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Money Jan 27, 2012

Why property is not always a healthy investment for you

By Arjun Parthasarathy

Everyone wants property prices to come down, but nobody wants it to stay down. Property prices are unaffordable and not economically viable at present in many parts of India. However, no interested property buyer will ever want property prices to stay down; it does not figure in his or her thoughts.

The last part is a bit scary as every Indian believes that property prices can only go up in his or her lifetime and their first, second and third investment will be property.

Property prices are unaffordable to many in terms of value to income ratios. Value to income ratios have gone up multiple times over the years with property prices rising much faster than income. For example, if your flat price has gone up by six times over the last 10 years and your income has gone up only three times, the value to income ratio has gone up.

You could have afforded to buy a flat 10 years back, but someone earning as much or less than you cannot afford to buy a property now given than the income is not sufficient to service loan instalments.

Property prices are unaffordable to many in terms of value to income ratios.Reuters

Rental yields in many parts of the country are abysmally low. Rental yield is the rent earned to property price, and it is as low as 1 percent in some areas of the country. It does not make economic sense to buy property for investment as interest on fixed deposit is much higher at 9 percent. It actually makes sense to sell property and invest in fixed deposits at such low rental yields.

Yet, despite the unaffordability factor and economic unviability, you will continue to believe that property prices will keep going up. Even if prices do come down, you will believe it is temporary and prices will go back up.

This is where many of you make a big mistake. Overextending yourself to buy a place for you to live in is fine but overextending yourself to buy a second and third property for investment in the hope that prices can only go higher is downright irresponsible.

You may even have to sell your first property if prices go down and stay down. And this cycle has happened in India and will happen again and again. The length of the cycle can get longer, leading to huge losses for owners as well as lenders against property.

Why should property prices come down and stay down?

Property prices can come down and stay down when it is unaffordable to the end user and property investors are the only buyers of property. In cities such as Mumbai, 70 percent of property is bought by investors and these investors are looking to sell out at higher prices to the end user at some point of time.

Investors can sell to each other but given investments have an opportunity cost attached to it, there has to be an end user of the property. At present rental yields are too low to find any value in renting out property and income is unlikely to rise fast enough to make property unaffordable.

You cannot explain away the expected rise in property prices due to demographics or lack of space. Tokyo is one city where everything is right for property prices to skyrocket as it is a highly populated and extremely rich city, but property prices in Tokyo has been in a two decade long slump.

Many of you who have bought property in the late 1990s and early 2000s would have bought it from investors who have sold it at half the price they purchased in the mid 1990s. Yes demographics and land availability can explain the past rise in price but it cannot justify a speculative bubble if ground realities do not work.

Will prices go up or come down from now?

Investors in property will say prices will go up while end users will say prices will come down. If end users do not buy property on expectations that it will come down or due to the unaffordability factor, investors will have to search for another investor to buy (greater fool theory). If another investor does not come along, investors will then have to sell at a loss (either absolute or in terms of opportunity cost). Hopefully, investors lose and end users gain.

Arjun Parthasarathy is the Editor of www.investorsareidiots.com, a web site for investors.

by Arjun Parthasarathy

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