Real Estate as a part of your Asset Allocation

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Real  Estate as a part of your Asset Allocation

Before I pen down my ideas on the above subject, let’s understand what asset allocation is.

Asset allocation is an investment strategy that aims to balance your risk and reward by apportioning portfolio’s assets according to individual’s goals, risk tolerance and investment horizon. The main asset classes are:

equities,

fixed-income,

real estate,

gold and cash and cash equivalents;

 Each of these have different levels of risk and return, so each will behave differently over specified time horizon. Allocation of capital to different asset classes is one of the most important decisions in determining the future risk taken and overall returns generated by the total portfolio. The returns are volatile in nature including positive and negative returns and the same hold true for real estate as well.

In my previous article, I had highlighted the importance of having real estate in your investment portfolio. Let me give you some of the pitfalls of investing in real estate and thus we should avoid going overboard on it and have a balanced portfolio.

Pitfalls of Real Estate:

·         There is a general myth that the real estate prices never fall. The reality is that real estate like any other asset tool has its cycle of ups and down when the prices go up based on the demand and goes down when the demand is low. The Real estate prices in NCR region alone have corrected by 25% in last 2 years. As it is a high capital asset class, a correction of such magnitude has a significant impact on our net worth.

·         It gives you steady rental income that grows over time but the rental returns are good in commercial properties (8 -12%) against the residential property that gives you the rental return of 1.5% - 3%.

·         It saves on tax. Actually it is the residential property where you get the tax exemption while there are no tax benefits on the loan against the commercial property. This deduction also is added back to your taxable income if you sell the property within 5 years of taking the possession of the house.

·         As it is a high capital class, the liquidity of the asset is difficult. This asset cannot be used for emergency needs or urgent fund requirements.

Taking all the above factors into consideration, please use your discretion while investing into real estate. Some of the Investment Opportunities that Real estate offers are:

·         Capital Gains

o   while participating at the launch stage of property and taking advantage of value appreciation

o   Participating in auctions of the stressed assets. (Generally for the HNIs)

o   Cyclical or periodic appreciation of the property

·         Rental income The returns on a residential property range anywhere between 1.5% - 3% of the market value of the property while the rental returns on the commercial premises range between 7% - 12% depending on the market demand. The interest on the loan on residential property can be deducted from rental income in the same property and gives added tax benefit.

·         NCD: The real estate sector is still considered amongst the riskiest of the sectors and the developers find it difficult to raise required funds. This opens up the opportunity to invest in high yield debt instruments like NCDs (non-convertible debentures) floated by these developers. The risk of investing in these NCDs is higher than the normal debt and needs to be taken into consideration before investing.

·         Reverse Mortgage: A reverse mortgage is a loan that allows older homeowners to access the equity in their homes. Instead of making a mortgage payment to reduce your debt, you receive money and increase your debt. Reverse mortgages are an option for people who want to turn substantial home equity into cash

·         A REIT, or Real Estate Investment Trust, is a company that owns or finances income-producing real estate. Modeled after mutual funds, REITs provide investors of all types regular income streams, diversification and long-term capital appreciation. REITs typically pay out all of their taxable income as dividends to shareholders. In turn, shareholders pay the income taxes on those dividends.

I will deal with details on all these opportunities in my subsequent posts. Thank you again for taking out your valuable time to read this post. Await your suggestions and inputs.