old loans which were backed by government guarantees and sold them on exchanges as debt securities. This gave banks an almost unlimited ability to lend money to people. This is because they did not have to keep the loans on their books for very long. They could just sell the loans to a third party who services them. This increased ability to lend money and the absence of any risk created a flood of credit in the American market. This excessive money was once again chasing a limited stock of houses leading to a massive rise in their prices. As soon as this securitization system dried up, there was an immediate and unprecedented fall in the prices of houses. Entire neighborhoods had to be destroyed to reduce supply so that the prices of other houses were prevented from falling.

Lower Borrowing Rates

Japan was one of the first countries to experience this mega real estate boom and bust during their lost decade. The property prices in 1985 rose so high that it became impossible for the average worker to buy a house in Japan. To fuel the real estate boom, interest rates were dropped to near zero levels. Once again, too much money was being created in the market. This too much money was chasing too few real assets, and the prices of those assets reached new highs. When interest rates rose, the property prices collapsed, and people’s life savings were wiped out. Today, over three decades later, the prices are yet to reach the same level. The Japanese homeowners are still paying off their homes which they bought at extremely inflated prices.

Migration and Foreign Investments

Another major cause of the real estate boom is a rising immigrant population. As, the population increases, so does the need for housing. As a result, a supply shortage is created, and this exerts an upward pressure on the houses. However, this is not the problem. The problem is that these migrants tend to have access to cheap finance in their home country. A lot of them are willing to take the foreign exchange risks and invest in other countries. This is what is happening in Canada as their housing bubble is created mainly by Chinese billionaires who are borrowing at home and investing heavily in the Canadian reality markets.

To sum it up, financing is an integral part of any housing bubble. Prices cannot rise until there is access to easy finance.

The post The Link between Credit Growth and Real Estate Bubbles appeared first on Management Study Guide.

Common Reasons Companies Opt For Co-Working Spaces

• Cost: This method is particularly useful for startup companies. Most of the startup companies today are in the hi-tech space. This means that they require offices with facilities such as video conferencing, VOIP enabled phones, leased internet lines, etc. However, setting up all these facilities from scratch is a bit expensive for startup companies who are usually strapped for cash. Hence, it is economically as well as operationally feasible to use this plug and pay model for office space. For a startup company, this works out to be more expensive on a per month basis. At the same time, bigger corporations find this model to be cheaper by around 25%

• Infrastructure: Co-working spaces allow the cost of the operation to be reduced without affecting the infrastructure quality. Usually, such shared workspaces have conference rooms and even video conferencing facilities. Companies get readymade infrastructure from day one. They can focus more on the core tasks performed by the company instead of paying attention to administrative tasks which add to the time and cost but do not produce any value for the customer.

• Travel Convenience: Several multinational companies tend to opt for this model in Tier-2 and Tier-3 cities. This is because these companies do not require a full-fledged office in these cities. Instead, they have a team of 10 to 15 personnel. They do not want to compromise on the quality of office space or the facilities that they provide their employees. Also, they want their offices to be centrally located because most of the times these employees work with the sales department and need to travel extensively. It is for this reason that shared working spaces become a viable alternative. The infrastructure is shared with other teams. It is just that these other teams may belong to a different organization altogether.

• Shorter Commute Times: Employees in big cities are tired of spending hours commuting to and from work. Apart from a nine-hour job, many people spend another four hours commuting to and fro. This commute time does not add value and hence should be eliminated. One of the ways of eliminating this is to start using shared workplaces.

  All workers should not be required to commute to one location for work. Instead, workers should be allowed to log in to the nearest shares workplace center. Time saved commuting results in more productive employees who can work longer hours in tasks that actually add value to the organization.

• Flexibility: Increasing the size of an organization becomes a logistical problem in traditional offices. For instance, a company may want to increase its employee strength by ten employees. However, they cannot rent additional space for only ten more employees. They have to rent an entirely new office unit.

  Alternatively, they have to cramp up the existing workplace and ensure that they ten new employees fit in the existing office. However, with shared workspaces, this is not the case. Companies can rent exactly as many desks they need and for the exact period of time that they need.

Problems with Shared Workspaces

• Cost Allocation: Allocating costs on a shared workplace can be a very difficult task. In a fully leased office, the company pays all the electricity bills, water bills, property taxes etc. However, in a shared workplace, these costs need to be apportioned. This is where disagreements begin to happen.

