Personal Finance

Why realty investment gets better as you age

B Venkatesh | Updated on September 29, 2019 Published on September 29, 2019

When your active income stops, investing in stocks becomes risky

The attractiveness of real-estate exposure improves as you age. That is, investment in real estate is more useful as you approach retirement than when you start your career. Here is why.

First, rental yields are low. This is because of the large investment value due to expensive land prices. The expected returns from a portfolio of the same value containing stocks and bonds are higher. So, why invest in real estate when you can improve your risk-adjusted returns on investment?

That said, at retirement, your active income stops. You, therefore, become averse to investing in stocks because you may not be able to bring in additional capital to make good any shortfall in your investment value due to declines in the stock market.

Your primary choice of investment then is monthly income bank deposits. While bank deposits offer stable income, they expose you to inflation risk. Rental income moves up, at least partially, in line with price levels. Second, investment portability is important in the present world. That is, it is optimal for you to hold financial assets than physical assets because your employment may require you to relocate frequently. Investment portability is not an issue when you retire.

It is important that as a retiree, you buy two or more smaller properties instead of one large property. This will improve your rental yields. Also, it is better to buy land in a gated community to avoid encroachment of the property.

Does this mean you should not have real-estate investments when you are working?

Growth asset

During your working years, you should invest in growth assets, not income assets. That means your primary source of investment returns must be from capital appreciation, not income returns. This is because your active income will pay for your living expenses.

Your investments in real estate could be in the form of land, which can fund any life goal including your child’s college education. But they should be a supplementary source of cash flow, not your primary investment for any life goal. Why? Because you may be unable to convert the investments into cash when you need the money, as land is an illiquid and lumpy asset.

Finally, a note on self-occupied land. Because it does not generate actual cash flows, it is not considered an investment.

The question is: should you buy a house for self-occupation early in your career? That depends on your emotional needs. The benefit is the pleasure of living in your own house. The trade-off is that you are converting your human capital (present value of your future income) into a single, lumpy and illiquid asset. This is because you are borrowing against your future income to buy the house.

In recent times, many young professionals are choosing to live in rented apartments, accumulating their savings to spend on experiences (read vacations).

The writer is the founder of Navera Consulting.

Published on September 29, 2019
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