Real estate investing: Why you must do due diligence before making the big leap

A careful evaluation of finances and how a property investment fits in with meeting crucial goals is imperative.

Status symbol, tangible, regular source of passive income—all these factors make real estate investment an alluring option. We are often told by our elders: “Property investment will never result in a loss.” This brings the survivorship bias into play.

Investors in real estate typically overestimate their chances of success, assuming they can never lose money in property investments. But it is not all sunshine and rainbows in the realty market. There are not-so-pleasant cases and it is worth dispelling all the myths associated with property investing. So, let me share a few anecdotes with you.

Unlucrative deal

An NRI (non-resident Indian) client bought a small (500 sq ft carpet area) two-bedroom-hall-kitchen (BHK) apartment in a prime locality in a Mumbai suburb five years ago for Rs 1.70 crore. Post-pandemic, there was a record redevelopment of buildings in this locality. Very soon after she bought her flat, the view from her property—one of its main attractions—was blocked completely, with high-rises coming up close by. She had to go in for a distress sale of the property, unable to get her asking price from the buyer.

Anticipating less scope for appreciation in the future, she was willing to bear the loss and invest in better, more lucrative options. After adjusting for rental income and interest cost, the net proceeds received were at a loss of Rs 1.50 crore.

Lesson: Real estate investment can result in losses. The realty market is fragmented and a heavily localised business. While location matters, there could be other factors at play that cannot be anticipated or do not work in the investor’s favour. So, it is prudent to tone down unrealistic expectations.

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Opportunity cost

A client invested in a house in Panvel, on the outskirts of Mumbai, around six years back for Rs 20 lakh. The annual rental yield over the years has been very low at 2.4 per cent per annum and even the property appreciation is not much, around 4 per cent on average. Locking money in real estate appeared to be an untimely decision in hindsight. Now, he has two crucial goals to be met—a downpayment for a new house (present occupancy is quite old) and his son’s higher education. His investment would have appreciated much better in a growth asset like equity. It would have helped as he is already underinvested in equity.

Lesson: Asset allocation matters more than anything. It is important to fill up one’s debt and equity buckets suitably first in the total portfolio and then consider putting money into real estate, which require big-ticket funding. Investment decisions need to be taken in totality rather than on a piecemeal basis. They also need to be aligned with your short-term and long-term financial goals.

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Management hassle

A client who had put up his old property on rent was facing many management issues. These include difficult tenants, late payment, property misuse, repair and maintenance issues, society issues, finding new tenants and brokers, etc. This was despite no logistical problem as the house was just 2-3 km from where he was staying. He finally sold the property and is unwilling to invest in a new one, even willing to forgo the tax saving this would entail. Peace of mind is of greater importance to him.

Lesson: An investment decision, especially one in a property, need not be just from a returns point of view.  The investor should assess his availability and willingness to run around and be involved in managing the rental property. Can it be delegated to some relative or to professional agencies? This is even more crucial when the property is located in another city or state.

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Should one not invest in real estate at all?

The anecdotes shared above are not intended to imply that investment in real estate is always a bad call. For anyone wishing to invest in this asset class, the thought process behind committing big-ticket money needs to be crystal clear. Many investors invest for a regular rental income. They do not have an exit strategy in place, though.

Some buy property as a retirement house although they are many years away from hanging up their boots. Some buy a house as a vacation destination but hardly find time to go there and eventually give it up on rent or keep it idle. Parents buy a spare nest for their children when they don’t even know where their offspring would eventually settle down, in India or abroad.

This is especially true for retail investors who lock in their lifelong savings by buying property before taking care of their crucial financial goals.

A careful evaluation of finances and how a property investment fits in with meeting crucial goals is imperative. Location, scope of passive income, future utility, potential of capital appreciation, financial preparedness, impact on goals, exit strategy, availability to manage—a thorough due diligence on all these aspects needs to be done by an investor before taking the big leap.