  Some companies believe that headcount in a more appropriate metric to allocate costs. On the other hand, other companies may believe that headcount is more appropriate. Also, since the bill is being shared, companies will not have an incentive to minimize the usage of electricity, water or other such scarce resources.

  Developers are trying to circumvent this problem by building these costs within the lease prices. However, that ends up causing wastage of resources and even leads to disputes in many cases.

• Privacy: Shared workspaces are cheaper and may have better infrastructure. However, most companies would not be comfortable in locating their critical operations to such facilities. The reason behind this is simple. There is a high chance of data or other intellectual property being stolen. Also, if the strategy of a company is leaked to its competitors, it may lose its competitive edge. The shared workspace model, by definition, cannot overcome this problem.

The future of workspaces is likely to be a fusion of the two models. The regular, mundane work which is not mission-critical may be performed at shared workspaces because of lower costs and other advantages that they offer. However, higher-end tasks which involve sensitive data and strategy information may continue to remain within the realm of leased workspaces.

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Even though the property under consideration is the same, the motives and capabilities of the buyer vary vastly. As a result, the deals made will be very different.

This article provides information about the different types of counterparties present in the market and the pros and cons of dealing with them:

Buy/Sell Transactions

Buy/ sell transactions are relatively permanent. This means that they are somewhat difficult to reverse or get out of. Hence, one needs to be a lot more careful of such transactions as compared to the usual rental ones.

Choosing the right counterparty to conduct the deal with goes a long way. Not all counterparties have the same motive, level of information or financial power. Therefore, your inability or ability to negotiate the right deal depends on your choice of opponent as well.

1. Developers: Developers are the worst counterparty that one can select. This is because developers have deep pockets. Also they have a full time team of people who are engaged in dealing with the marketing of real estate and also its legal aspects. Therefore, if you are trying to negotiate pries with a real estate developer, it is basically David against Goliath. This is because, real estate developers deal with investors like you day in and day out and are more experienced at the game.

   Furthermore, they have the deep pockets required to sustain losses and as such are not likely to panic if you pull out of a deal. Also, their legal teams are capable of creating hidden costs for you that you (a non legal person) will not be able to recognize and avoid.

   That being said, it is not impossible for you to get a bargain from a real estate developer. However, you will only get a bargain when the market as a whole is going down.

2. Individuals: The next option is to choose individual owners as your counterparty. This option is amongst the most feasible ones because your counterparty is likely to have the same financial power, time and team as you do. As such he/she cannot outnumber or out-power you.

   Also, properties are emotional investments for most people. Therefore, if an individual has listed their apartment or house for sale, one can be rest assured that they are serious about the transaction and need the money. This provides you with an opportunity to negotiate hard as an investor. Also, it is likely that the counterparty may be willing to negotiate and you may end up getting a better deal.

   Most successful real estate investors recommend exclusively searching out for listings posted by individuals and dealing with them. The closer these listings are to their expiry, the better it is! Individual investors usually do not have the patience or the deep pockets required to sustain a stand-off.

3. Brokers: Brokers form a medium risk counterparty. One is better off dealing with brokers as compared to dealing with developers. This is because brokers do not have the financial capacity that real estate developers do. Neither do they have the marketing or legal teams. Also, since they do not have an ownership in the property, their motive to undertake as many deals as possible.

   One must also understand that their motive is to raise the price as much as possible since they are paid a percentage of the sales proceeds.

   The only advantage that a broker has is that they have superior information network. They see hundreds of deals being closed every week and are better adept at negotiations and have the best information pertaining to current market prices.

Rental Transactions

Rental transactions are easily reversible. One can opt out of a property at a month’s notice. Hence, the choice of counterparty in the rental scenario is not as important. However, we have still listed down the options, their advantages as well as their disadvantages.

1. Corporations: Corporations that usually lease out properties are Real Estate Investment Trusts (REITs) or huge financial institutions.

   These corporations have efficient property management processes in place. Therefore, one is less likely to suffer from breakdowns of utilities and amenities while leasing out from corporations. Also, they want to be competitive and try to price their rents somewhat below the market price. Therefore, if you are a tenant, dealing with a corporation is a good option.

2. Individuals: Individual landlords do not have their processes in place. Therefore there is a greater chance of leaky faucets and broken windows if you rent out from individuals. Also, their housekeeping facilities may not be up to the mark. To top it up, they may try to charge you higher rents. Therefore it is not advisable to rent from individuals if better options are available. The above points may obviously not be true for all individuals. Some of them may provide the best service at the most reasonable rates.

