Perspective: Residential Real Estate in its current form isn’t an investment worthy asset class
In the US, there is a clear distinction between condominiums (condos) and apartments. Condos are meant to be sold whereas apartments are built to be rented out. On the other hand, in India, all residential projects are built to be sold. There isn’t any institutional quality ‘built-to-rent’ residential project.
Given the above, developers in India design the apartments keeping the needs of end-users (predominantly, families) in mind. Consequently, almost every residential community, by and large, will have 90–100% of 2 or 3 Bedroom, Hall, and Kitchen (BHK) apartments. Broadly, these 2 or 3 BHK apartments are anywhere between 800 to 2000 sq ft in size.
To explain the numbers, we will talk about 2 BHK apartments in Bangalore, the IT capital of India. Broadly, depending on the micro-market, the sales price (all inclusive) of a ~1000 sq ft (super-built up area) 2 BHK apartment would vary between INR 4000 to INR 8000 per sq ft. Let’s take an average of INR 6000 per sq ft. That’s the price of bare-shell apartments. The buyer would then need to get electrical fixtures, wardrobes and woodwork in the kitchen done to make it rentable. The cost of all these, on an average, would be approx INR 1000 per sq ft. Hence, the total cost to the buyer is INR 7000 per sq ft.
A semi-furnished 2 BHK apartment would fetch INR 12000 to INR 32000 per month, once again depending on the micro-market. Let’s take INR 22000 as the average i.e. approximately INR 22 per sq ft per month (for a 1000 sq ft apartment). Insurance, property tax, annual electricity deposit, basic repair and maintenance would be at least 10% of the rental income. Hence, the net income to the buyer would ~INR 20 per sq ft per month. Please note that we have not adjusted for occupancy, and not deducted any interest payable to banks/NBFCs (if the owner has taken any debt to buy the property)
Hence, the rental yield from the investment is (INR 20*100/ INR 7000) = 3.5%. In simple words, if one puts INR 100 into buying a 2 BHK property in Bangalore, one would get INR 3.5 annually in the form of rents. The safest investment instrument in the country, Government of India (GoI) bonds, is offering 7.75% interest rate i.e. if one puts INR 100 in a GoI bond, one would get INR 7.75 annually without having to worry about anything. More generally, the average rental yield from residential properties is 2–3% across India.
So, an investor in residential real estate has to rely purely on capital appreciation to justify the very basic opportunity cost of not investing in a GoI bond. Capital appreciation is driven by external factors — a new metro line/bus depot, road, a new office park, retail/mall etc. getting built — and not something that is under the control of the investor. Moreover, areas that fetch higher rentals (INR 22000 in the above case) would have already witnessed significant development, leaving limited scope for additional capital appreciation. To conclude, residential real estate in its current form doesn’t seem to be a viable investment option. But there is a silver lining — there are evolving business models such as shared homes, serviced apartments and co-living that offer better returns to investors from their residential real estate investments.