An article by Vijay Venkatram, Director, Wealth Forum. Worth a read.

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11th July 2011

Is property really your big threat? 
 

Many advisors have told us that their real competitor is not a bank or another advisor - but the property market. Advisors often watch helplessly when their clients redeem large chunks of their financial portfolios to fund property investments. Isn't there anything that you can do better than to watch this situation helplessly? Is it really true that wealth creation avenues that you offer - like equity funds - come nowhere near property in terms of performance? If they do compete well, why are we not able to effectively communicate this to our clients? Why are we not able to establish to our clients that they are perhaps better off investing in equity funds than in property? We provide a humble perspective… 
 Over the last couple of years, I have heard many advisors complain in anguish that their real competitor is not a bank nor another IFA - but the property market. Most advisors who have HNI clients have similar tales of woe : of customers cleaning out a substantial part of their financial portfolio to buy a house as an investment. You painstakingly build your AuM over the years - only to find that one fine day, a large chunk of the portfolio gets redeemed to fund a property investment your client just made.

Property - an advisor's biggest threat

Investors' love affair with real estate is only too well known to all of us. It provides a heady cocktail of being a tangible asset having appreciation potential and some income potential as well. There is also this strong perception that you can't lose money in real estate, if you have the "holding power". There are also so many stories in the media of home prices reaching stratospheric levels and how some wise investors made a killing by selling their houses at 10, 20, 50 and even 100 times their cost. There is enough evidence of wealth creation in property markets for any investor to continue to hanker for even more exposure to property. Almost every HNI investor will have stories to tell you about how he or his friend bought this flat 10 - 15 years ago at just Rs. 10 lakhs and how it is now worth easily more than 15 times the cost price. And, if you were then to try and counter the argument by saying that equity has a similar or perhaps even greater potential to build wealth over the long term, the most common objection you will encounter is "Look, equity funds that I bought in 2007 are still to make me money. I am better off in real estate". So, how do you tackle this 800 pound gorilla called real estate that is eating away into the financial portfolios of your clients?

Is property really the best investment?

I recently met Sundeep Sikka, CEO, Reliance Capital AMC, who shared this wonderful insight with me: "Vijay, the problem you are talking about is exactly what we also face very often. But, it helps to do a little homework, to see the facts in the correct perspective. One of our large investors was here in our office the other day. He was talking about real estate and how it has built fantastic wealth for so many individuals and how it is clearly the best wealth creation opportunity. He picked on the recent headline grabbing real estate deal in Mumbai - an investor sold his 3600 sq ft apartment in Samudra Mahal, Worli for Rs. 33 crores - an eye popping Rs. 100,000 per sq.ft. This is the costliest real estate deal recorded in India. He told me that the investor paid only Rs. 25 lakhs for this flat back in 1972 and has now cashed in a whopping Rs. 33 crores from this investment. Can your equity funds give that kind of return - he asked. While talking with him, I asked one of my colleagues to quickly run some numbers for me. I was startled with the results. This flat that was being talked about - the costliest real estate deal in India - had actually yielded an IRR of around 13.7% to the investor. A simple excel computation establishes that the rate of return for 25 lakhs to grow to 33 crores in 38 years (1972 to 2010) is around 13.7%. I pointed this out to him and proceeded to show him how our equity funds have comfortably beaten that return over the 15 years of their existence ! The point is that we need to do our own homework to demonstrate that equity funds compete very well against real estate when it comes to long term wealth creation."

How are returns expressed?

That conversation set me thinking. The fact is that equity funds have delivered 15 year CAGR in the region of 20%. The fact is that this is significantly higher than 13-14% CAGR that one of the highest priced real estate deals fetched the seller. Why is it then that the perception continues about real estate being a better wealth creator for investors? The crux I think lies in the way we talk about returns. In the real estate market, its always absolute numbers that are talked about - never CAGRs.

The place where I stay (Powai, Mumbai), for example has seen prices move up from their 1996 levels of Rs. 2000 per sq ft to over Rs. 20,000 per sq ft today. A flat that cost Rs. 40 lakhs in 1996 is today worth Rs.4 crores. That works out to a very healthy CAGR of 18% over a 15 year period. But, what we hear is 40 lakhs becoming 4 crores - that sounds a lot more than 18% CAGR. To put this in context, if the same investor had invested in a fund like Reliance Growth Fund in 1996, that Rs. 40 lakhs would today be worth over Rs. 11 crores ! Suddenly, this wonderful 10 fold appreciation in property prices pales in comparison to a 20+ fold gain in this equity fund over the same period. When one says that the fund delivered a 27% CAGR over 15 years, it sounds great to financial advisors. But investors are not readily able to grasp the magnitude of the performance. Translate the same performance in laymans language - say that Rs. 40 lakhs invested in 1996 grew to Rs. 11 crores by 2010 - and investors now begin to grasp the magnitude of wealth actually created.