3. Brokers: Brokers have the incentive of raising the rents as high as they can because they get paid a percentage of the rents. As a result, if you are looking to lease out, you may approach a broker. However, if you are a tenant, consulting a broker should be your last option.

The post Choosing the Right Counterparty in Real Estate appeared first on Management Study Guide.

The situation has therefore completely changed from socialism to capitalism. This drastic change in the Chinese real estate market has been documented in this article.

Communism

The Chinese real estate market forms a fascinating tale of the rise of hardcore capitalism in a communist country. In the beginning, i.e. in 1978, Chinese real estate had no price. This was because all the land in the state of China was owned by the government. The Chinese constitution prohibited private ownership and transfer of land.

As such, there could not be any buy or sell transactions. All the employees were also working for the government. Therefore they would be provided housing on the basis of their seniority, number of years of service and size of their family amidst other factors. At this juncture, it would have been impossible to predict that one day China would become one of the biggest real estate markets in the world and would one day be a major example used in debates pertaining to real estate bubbles.

Privatization Takes Over

Things began to slowly change in the socialist economy of China. The economy no longer remained socialist in 1988 when the constitution was amended. Laws which did not allow for private ownership of land were now amended.

The latest laws divided land into two categories:

1. One category was reserved for the people of the lower income households. These houses were to be sold on a cost plus basis. Also, the government would keep a strict check on the costs incurred in building these houses. Developers who created and executed these projects without any hiccups would get tax credits for the same. Ideally these houses were sold at 5% above the cost price to the low income families.

   However, there were restrictive conditions which made it difficult to qualify for such a home. Also, exit from such a home was not easy as the government prohibited selling off these homes for a period of at least 5 years after its purchase.

2. The other types of houses being sold were commodity housing. This was the category of the real estate market that was driven by the markets i.e. investors could freely buy and sell their properties at whatever prices they saw fit. In the meanwhile, they could also rent out these properties. The rent control act of 1994 completed the transformation of a part of Chinese real estate market from socialistic to capitalistic.

Property Boom

The next couple of decades saw one of the biggest property booms that the world has ever witnessed. The size of the government controlled affordable homes in the economy has been steadily shrinking. Over time, they have been replaced with commodity housing. Even though the supply of commodity houses has greatly increased across Chinese cities, so have their prices.

The average price rise for over two decades has been in double digits every year. This means that the prices of houses have increased by a minimum of eightfold during this twenty year period. In many cities, the averages have been as high as 26% compounded annual growth rate for around two decades! This can be considered to be one of the biggest and longest lasting bull runs in any real estate market across the world. The rapidly rising prices made real estate go out of the reach of working class population. This prompted the Chinese government to once again enact stricter laws.

Strict Laws on Second and Third Home

The Chinese government has enacted strict laws to curb the purchase of second and third homes in most Chinese cities. These laws were enacted to ensure that poor first home borrowers were not facing competition from wealthy second or third home borrowers.

The laws entail that people buying their second home must make a down payment of at least 60% of their property value. Similarly, if the person is buying a third home, they would be provided no financing and would be required to pay the entire amount in cash.

This law had serious repercussions on the housing sales in tier-1 and tier-2 cities. The rapidly rising house prices quickly saw a correction. China thus saw its first real estate bust during this period!

Stimulus Package

In 2008, the Chinese government provided a stimulus package to revive its banking sector and encourage lending. However, this ended up once again increasing the real estate prices which the government had taken so long to subdue. The banks were flush with cash and real estate developers seemed keen on borrowing and as such a lot of money was lent to them at a frantic pace. For a short while, the bust quickly turned into a boom. However, this boom was extremely short lived.

Misallocation

The Chinese developers built huge gated communities and townships. Most of these were built for the higher class people since there is minimum government regulation in that price range. However, the elite class has not purchased these houses. As a result, China now has entire towns and cities which are ready for inhabitation. However, they have not been inhabited. They are commonly referred to as ghost cities by many economists and represent one of the largest misallocation of funds in the history of the centrally managed Chinese economy.

At the present moment, some cities in China are witnessing a downfall in their property prices whereas the prices have stagnated in some other cities. If the market sentiment is to be believed China is about to witness a serious correction of real estate prices.

The post China’s Real Estate Market appeared first on Management Study Guide.

