In today’s world, one cannot simply live just on the earnings they make. Living day to day on the salary we receive is not sufficient to live comfortably. So how do we increase our earning potential? As Indians we have always been taught the importance of savings, our parents always told us to keep aside a certain amount every month for a rainy day. While saving is a good start, it is still not enough to fulfil our basic needs in the long run. Lot of factors like inflation and depreciating currency will cut into our savings. Let me give you an example, if you saved Rs. 10,000 in your current account last year, the value of your money today will actually be Rs. 9380/- as the inflation rate in 2020 was 6.2% (10 year average of India’s inflation rate is also 6.1% from 2012 to 2021). The value of your money depreciated by Rs. 620. This is due to the growing inflation year over year. So clearly, saving money in your current account is not a good idea. For you to have kept the same value of your savings, it should have grown by at least 6.2%. This is a very important problem to solve because we are saving all this money for a rainy day somewhere in the future, where we want to see an increase in our savings, not decrease.
As most of you know, the solution is clearly to invest your savings in ways where it will grow annually, more than the inflation rate and give you returns. Investing in simple terms is making your money earn more money. There are multiple ways for you to invest your money, each option comes with its own pros and cons. Each option will have its own risks and our investment should depend on our risk appetite (We will go into more detail about this in our Risk category article). In this article, let us discuss two of the most popular investment options, investing in the stock market versus investing in real estate. Investing in real estate showed 1.5 times more return on investment compared to investing in the stock market over the period of 10 years. Let us take a look at how we arrived at these numbers.
Both Real estate and stock markets have multiple risk level options that you can invest in. You can invest in residential, commercial or land in real estate. You can go with mutual funds, index funds, ETF’s, direct stocks etc in the stock market. In recent times, a combination of real estate and stock market has emerged in the form of REIT’s as well. Both the markets have been growing at an average rate of 12% year over year (based on RBI house price index and Nifty 10 year average growth). Given the similarities, what option should we go with when investing? To answer this question, let us take an example and dive into it.
Let us consider the example of Mahesh and Mahima. Both of them managed to save an amount of Rs.25,00,000 and now want to invest this amount. Mahesh decided to invest in stock markets and got a variety of high risk and low risk options with an average return of 10%. Mahima decided to invest in the real estate market and selected a residential property in Miyapur (high growth area in Hyderabad) for Rs.75,00,000. Mahima had to take a loan for the rest of the amount to buy an apartment. She got a loan at 7% interest rate (based on current loan rates given by major banks). Let us take a look at both their investments 10 years from now
Mahesh’s investment grew by 120% over the 10 years and now became Rs.77,64,621 (if we reinvest the yearly returns & dividends). If the investment is equity or mutual fund based, then the capital gains received after long term investment will make it eligible for a tax benefit on the gains for up to a maximum of Rs.1,00,000 leading to tax savings. Mahima’s investment is a little more complex to calculate as the loan component comes into the picture. She invested a total of Rs.75,00,000 which grew by 120% over the 10 years and became Rs. 1,65,00,000. She also paid off her loan for the next 10 years with a 7% interest rate which amounted to an interest of Rs.19,66,480 (calculated using an interest calculator, click here to calculate). She also received a rental return of 3% from her apartment every year which added up to Rs.22,50,000 ( 3% avg return every year * property value*10 years). In addition to this she also saved on taxes up to 2 Lakhs on interest paid for housing loan per year (as per section 24 of the income tax act) as the interest amount she paid Rs. 19,66,480 is exempted from income tax which is not the case in the stock market. Apart from all the benefits, she had to bear some expenses as well such as EMI’s, property tax and maintenance dues. She had to pay an EMI of Rs. 58,054 every month, a total of Rs. 69,66,480. She had to pay property taxes to the GHMC every year for the property she owned which is around Rs.50,000 every year (property tax varies from city to city, you can calculate your property tax from the GHMC property tax calculator here) which adds up to Rs.5,00,000 for 10 years. Maintenance is an added expense which will amount to around Rs.3,60,00 (based on the average of Rs.2.5 per sft per month) If we deduct the expenses and add the returns, the total adds up to Rs. 1,09,23,491 and an additional savings on the Income tax of Rs. 19,66,480. If this is the first house owned by Mahima then she can also avail some income tax benefit on the principal amount as well, given she did not max out on other saving schemes (refer to section 24 in income tax act for more details).
If we compare both their returns at the end of 10 years, Mahesh made 3.11 times of what he initially invested and Mahima made 4.37 times of what she initially invested. I based all the assumptions under the average market conditions. You can play around with these numbers in the excel calculator provided in our toolkit. Mahima made more than what Mahesh made in this scenario. There are exceptions in both these cases but this is the result if we consider conservative assumptions based on average market conditions.
As you can see from the above example, real estate can be a very lucrative investment. Based on historical data, you can’t go wrong with investing in either the stock market or real estate but in the long run you will reap more benefits from a real estate investment. One of the common practices is to start by investing money in the stock market as it requires a low initial investment and convert it into real estate as soon as the required capital is accumulated.
|Investment in Real Estate||Investment in Stock Market|
|Real estate in India provides returns of 3% for residential and 6% for commercial every year||Average dividend yield for BSE Sensex is 1.6%|
|Accessibility to Loan||No accessibility to Loan|
|Income tax benefit is given for interest rates paid to loans up to Rs 2,00,000 per year||Long Term Capital Gain tax benefit up to Rs 1,00,000 when long term investments are divested|
|High initial investment needed||Initial investment can be low|
|Ownership of physical tangible property||No physical or tangible ownership|
|Effort required for liquidation: Medium||Effort required for liquidation: Easy|