Let’s consider a real-life example. A friend of mine owned a property for which he was getting offers in the range of ₹4.25 crore to ₹4.5 crore. However, he was determined not to sell for anything less than ₹5 crore. He held onto the property for five years and finally sold it for his desired price of ₹5 crore. On the surface, it may seem a successful investment. But did he really strike a profitable deal? We’ll find it soon.
How do investors typically measure losses and gains?
Investors often assess losses or gains based on the purchase price. If they sell a property for less than what they paid, they consider it a loss. If they sell it for more, they see it as a gain. While this simplistic approach holds some merit, it neglects other crucial factors, especially the opportunity cost and the time value of money.
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Where real estate prices fall, many investors are reluctant to sell their properties at a loss. They hold on, convinced that prices will recover if they wait long enough. This mentality gives them comfort because they equate not selling at a loss with not suffering a financial setback. They wait for the market to offer a price that meets or exceeds their purchase price before selling, reinforcing the belief that there are no losses in real estate investments.
Opportunity: the overlooked cost
What many real estate investors fail to account for is the opportunity cost, or the returns they could have earned from investing their money elsewhere. This is a crucial concept that can turn what seems like a successful sale into a financial loss when viewed in a broader context.
Let’s return to the case of my friend. Although he eventually sold his property for ₹5 crore, the price he originally wanted, he actually experienced a significant loss in terms of opportunity cost.
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Had he sold the property five years ago for ₹4.5 crore and invested that sum in a fixed deposit (FD) yielding 7.50% annual returns, his investment would now be worth ₹6.46 crore. By holding onto the property, he missed out on ₹1.46 crore of potential returns from a safe investment.
Now, let’s consider a scenario in which he invested in a diversified mutual fund portfolio that generated 12% annual returns. His potential investment value would have ballooned to ₹7.43 crore in five years, meaning his opportunity cost would be a staggering ₹2.93 crore.
The time value of money
Another key factor often overlooked by investors is the time value of money. Money loses value over time because of inflation. Though my friend got the price he wanted, inflation caused the purchasing power of that ₹5 crore to diminish over five years.
For instance, if we assume a lifestyle inflation rate of 7%, the ₹5 crore he received today is worth only ₹3.56 crore in terms of purchasing power compared to five years ago. While he may feel like he made a profit in nominal terms, he suffered a significant loss in real terms after adjusting for inflation.
Real estate can also deliver absolute losses
It’s important to acknowledge that real estate investments are not immune to absolute losses, either. Consider another client of mine who bought an apartment built by one of the largest and most reputable real estate developers in Delhi NCR for ₹1.05 crore. Eight years later, feeling disillusioned, he sold the property for ₹90 lakh, booking an absolute loss of ₹15 lakh.
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Had he held onto the property for another two years, he could have sold it for ₹1.30 crore, translating to an annualised return of just 2% over 10 years. Even in this scenario, while the investment would have appreciated slightly, the returns would have been far from impressive, especially when compared to other investment options that could have delivered higher returns with better liquidity and no hassle of maintenance.
Take a balanced approach to investing
It’s essential to have a well-diversified investment portfolio that spans several asset classes such as equity, debt, gold and real estate. Overexposure to a single asset class, especially one experiencing a speculative boom, can leave you vulnerable to severe downturns. Often, when everyone is rushing into a particular asset class, prices are already inflated and the risk of losses — whether in absolute terms or through opportunity cost — increases.
Any asset can undergo a price correction or a time correction, or both. Being mindful of these concepts can help you make better investment decisions.
Sumit Duseja is a chartered financial analyst and co-founder & CEO of Truemind Capital.