Similarly, REITs are easier to liquidate than traditional real estate investments. REITs also allow investors to diversify their holdings. Instead of investing $100 in the same property, they can invest $1 each in a portfolio of 100 properties. Lastly, investors benefit since their liabilities are limited to the extent of investment that they make in the REIT.

However, apart from these advantages, there are a lot of disadvantages associated with investing in REITs as well. Some of them have been listed in this article.

Varying Returns

The returns provided by REITs vary widely depending upon the underlying trust in which the investment has been made. This is because, to the layman, all REITs appear similar. However, in reality, each one has very different risk and return portfolio.

For instance, some REITs make equity investments in the real estate assets that they own. Whereas on the other hand, some REITs loan money to developers to build real estates. Hence, the risk and reward profile of both these REITs will be very different. For instance, if the interest rates in the economy go up, the mortgage based REITs will go down in value since newer funds will be able to provide better returns. On the other hand, equity REITs will appreciate in value. This is because as interest rates increase, so do rents.

Apart from equity and debt investments. The returns provided by REITs are varied based on the industry in which they invest money. For instance, REITs which invest in commercial real estate tend to provide consistent returns. The same in the case with the ones which invest money in hospitals and other medical establishments. This is because the underlying industry in which they invest money is performing well.

At the same time, there are other REITs which invest in hotel properties. There are still other REITs which invest in properties owned by retail establishments. It is a known fact that these industries are not performing well. As such, REITs which have invested their money in such properties are also not performing well.

Hence, investors have to be very careful about the specific investment vehicle that they choose. Many factors influence the returns that they may be able to generate on their investments.

Time Bound

Real estate, as an asset class is illiquid. This means that investors cannot really liquidate real estate as quickly as other asset classes like shares or bonds. This problem arises because of the huge monetary value of real estate assets.

REITs also face the same problem. REITs are time bound. This means that at the end of a specific time period (let’s say ten years), the REIT management is supposed to sell off the property and distribute the returns to the owners. Since many REITs mature at the same time, they can exert downward pressure on the prices. REITs may also be forced to sell at a time when prices are depressed.

A lot of times, when REITs mature, new investors buy the assets being sold by old investors. However, when the prices are down, finding new investors becomes difficult, and the properties actually have to be sold to liquidate money and pay it off to the investors.

Higher Fees

REITs are just like mutual funds. This means that they also collect a wide variety of fees from their clients. This is in addition to the percentage of profits that are earned by REIT investors as commissions. Many investors have complained that the management of many of these REIT trusts have complicated compensation arrangements. They use additional complexity to charge more money from unsuspecting investors.

Limited Growth

REITs do not grow too much in value. This is because they are mostly structured as pass-through entities. About 90% of the rental income that the REITs earn from these properties is paid out to the investors as a dividend. A mere 10% is retained and that too, for emergency purposes and administrative expenses. As a result, REITs are generally unable to increase the number of properties which they manage. Any growth is merely the result of price appreciation.

Tax Implications

Since REITs are pass-through entities, they are seldom taxed at the corporate level. This may vary based on the country where the investments are being made. However, this is generally the case all around the world. The dividend income from REITs is simply added to the other income earned by the individual. In many cases, this means that investors in REITs have to pay as much as 37% tax on the income that they have earned from their investment. Hence, REIT incomes are taxed at a higher rate compared to other investments such as stocks which only have to pay a preferential rate of tax.

The conclusion is that REITs also have many disadvantages. Therefore, like other financial tools, investors need to carefully scrutinize the investments made in REITs as well.

The post The Problem with REITs appeared first on Management Study Guide.

It is no secret that the Indian Real Estate Sector is down in the dumps and needs to be revived quickly. Following the Demonetization of the high value Indian Currency, the sector, which is basically cash driven slumped to the extent that the number of deals and transactions which were being done came down by 50%.

Moreover, the sector is also reeling under the well intentioned, but, thoughtlessly implemented RERA or the Real Estate Regulation Act that was introduced by the Indian Government to bring in more transparency and accountability into real estate industry in India.

Indeed, it can be said that both these measures were like a Double Whammy to a sector that was already facing headwinds due to overcapacity and funding problems.

Thus, it is the contention in this article that there must be urgent steps taken to revive the Indian Real Estate Sector, if not for anything else, but to carry forward the intentions of the government into creating affordable housing for all by 2022.

Structural Problems Need Radical Solutions

As mentioned earlier, the basic problem with the Indian Real Estate Sector is structural. What this means is that due to its cash driven nature and means of funding, often from dubious sources, as well as lack of transparency and accountability, the sector is unlike what is the case with the developed economies where these problems are either negligible or are managed well.

