Is real estate the right investment option for you?

KARACHI: Despite the many real-estate booms and busts that the Pakistani property market has gone through over the last two decades, most individual investors remain convinced that land remains a good, long-term investment. Yet, while this assertion may well be true (there is no empirical evidence either way), investing in land may not always be the right move for every investor. This article will try to lay out what factors to consider before deciding whether real-estate investment is right for you.

The real-estate market in much of the country is ill-documented. Not undocumented, mind you. There is a fairly lengthy and complicated paper trail for most real-estate transactions, but due to the propensity for tax evasion, most people do not report accurate transaction data. Hence it is not currently possible to determine whether or not real-estate appreciates at a rate faster than inflation with any real certainty. For arguments sake, let us assume that it does and thus is a worthwhile investment from a returns perspective.

Rental income: usually not the best reason

Perhaps the single biggest reason people invest in real estate is the rental income. It is a stable source of income from an asset that will appreciate in value over time. It seems like a win-win situation. And while the relative stability of the income and asset value appreciation is undeniable, it is worth exploring whether or not an investor can do better.

Anecdotal evidence, gathered through a brief survey of real estate agents, as well as individual real estate investors, suggests that the best annual rental income one can hope for usually does not exceed 4 per cent of the total assessed value of the property. One can do better with a savings account, which yields a pedestrian 5 per cent, in terms of income and even better by investing in fixed income mutual funds, some of which average above 12 per cent.

But of course, those mutual funds and savings accounts do not deliver asset value appreciation. For that, one has to turn to good old fashioned stocks. But if one seeks stable dividend income, then it cannot simply be any stocks. The best option for investors who seek both income as well as investment growth is energy sector stocks, such as those of the Oil & Gas Development Company (KSE: OGDC), Hub Power Company (KSE: HUBC), Pakistan Petroleum (KSE: PPL), etc.

The dividend payouts of these stocks tend to be very stable, although they usually pay quarterly or semi-annually. And given their constant drive for more profits, their stock prices tend to keep increasing over time, though they are much more volatile in the short run than real estate prices.

Liquidity: not quite the trifling concern

One of the single biggest drawbacks of real estate investment that even the most ardent investor will agree to is the fact that such an investment is not very liquid. For instance, if one requires a large sum of money in a hurry, it is difficult to get it if most of one’s investments are tied up in real estate. Selling property takes time and is subject to market timing risks.

In addition, one usually has to sell off an entire piece of property in order to get the money, thus introducing another factor: reinvestment risk. It may not always be possible to invest in a property of similar quality the next time around.

Transaction costs

It is more expensive to invest in real estate than in securities, either bonds or stocks. There are estate agent fees, taxes, registration charges, etc. Not to mention the fact that selecting a good property is hard work and that incremental investment is almost impossible for most ordinary investors.

When it might all still be worth it

This is not to suggest that real estate investment is always a bad thing – far from it. It is good for people who want to have steady income and cannot afford sharp fluctuations in the value of their assets. It is also not bad if one does not anticipate large expenses and has a sizeable liquid investment to supplement the real estate. But it would be inadvisable to put all of one’s eggs in the real estate basket. Lehman Brothers did that. Look what happened to them.

Published in The Express Tribune, August 2^nd, 2010.