QC Adsense

Sunday, March 10, 2019

What’s the true ROI of owning a flat? (What-Ifs Part 2)

In the past 2 blog posts on this topic, I documented what actually happened with an investment in a flat in Bangalore, which turned out to be rather mediocre outcome, and then we talked about what if conditions were in fact somewhat better.

In this post, I am going to write about things that could have potential gone wrong with investing in a flat.

Developer delays

The first and foremost scenario to worry about is what if the developer you are buying a flat from does not complete the project on time. This is a rather common scenario - read here and here. I was rather lucky that in the case I have presented, I did not suffer a delay. (There was a small delay of about 2 months, which to be honest, is almost expected in Indian projects.)

When a developer delays a project, there is both a tangible loss (loss of notional/actual rent) as well as intangible loss (dealing with the banks, current landlord, emotional turmoil etc). It is obviously extremely difficult to quantify the intangibles, but a delay of 1 year alone could cost you as much as 0.55% in IRR over the entire project timeline. It is not uncommon for projects to be delayed by as much as 3-5 years.

Developer disputes

Imagine receiving a property in which one or more of the facilities promised have not been delivered? Or if the developer delivered a project but there are deviations from the plan approved by the authorities?

These things happen, but how to quantify the effect of this? As in the above case, the intangibles are enormous and impossible to estimate. The closest I could come to is to use the fines of Akrama Sakrama scheme in Bangalore, where the authorities permitted deviations of upto 25% to be regularized (i.e. the authorities would let the new owners off the hook so long as the constructed property is safe) for a fine of 6-8% of the market value, as the cost to the project. To simulate this, I am going to apply a 6% fine somewhere in the middle of the ownership and use the original purchase price as the market price, though the likely market price at that time is most likely going to be higher.

Estimating this gives us an IRR drop of 0.41%.

Incomplete Projects

This is the worst case scenario of all the scenarios I can think of - the developer never completes the project. This the scariest scenario, leaving you in a semi-permanent limbo state. I don't think I can quantify this state of affairs where both the tangible and the intangible reversals could be enormous.

Interest rates being higher

Interest rates in India go up and down, like in every other country. Most loans these days are issued on a variable interest rate basis and normally pegged to something like the RBI repo on the reverse repo rate, either directly or indirectly.

My EMIs were paid between 2006 and 2012, during which repo ranges between 6 & 9 %, averaging perhaps at 7%. Accordingly my rates of interest were between 7.75% and 12%, averaging at about 10%. I had some initial discount on the actual rate for first 2 years that eventually disappeared and I was paying repo + 3%.

You never know what the RBI is going to do and how the macroeconomic situation shapes up - clearly, this could have easily been 11% averaged out. So let's simulate this scenario too. For sake of simplicity in the calculation, I am just adding 8% to all my EMI payments. (Assuming that 80% of the EMI is for interest, which is assumed to be 10% higher and 20% of the EMIs for principal, which seems fair, because the bulk of my loan was settled through pre-payments.) I am leaving the pre-payments as it is. Pre-EMIs, which are interest only payments, are simulated at 10% higher.

Estimating this gives us an IRR drop of 0.61%.

Unexpected maintenance costs

While my apartment did not need any big maintenance projects to be conducted, such projects are not unheard off. Lifts need replacement, specially in India, where the quality of the lifts are generally very poor, and so might be the case with Gyms, Swimming Pool, Sewage Treatment plants etc. On top of this, projects like Cauvery Water hit an owner with a one-time cost - that of paying for the installation. Since my project was relatively small (20 flats), we avoided these because we didn't have these amenities. However, such a cost is not unheard off. Since such a cost is unpredictable, I am treating them the same as a Sakrama fine (read above).


Here is a summary of the various simulations I ran

XIRR - Pessimistic Scenarios
Actual Transactions8.16%
SimulationDelayed Project7.63%
SimulationSakrama Fine (6%)7.75%
SimulationIncomplete ProjectsN.A.
SimulationHigher Interest7.55%
SimulationSakrama Fine (6%)7.75%

As before, all data is here. Feel free to perform your own simulations. Leave a note if you find anything interesting.

The purpose of this blog, and the entire series, was to bust the myth that real estate is always a good investment, which seems to be the general wisdom in India, if not in other countries. As you can see, the rate of return for a real case was rather modest, and various simulations of both optimistic and pessimistic scenario are presented, just to provide further context. The best scenario seems to be a return of about 10.53%, which is still lower than average returns in the Indian stock market in the intervening period.

More on this topic at this blog post on why your home is not an investment.

Sunday, November 11, 2018

What’s the true ROI of owning a flat? (What-Ifs)

In my previous post, I had documented the true ROI I had received from owning and eventually selling it and going through the lifecycle of the investment.

For obvious reasons, the ROI there isn't stellar. It was just at the borderline of the inflation rate over the years, which means it just about preserved my capital, but did not generate any. Incidentally, I wouldn't have needed to pay any capital gains, because the gains didn't even keep pace with the indexation benefits over the years.