This is in contrast with the Indian Scenario where transparency and accountability are major problems. For instance, nearly 60% of the projects are either delayed or handed over incomplete fashion making it harder for the homebuyers to move in into fully finished homes.

Apart from this, most builders do not seek the necessary approvals before embarking on the projects, which can be a source of irritation and downright nuisance for the homebuyers who are then left grappling with these problems.

In addition, builders rarely compensate for the delayed projects as well as refuse to take responsibility for unfinished or incomplete as well as defective buildings.

Some Attempts at Reform

Thus, any attempt at reform must first address the structural issues and this is where we mentioned the RERA as a well meaning law. For instance, under the provisions of this act, builders have to take full responsibility for handing over completely finished homes and cannot shirk the consequences.

In addition, the RERA spells out means of redress available to the buyers who can approach the statutory authority or the RERA regulator who is supposed to provide relief and succor to aggrieved homebuyers in case of defective and other issues.

Moreover, the RERA also addresses the chronic problem of financing for homes wherein prospective homebuyers are provided with legitimate and transparent funding in the form of loans from established and reputed lenders.

In short, what the RERA seeks to do is to introduce more transparency and accountability into the Indian Real Estate Sector.

Demand Supply Mismatch and Overcapacity and Shortage at the Same Time

Having said that, there are other problems as well from the supply side as well as demand side of the equation. For instance, many major Metros in India often suffer from a glut of capacity wherein there are homes aplenty, but, not enough buyers mainly due to such homes being used to park funds by the builders.

In other words, despite several measures, the government has been unable to rein the tendency to build homes without assessing the demand and in turn, use the excess funds and the liquidity in the system to be exploited by the builders who use such funds to build mega projects, some of which turn out to be White Elephants that are built for building sake and without any homes actually being occupied.

On the other hand, genuine homebuyers in these metros often find that there is a shortage of capacity within their affordability and means as most homes are either overpriced or too far from the city downtown to be bought.

Thus, the Indian Real Estate Sector is down in the dumps also due to mismanagement and misalignment of the demand and supply equations that tend to skew the availability and consequent shortage in a manner where the problems are too many to be addressed in a meaningful fashion.

While Demonetization and the RERA were supposed to rein the sector and bring some discipline, the key aspect here is that the government should have gone the distance and tackled the problems mentioned above.

For instance, it could have touched upon the potential Hot Potato of Benami ownership that has been identified as a key problem and that too, very sensitive to resolve. Indeed, there were high hopes after the Demonetization and the passage of the RERA that these problems would be addressed as well though what transpired was entirely different.

Needed Reforms

What the discussion so far indicates is that fundamental reforms need to be undertaken to make the Real Estate Sector in India into a developed economy one and bring in world class standards. This can only happen if there is adequate political will as well as boldness in taking unpopular but highly effective measures such as the ones suggested here.

Indeed, if the government could do a Demonetization kind of exercise on the Real Estate Sector as well, it would indeed be a truly transformative and revolutionary measure that would address many of the problems faced by the sector.

The post Why the Indian Real Estate Sector is Down in the Dumps and How it can be Revived appeared first on Management Study Guide.

Now, in case of stocks, temporary greed and fear in the market may make it possible for the prices to go high and low. However, when it comes to real estate, it seems highly unlikely that someone will sell their million dollar home for less than what it is worth only because of temporary ups and downs in the market.

The massive ticket size of real estate investments automatically makes investors more patient. Hence, the question arises, “When and how can someone come across an undervalued real estate investment ?”. This article will list down some of the common scenarios under which properties sell for less than their worth.

Seller Duress

The prime reason that any real estate investment will sell for less than what it is worth is seller duress. When we assume free market prices for properties, we make an underlying assumption that neither the buyer nor the seller are in any rush to close the deal. They are aware of what the property is worth and are willing to put in the time required to find a buyer that agrees to the valuation.

However, in reality, a lot of sellers face financial duress. Sometimes they are laid off from their jobs. At other times, they are filing for divorce. Still others have racked up credit card debt or have suffered losses in the stock markets. The answer to most of their predicaments is fast cash. It is important to pay attention to the word “fast”. These sellers value time a lot and are willing to offer a bargain if the seller can provide immediate cash and alleviate their financial duress.

