Stock & Real Estate

I have friends in the stock market who confidently give advice on the real estate market. They are real experts in the stock market and that gives them the extreme confidence to make predictions about the property market. Most of the times, they have been proven to be wrong. That is because of the fundamental difference in these two asset classes.

1. Stock market is totally organised and transparent. All transactions are routed through a central exchange and are visible to all parties. Just imagine if there was a need to list all properties on a single exchange and all transactions had to be compulsorily routed through this exchange. The property market would undergo a drastic transformation with this one single change.
2. Stocks are pure investments. Real estate is consumption plus investment. Hence there are a lot of emotions involved in the real estate market. A person who is comfortable in Bandra (West) will not move to Bandra (East) even if there is a chance of higher appreciation in Bandra (East).
3. In real estate many times the supply is limited in certain micro markets. Hence the general rules might not apply in certain areas. To some extent, this also applies to the stock market. However, in stock market majority owners would be willing to sell at a certain price. This might not hold true in the real estate market.
4. Stock markets are ruled by fundamentals and technicals. In the real estate market, there is no place for technical charts.
5. I once heard Osho saying that unless you know God, you should not talk about him; you will ruin people’s lives. The same applies to stock market pundits who confidently advice people about real estate!

 

Real estate v/s Stock Market

I have witnessed a funny relationship between investors in these two asset classes. Each side sticks to its view about the superiority of its own investment. What’s really funny is that they circulate reports about the risks in the other’s markets and how the market is going to fall.

We must realize that in today’s world all markets are intertwined. If real estate falls, then sooner or later stock markets too will fall- the degree may vary though.

Each has its own advantages and disadvantages. Stock market investment can be unnerving at times if the stakes are high and one looks at the ticker constantly. One is not supposed to do that for long term investments; however the fact is that one tends to look and pay the price for an emotional roller coaster ride.

Real Estate – is it fairly priced?

When we evaluate the price of a stock, we see the ratio of price to earnings. If the price to earnings ratio is very high, we say that the stock is overvalued. Today the overall market is priced at around 16-18 times forward earnings. Does that mean that you are paying 16 years earnings in advance? The answer is “NO.” Generally the earnings of a corporate are expected to grow. Hence if we factor the growth it means that we are probably paying for 10 years future earning to buy a stock. And that is considered fair.

Now let’s look at the price of real estate. In Mumbai, the rental yield on residential property is around 1.5% per annum of the market value. This means that price to earnings ratio is around 66 times. So either the rent is too low or the price is too high. The rent yield in Mumbai might probably be the lowest in the world. So what does it mean- Is the demand for rental properties for homes low as compared to the supply? Are there too many investors in Mumbai residential properties who drive up the price due to their demand and then drive down the rent through supply?

The yield in commercial property is high- around 7% to 9%, per annum. So is the commercial property undervalued due to low demand from investors or are the rents high due to higher demand from Corporates? There was a time when commercial property value was higher than residential. Today the position is reverse. Earlier people used to operate offices out of residential property. Now it would be foolish to do so. How times change!

Investment and your temperament

Certain investments do not suit your temperament. I would be very uncomfortable investing in a painting worth a million dollars and leave it hanging on my wall. What if my grandson took fancy and scrubbed something on that painting. I don’t understand why somebody will pay be more than a million dollars for the painting for me to make profit out of it. If I don’t understand it, the solution is very simple – I must stay away from it.

I have a client, a top film star who had invested a significant amount in an I.T. startup during the dot com boom when valuation depended upon eye balls and not revenue. The markets had tanked and it was a rare opportunity to buy real blue- chips at a heavy discount due to the bad market sentiment. I was explaining to her my logic of why she should invest in shares and how and why the price will move up. After an hour or so she said “Sukhbir, even if you sit here the full day talking about this gibberish, it will not make sense to me”. So I asked her one question “Will you be able to sleep peacefully at night after investing in the stock market?” She said “No”. The solution is very simple in this case- she must stay away from stock market. Eventually I advised her to invest in real estate and today she is happy with the advice.

There was a time where I had huge exposure to the stock market. Almost 100% of my liquid net worth was invested in the market. Not 100% but may be 90%! As a result one part of my mind was always on the markets. Everyday my portfolio value would swing by Rs 5 to 10 Lakhs. So one day I would make a profit of Rs 10 Lakhs and I would be very happy. Next day I would be down 8 Lakhs and would feel sad. This emotional roller coaster ride was distracting me from my work. Even during working hours I would be looking at the share prices on the computer. I realized that my temperament was not suited for this kind of market any more. The solution was very simple. I sold off all my shares when Sensex was 7,000 (in 2005) and invested in commercial real estate. Today (in 2013) the cumulative rent collected from that property exceeds my original investment and still the property is worth more than the Sensex. So I have no regrets.

I am not saying that investing in the stock exchange is bad. I am just saying that it does not suit my temperament as I am a conservative investor. Moreover, the way it operates today does not give me a feeling of being in control. So I have a very simple solution – I stay away from it.

The best avenue for investment is something that you understand. Then you will believe in it. This conviction will help you tide over difficult times. So invest time in trying to understand your investment avenues and your temperament.

Would you like to share your stories on temperament?