Surely there must be unique factors specific to my investment that could be dragging down ROI? Is it then possible that under different circumstances, the ROI would have been significantly higher?

This is quite possible. Property investments almost always have a unique story and it is very tough to generalize what happens on the average case. However, what is possible is to tweak my particular experience to see if there is a significantly different outcome.

I have run 4 simulations on the data to see what might have happened. So I present the results. Following the trend of sharing my raw data, you can find the raw data of the simulations here.

Higher Rents

I have seen other property owners often spend a bit more money in furnishing the apartment significantly better than what I did. Most do this because they like to live a better furnished house themselves, but many do because it is expected to increase rental yields. In my first simulation, I assume that I spend ₹ 3,00,000 initially (instead of the ₹ 1,30,000 I actually did), but assumed that both the notional rents and the actual rents go up by 50%.

src: https://www.nytimes.com/2015/01/25/realestate/for-sale-multimillion-dollar-homes-fully-furnished.html
This is actually an optimistic scenario. My original investment got me a barely furnished apartment and my wife and I penny pinched along way to even get the furnishings done in this budget. It is unlikely that ₹ 3,00,000 would have made the apartment significantly better to gain a 50% higher rent uniformly across the life cycle. But assuming such optimistic scenarios, we arrive at a yield of 9.16%, a clear 1% gain in XIRR rate. Nothing to scoff at.

100% Occupancy

In my experience, the apartment was either occupied by my family or rented out, only for about 77% of the time. If you live in the apartment all along, you retain 100% occupancy. It is possible to have a single tenant occupy your apartment throughout your ownership giving you 100% occupancy. The latter is a highly optimistic scenario, but possible. Remember, we are doing what-ifs here.

src: https://en.wikipedia.org/wiki/Pigeonhole_principle

Take the base data and applying 100% occupancy gets return to 9.31%. This is an 1.15% top up on the current XIRR. Again, nothing to scoff at.

Higher Sale Price

The third possibility is that I sold it when the market isn't a sellers market. What if the sale price was significantly higher than the current sale price. Among the what-if scenarios, this is the most likely one to have panned out for most other property owners. An astute seller will wait till the buying price is right.

In my case I had the apartment on sale for a little over a year., which is a fairly long time to wait for the right price. Despite that it is possible it didn't fetch the right price. So, I ran a simulation that sets the sale price at ₹ 50,00,000 (instead of the real-life ₹ 39,50,000). With this the XIRR jumped a long way to 10.53%. This is a significant jump over the original XIRR.

No Bank Loan

The final simulation I wanted to run was to check what would happen if I hadn't taken a loan out. What if I had the money to put into buying the apartment and avoided the interest and fees that I paid to the bank over the years? Turns out, that this simulation has an effect of increasing the XIRR to 9.5%.
src: https://www.washingtonpost.com/news/where-we-live/wp/2017/04/11/planning-to-borrow-from-your-401k-for-that-home-down-payment-it-may-not-be-as-easy-as-you-think/

Comparison to Stock Market

Finally, what would have happened if I had taken all my cash outlays in the apartment and invested it in a mutual fund, and used the same fund to withdraw cash for the rents that would have supplanted the notional rent and rent inflows I enjoyed? This simulation gets a lot more interesting.

For the purpose of this simulation, I selected Franklin India Taxshield - it is a somewhat conservative fund, meant to be used for Sec 80C tax benefits, originally with a 3 year lock in on investments. The fund is probably a good selection because it would offered very similar tax benefits as a flat purchase in India.

This brings about the XIRR to a whopping 13.91%, a massive 6% on top of the original XIRR. The extra 6% increases the final outflow to ₹ 69,37,000 (instead of the real-life ₹ 39,50,000), giving a 75% upside over the market.

Remember that in this scenario, you would also never be in debt, as you haven't raised a loan. You are just replacing your payments to the bank with investments into the fund.


Here is a summary of the various simulations I ran

Actual Transactions8.16%
SimulationHigher Rents9.16%
Simulation100% Occupancy Rate9.31%
SimulationHigher Sale Price10.53%
SimulationNo Bank Loan9.50%
SimulationFIT (Stock Market) Comparison13.91%

As before, all data is here. Feel free to perform your own simulations. Leave a note if you find anything interesting.

More on this topic at this blog post on why your home is not an investment, and in part 2 of what-if analysis.

Thursday, November 08, 2018

What’s the true ROI of owning a flat? (The facts)

Anyone who offers you investment advice, specially in India, will tell you that buying a property is (almost always) a good investment. They will compare projections and stories from generalized price trends to explain why this is a good investment. What very few will give you is a numbers based analysis of what owning a property means from beginning to end. This post attempts to do that.

src: https://cdn.images.express.co.uk/img/dynamic/51/590x/House-prices-840997.jpg

Recently, I sold off the flat that happened to be my first investment, way back in 2005. This brought me to the logical conclusion of having owned it through its lifecycle providing me a better perspective of what return on investment (ROI) home ownership offers.