Seller Ignorance

Also, we have made the assumption that the seller is fully informed about the worth of their property. This is a farfetched assumption. The reason being that real estate prices are not listed like stock market prices. Rather they are approximate prices and can differ from property to property. Therefore, it is very likely that the sellers of some properties are not aware of the particular advantages that are provided by their property and do not charge a premium for the same. As such, it is highly likely and probable that an investor may come across an ignorant seller who accepts an offer for less than what the property is worth.

Financier’s Loss Mitigation Agenda

Many times, buyers default on their loan obligations. This could be due to a personal financial emergency like a job loss. Alternatively, it could be because the interest rates on their mortgage went up significantly. As a result, they can no longer afford to make the payments. In either case, the property is foreclosed on by the banks.

Once the banks have control of the property, the scenario completely changes. Banks have no interest in making profitable investments with repossessed properties. Their motive is simple and clear. They want to minimize their losses and sell the property to the first buyer that offers a decent price. As such, banks may not wait a whole lot of time, to realize the true worth of the property that they have acquired. Many real estate investors have made their fortunes by consistently hunting for foreclosed homes.

Creative Improvements

Another strategy to create a positive cash flow from a real estate property is that certain creative improvements are made to that property. This means that you buy, let’s say a big family house with 4 bedrooms. Now, there are very few families who may want to rent out a 4 bedroom apartment. Therefore, you retrofit the house to create 4 self sufficient studio apartments. These apartments can be leased out by students or working professionals. The combination of 4 studio apartments which are fully furnished for their target audience may provide at least 50% more rent than if the same property were leased out to a family.

The real estate investing world is flush with stories of investors who made millions making creative improvements to their property. However, this seems to be a risky strategy to say the least.

Information Asymmetry

Lastly, some real estate investors are more well connected than the others. As a result, they have a better idea of the development plans that the government has created for a particular neighborhood before such information is made public. As a result, they have an edge over other investors and know about the adjustment in the value of the property whereas the rest of the market does not. Therefore, they are poised to buy the properties at undervalued prices and make a gain as the prices rise.

This form of investing is called insider trading. It is illegal and can lead a person to prison. However, in the real world, there are many real estate investors who have made their millions this way.

Therefore, there are multiple scenarios under which a person can obtain title to a property at a price which is less than its market value. One just needs to be more diligent and watchful for such opportunities and utilize them one they arise.

The post Why Properties Sell for Less Than Their Worth ? appeared first on Management Study Guide.

However, surprisingly, the tide has already started to turn. As per the data released in early 2019, 2018 has been a bad year for the real estate market across the world. There is no major city, financial or trade centre, which has not seen a decline in real estate prices in the past year. The reasons behind the decline are a mix of global as well as regional factors. In the article, we will have a look at some of these reasons.

London: The decline in prices has been quite pronounced in London city. According to a report by Savills, the real estate prices in London are down by close to 19% from their peak which was in 2014. The London property market has been hit hard by massive changes in the regulatory and political environment.

Firstly, there is the Brexit which will fundamentally change the nature of buyers in the London market.

Many European companies, as well as international funds, are looking to liquidate their holdings whereas there are not enough buyers in the region.

The British government has also become very vigilant about the fact that money laundered from countries like Russia and China is making its way into the London realty market. The crackdown on this money laundering has started impacting the real estate market in a negative way. To top it up, property taxes in London have been increased even further making the city unaffordable.

Sydney: The property prices in Sydney have already fallen more than 12% since 2014. There is a likelihood of the prices declining by a further 8% in this year. These declines are catastrophic given the fact that Sydney had never seen a property price decline in the past four decades.

Even when the entire world was suffering under the effects of the Great Recession in 2008, the Sydney property market was steady. The decline in prices has been caused by a slew of measures introduced by the Central Bank of Australia.

Firstly, the interest-only loans which were popular with speculators have been banned from the market.

Australia has also increased the sales tax which is levied on sales of homes. This has been done in order to prevent incessant flipping of properties which was leading to an unsustainable rise in prices.

New York: According to a leading brokerage firm in New York, the median prices of apartments in New York have gone below the $1 million mark for the first time since 2015. The number of transactions happening in the New York market has gone down by 22% from last year whereas the number of homes for sale has increased by 15%. Hence, the market has suffered a 6% fall in price. The main reason for the decline in prices is two-fold.

Firstly, the Fed has hinted towards an aggressive stance for the first time in the past decade. Interest rates have been raised four times in the past year, making mortgages expensive and pricing people out of the market.