Financial advisors have got very used to quoting CAGR numbers when talking about returns. Their real estate counterparts talk absolute numbers - and absolute numbers always sound a lot more than CAGRs. More importantly, investors relate better to absolute numbers rather than abstract CAGRs. When you talk of wealth creation, people are more interested in knowing how wealthy they became or could have become or are likely to become rather than the rate at which their wealth grew. I am not suggesting that we dispense with CAGR numbers - I am just suggesting that when talking about long term wealth creation, and when talking about past performance of equity funds, it makes sense to give a context to your clients by adding what Rs. 100,000 invested say 10 years ago would be worth today. The fact is that when it comes to long term wealth creation, equity funds have done just as well if not better than property - its for us to highlight this in a manner that our clients understand and relate.

Virtues become the main villains

As all advisors are aware, equity funds have many virtues which property cannot ever hope to match - we just need to keep re-iterating this in our conversations with clients :

Liquidity : Bull or bear markets, you can always liquidate your equity funds, at an efficiently determined price. Try selling a house in an economic slowdown - and you will know exactly the value of liquidity that equity funds offer. And you will also realise how difficult it is to get a valuation for your property in a market that just freezes in a downturn.

Transaction costs : Stamp duty and registration costs across the country are prohibitively high in property transactions. Equity funds, with a zero entry load, win hands down versus property on this score.

Taxation : You pay zero long term capital gains tax on equity funds - there is no way that property, with a 20% indexable tax can ever beat a zero percent rate.

Unfortunately, it is precisely these very virtues that are becoming villains and preventing investors take a genuinely long term view with their equity funds, the way they are forced to do with their property investments. With an effective zero tax on capital gains after a 1 year holding, efficient price discovery on a daily basis and negligible transaction costs, investors become far more trigger happy with their equity investments than they would ever dream of becoming with their property investments.

Time to ask your clients some serious questions

The biggest disadvantage for equity funds in their competition versus property is the time frame that investors are willing to give each asset class to perform. Investors happily look at property as inter-generational assets - but equity funds rarely get anywhere close to those kinds of time frames. Investors pride themselves on their "holding power" vis-à-vis their property investments during downturns - but somehow that same "holding power" vanishes when they look at their equity fund portfolios.

If we all believe that equity funds have the potential to do as well if not better than property over long periods of time, its really up to us to impress upon our clients this fact and get them to compare apples with apples instead of apples with oranges. Its time to ask your clients a few serious questions :

Did they sell their property investments in 2008, at a time when they redeemed their equity funds? If not, why not?

When property prices fell in 2008-09, were they tempted to look for bargains and snap up "good deals"? If yes, did they also feel like snapping up a good deal in the equity markets, which were at the 8000-12000 levels? If not, why not?

Do they keep comparing property prices in each locality of their city every month and switch in and out of houses based on which locality did the best in the last 6 months? If not, why do they feel like doing that with their equity funds?

Do they promptly sell their houses the moment they complete 3 years of holding period or do they keep hoping for prices to appreciate further - and therefore happily stay invested?

When they buy a house, do they mentally allocate it to their son / daughter? What prevents them from doing that when they buy equity funds with their same hard earned money?

In conclusion

There is no doubt that the Indian investor's love affair with property is indeed a strong on. There is no doubt about the long term wealth creation potential of property investments. There is no doubt that history is firmly on the side of property investments - in terms of showcasing the enormous wealth that this asset class has created in the past decades.

All that I humbly submit is that while all of this is true, it is really up to us to demonstrate that equity funds are just as good if not better in terms of their wealth creation potential - over similarly long periods of time. And they come with a whole lot of goodies thrown in for free like tax breaks, low transaction costs, liquidity, transparency etc. We can continue to fret about the 800 pound gorilla called property that is mercilessly decimating your clients financial portfolios and eroding into your AuM. Or you can recognise that you too have an 800 pound gorilla called equity funds that can compete handsomely against property - and win. Its up to us to position our gorilla correctly in the hearts and minds of our clients.