Which is better investment, Real estate Or Equity mutual Fund?

Short Ans: Equity mutual fund is way better.

I had this multiple times debate with my dad. Finally, we did some number crunching and I was finally convinced him that equity is better.

Dad: We sold a house in Chandigarh for 6 Lac in 1988 and now it’s valued at 4 Cr so almost 70x. Can equity give such returns?

Me: Let’s look at sensex in 1988 it’s was ~400 and now it’s ~ 28000 so almost so if you would have invested in sensex also you would have got 70x

Dad: Might be a coincidence, We bought a commercial plot in Gurgaon for 8 Lac in 1989 and now it’s valued at 4 Cr so almost 50x.

Me: Let’s look at sensex in 1989, it’s was ~700 and now it’s ~ 28000 so almost so if you would have invested in sensex also you would have got 40x

Dad: See real-estate generate higher returns than equity

Me: This is not a fair comparison, due mainly 2 reasons

1. You are not taking into account tax impact
So, if you consider 20% long term capital gain tax your 70x will go to ~60x and similarly that 50x will to ~43x.

2. You are looking at best of the lot property investments whereas I am looking Sensex which is a generic measure.
I really liked one stock Eicher Motors (bullet fan) do you know that this stock was priced at ~50 in 2000 and today it’s price ~24,000 that’s ~ 500x.

Dad: Ok, But I don’t know which stocks are going perform like Eicher Motors whereas in real-estate I understand the dynamics.

Me: I know that’s why I never recommend you to put money directly in stocks. You should buy equity mutual funds. Let me give example of couple of old funds to show their returns

1. Birla Sun Life Tax Relief 96: Invested amount from Mar-1996 to Feb-2017 would be 110x which is ~25% YoY. Tax benefit is over and above this.

2. Franklin India Prima Plus Fund: Invested amount from Dec-1993 to Feb-2017 would be 81x which is ~21% YoY.

1. Risk

Dad: These returns looks great. But what about the risk. You know real-estate rarely goes down.

Me: That’s not true. Do remember that we checked the price of the same house that gave you 70x returns before and during recession. It was almost down by 50%. Equity mutual fund were down ~60% so slightly higher but not huge difference.

Also, if you think about other issues like

Liquidity: Buying/ Selling house is very difficult especially in down market. Sometime it takes almost an year.
Transaction cost: It very high due to registration cost (~5%)

Capital Requirement: You need to have crores of Rupees to invest in real-estate and possibility of diversification is almost NIL.

Dad: Historically, this is fine but how can you say this will going to continue in future as well.

Me: After spending hours to think through this, it’s comes down to basics. Both real-estate and equity are investments and there returns can be divided into two parts:

1. Rental/ Dividend Yield
2. Price/ Capital Appreciation

Dividend yield for Sensex is around 1.5%. This net of all taxes etc.
Rental yield in India is around 2-3%. Let’s take 2.5% but after deducting income tax, property tax, maintenance, etc it goes to ~1.5%. Almost same as dividend yield.

Price Increase depends on two factors P/E and earning growth. If we assume P/E to constant, we only need to project earning growth. It will fair assumption that in long-run earning growth will be at-least sum real GDP and inflation.

GDP: 7%
Inflation: 5%
Earning Growth(GDP + Inflation): 12%

Capital appreciation depends on rental yield and increase in rent. If we assume rental yield to be constant, we only need to understand increase in rent. I have mostly seen a growth of 5-10% in rent. So, if you believe that rent can grow by more than 12% real-estate can perform better but it’s unlikely.

Dad: Hmmm, I suppose equity looks better as an investment option.

Few good mutual funds:

Option 1: Top Balanced Funds:

1. HDFC Balanced Fund
2. Birla Sun Life Balanced ’95 Fund

Option 2: Top Large Cap Funds:

1. Kotak Select Focus Fund
2. SBI Bluechip Fund

Option 3: Top Mid Cap Fund

1. L&T India Value Fund
2. Canara Emerging Equity
3. Mirae Emerging BlueChip Fund

Option 4: Top Small Cap Fund

1. HDFC Small Fund
2. Franklin India Smaller Companies Fund

Hope this helps. Happy Investing!

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