Secondly, the state of New York is now one of the highest taxed states in the country. This is the reason why many businesses are leaving New York for neighbouring states. Since the number of people exiting the state has increased, there are fewer buyers and more sellers which is exerting a downward influence on prices.

Hong Kong: The most expensive real estate market in the world is also not immune to the current slowdown. Experts are of the opinion that property prices in Hong Kong are down by at least 10%! JLL, which is a leading broker, has warned that these prices could fall as much as 25% if the trade war between China and the United States worsens.

Hong Kong follows the same monetary policy like the United States. Hence, when the borrowing costs in the US went up, they also increased in Hong Kong. Also, the Hong Kong government has been trying to reduce property prices. They have implemented a tax on vacant properties which is aimed at preventing builders from hoarding properties in anticipation of future price gain.

Mumbai: According to JLL, prices in Mumbai have declined for 2 consecutive years and are close to 15% below their 2014 peak. There is a slew of regulatory measures such as RERA and demonetization which have hit the real estate market hard. Also, the government has capped the tax breaks which were available to owners of second homes. This has driven investors and speculators out of the market. The property is still too expensive for end users who are following a wait and watch approach hoping for the prices to fall further.

The bottom line is that the heydays of real estate are now over. The sector is facing a decline in almost every city in the world, and this may be likely to continue for some time.

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Compare Annual Expenses

The average person has the tendency to think of home buying as an emotional decision. Then, also there is the conventional wisdom out there, which claims that buying is always better than renting. However, when it comes to sophisticated real estate investors or pretty much anyone who’s concerned about how their money is being spent, the conventional wisdom does not hold true.

Instead, it is advisable to think about whether it is more profitable to buy a given house or would it make more economic sense to rent a house. The trick here is to compare the annual expenses. Pay careful attention to the word “expenses”. We are not comparing cash flows. Instead, we are comparing expenses.

When we buy a house, we have a mortgage to pay. The mortgage is made up of two components. One of those components is interest, and the other is principal. The interest component is purely an expense. Simply put it is money that is leaving your pocket today and the money that you will never see at a future date. Hence, this is the amount that we will use in our calculation. On the other hand, the principal component of the mortgage payment is your savings. Hence, it is like taking money out of one pocket and then putting it into another pocket. Since this money is savings, we will not include this in our calculation.

Hence, our expenses for owing the house will include interest (after deducting tax shield), property taxes, insurance and maintenance. This would be the amount of money that is consumed during the period.

On the other hand, the expenses pertaining to rent are pretty simple and straightforward. Firstly, there might be a one-time expense of paying a deposit to the landlord. However, this is not an expense it is just an interest-free loan as one will receive the same money back when vacating the house. Apart from that, there is also the monthly rental that has to be paid. Some people also factor in the opportunity cost of the down payment that has to be made to acquire a house. This means that if you did not buy a house, you would end up earning a certain amount of interest from your down payment money. This must be reduced from your monthly rental.

Hence, a basic version of the rent vs. buy decision would be to compare the annual expenses that would arise as a result of either buying or renting the house.

Future Annual Expenses

Also, it needs to be understood that neither buying nor renting are one-day decisions. These decisions require commitment and have to be executed over a period of many years. Therefore, while comparing annual figures is the right thing to do, one must ensure that they do not compare fdata for only the current year. Rather, the cash flow and expense projections should look several years into the future.

This is the part where the rent vs. buy decision gets complicated. This is because the decision is extremely sensitive to the capital appreciation that we assume in the future. If we change the capital appreciation by one percentage point, we would end up changing the net present value by a huge amount, for example $50,000. To top it up, predicting future real estate prices is extremely difficult. Therefore, one needs to be very careful of the future assumptions that one is building into the model as they can literally turn the decision upside down.

Riskiness

The rent vs. buy decision is also dependent on the risk appetite of a given individual. Some people have no qualms with the risk that a mortgage brings along. A mortgage increases the risk because there is interest to be paid and also the investor becomes highly sensitive to price changes in the market. Hence, the personal net worth of an individual can change dramatically if they have a mortgage because mortgage essentially is an extremely leveraged bet.

More risk averse people prefer renting. This is because rents do not fluctuate nearly as wildly as property prices do. Even if the rents do change dramatically in a given neighbourhood, the person has an option to move into a different neighbourhood or even a different city if required!

Stability vs. Flexibility

When we buy real estate, it’s like throwing anchor in a particular place. Our lives become stable. Usually, people decorate their homes based on their preferences and when they own the house they can do so. Also, renting involves frequently moving to different houses periodically. Buying a home cuts out this movement and as such provides stability.

On the other hand, renting provides a person with the flexibility to experiment with different neighbourhoods, different apartment sizes at different costs to see what fits them best. People whose jobs require them to move regularly are also better off renting.

To sum it up, the buy vs. rent analysis is partially financial and partially emotional. The financial part of the analysis is difficult to work out because of the future assumptions. However, one also needs to understand the level of risk and flexibility that they desire before jumping into such a decision.

The post Your Home: Rent vs. Buy Decision appeared first on Management Study Guide.

Also, most of the people that own real estate do not buy it outright. Instead, they buy it with borrowed money. The impact of this investment decision on their lives is huge. There is a term called “house poor” in America. This term describes the people who do make a decent amount of money. However, since they owe most of their money to banks in the form of mortgage payments, they have to lead a poor lifestyle.

Slowly, the millennials are realizing that the real estate dream may not be worthwhile. This is the reason millennials are prioritizing spending on travel and education over buying a house. Traditionally, a house has been believed to be an investment. In this article, we will list down seven major reasons as to why buying a house isn’t really an investment.

1. Illiquid

   Investments are useful because they can be promptly sold in times of need. Consider the case of stocks and bonds. These investments have a ready market where they can be exchanged for cash in a matter of minutes. The same is also the case with investments such as gold and silver.

   Real estate is probably the only illiquid investment that is held by middle-class people in their portfolio.

   Selling real estate is difficult in all markets. In downtimes, it becomes even more difficult, and sellers often have to wait six months to one year before they can obtain cash in lieu of their property. It is therefore not advisable for the middle class to have a huge portion of their portfolio in an asset class from where they cannot withdraw it easily.

2. Opaque

   The real estate market is not only illiquid but also opaque. In the case of stocks, bonds, and other securities, the listed prices are the exact same thing as transaction prices. However, in the case of real estate, the listed prices are very different than the rates at which transactions actually take place.

   It is very difficult for a buyer to actually know the correct buying price. The market is famous for buyers and sellers being ripped off by unscrupulous middlemen if they are not careful.

3. Transaction Costs

   Real estate also has abnormally high transaction costs. Firstly, each time a sale takes place, the government has to be given a large sum of money. Also, there are costs such as legal fees, brokerage and appraisal costs which are involved in every real estate transaction.

   Hence, each time a transaction takes place roughly 10% of the value is lost to transaction costs. This also contributes to the illiquidity point that has been mentioned above. However, the bottom line is that since the transaction costs are so high, buyers are left stuck with the property they purchased even if it turns out to be a mistake.

4. Low Returns and High Expenses

   Real estate investments are known for providing low returns. Traditionally, the returns on real estate investments have been less than the rate of inflation.

   It is only in the past few years that there was a sudden spike in the capital appreciation earned on real estate. The rentals earned are also negligible. Also, in order to earn rent, a lot of time, money and effort, has to be put in. Also, many times, it is just difficult to rent out houses. Hence, there is an element of risk as well.

   On the whole, the returns earned by real estate are comparable to risk-free investments even though a lot of risks has to be taken. This is what makes realty a bad bet for the middle class.

5. Employability

   Buying real estate forces a person to settle down in one geographical area. Because of the transaction costs mentioned above, real estate cannot be bought and sold too often.

   The problem with settling in one geographical area is that the opportunities are severely limited. This is the reason why millennials chose not to buy a house. In this era of layoffs and job changes, owning a house is more of a liability than an asset.

6. Leveraged

   As already mentioned above, real estate purchases are usually leveraged. This means that people are paying large chunks of their income in interest. All these payments are being made with the assumption that real estate prices will rise. The problem is that if the prices don’t rise, investors stand to lose a lot of money.

   It needs to be understood that the price doesn’t need to fall in order for the investors to lose money. Even if the price stays stagnant, investors have already lost a huge chunk of their savings which they paid out in the form of interest.

7. No Diversification

   Lastly, since real estate consumes most of the salary that a middle-class person earns, it consumes most of their portfolio.

   Instead of having a balanced portfolio which protects the investors in the event of a downturn, most of the savings of the middle class are in the housing market. This is the reason when the housing market went down in 2008 the entire economy went into shambles.

The bottom is that “buying a house as soon as you can” is OLD advice. Millennials are well aware of the several financial pitfalls there are to owning a home.

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