Let’s get into the facts. The property was a 3 bedroom flat in a complex of 20 flats in Devara Chikana Halli, Bangalore. I bought this straight from the developer, and I was the first owner. I made some very initial customization work before moving in, and for most part kept the house intact for the 13 years (there were 1-2 paint jobs and one round of general maintenance work we did). Then I sold it this year for a lump sum amount.

Details of the property

  • 960 square feet carpet area
  • 1190 super built up area
  • 3 bedrooms
  • 1 living room
  • 1 dining area
  • 1 kitchen
  • 1 common bathroom/toilet
  • 1 attached bathroom/toilet
  • 1 balcony 
  • 1 service area (attached to kitchen, doubling up as a second balcony)
  • 3rd floor
  • Dedicated parking was included


Rate₹ 1,170 per sqft
Cost₹ 17,44,000
(including registration, parking etc)
Initial custom work
& wood work
~ ₹ 1,00,000 - ₹ 1,56,000
Total cost~ ₹ 19,00,000

Including the interest on the home loan I took out, I paid an effective amount of ₹ 25,46,372. The difference between ₹ 25,46,372 and ₹ 19,00,000 was due to fee and interests paid through the life time of the loan to the bank. I closed the loan in 2012, but I had made interim prepayments to the bank between 2007-2012. There was no penalty/charges I paid in prepayment as I had negotiated such with the bank. This increased the cost of acquiring the property by roughly 34%.

Ownership and occupancy

I sold the property in September 2018, giving the family a total of 153 months of ownership. In this, we used the property as an active residence for 92 months. After this there were 26 months of tenancy to tenants who paid rent. The remaining 25 months, there was no occupant. The vacant periods were because we couldn’t find a tenant soon enough. This gave the property an occupancy rate of 77.12%.

During these 153 months of ownership, I contributed to the maintenance of the building, varying between 800 per month in the beginning to 2500 at the end. In addition to regular maintenance, the owners also chipped on a couple of occasions for special projects like the Kaveri water pipeline and the replacement of motor and a lift. I also paid 12 rounds of property taxes varying between 1600 per year to 4372 per year.


We have spoken so far about the costs, what about returns? Since I am a very data driven person, I have been maintaining a spreadsheet of all my outflows and inflows into this investment over the past 13 years. This includes everything I mentioned above, plus the rents I received.

I also maintained a “notional rent” as an inflow in my books for the months the family occupied the flat. This is the money we would have otherwise spent on having a place to live elsewhere. After all, this was our primary place of residence. The notional rent was always very competitively maintained - i.e. by enquiring at what rents did our neighboring flats in the building get rented out for. This was to ensure I kept a realistic set of books.

Eventually, when I sold the property this year, I got ₹ 39,50,000. This amount was quite realistic as the properties around us got sold for very similar (or actually lower than our price point) prices. We did not use a real estate agent and hence I am not deducting anything from the sale price.

(Before I get into the next section, I have to admit that the flat was much more than just an investment - my wife and I started our married life there; my parents lived in a house that they didn’t pay rent for, for the first time in their lives; my wife and I brought our first born to that home, and interspersed between these moments were many many great moments, like witnessing India lifting the 2007 World T20 with our friends in the living room of this apartment. That said, the purpose of this blog post is to look at the property from an investment perspective alone. This objectivity perhaps leaves out the intangibles of owning an apartment, but I am going to leave the reader to make their own assessments on what those are, since no two people can ever agree on intangible benefits.)

src: https://mountainshapers.files.wordpress.com/2012/08/sai41.jpg

So, now that we have all the inflows and all the outflows, what is the best way to calculate the return of investment on this property?

I use XIRR mechanism. In finance, Internal Rate of Return (IRR) is used a mechanism for comparing the value of one project to another, despite the variations in frequency of regular cashflows and terminal (beginning or ending) cashflow. XIRR is a variation of this formula, where the frequency can itself vary and so can the terminal cashflow (i.e. you could have multiple inflows and multiple outflows). The XIRR formula would take dates and cashflows and convert it into a rate of return. You can do this easily in Excel or Google Sheets.

src: https://www.goskills.com/Blobs/Modules/783/V-838/thumbnail.png

(Imagine that I had an invisible banker who said she will give me compound rate of return for any balance I maintain on any day with her bank, for whatever period I keep the money with them, what rate would such she have to offer to you to make her bank account equal to the property investment I made. This is why XIRR allows me to calculate.)

The XIRR for this investment happened to be 8.10%

Primary data is here, in case you want to scrutinize it yourself.

For the purpose of this calculation, I have ignored tax aspects of the entire investment. The tax effect is both ways - while you save on taxes by ownership (the interest becomes deductible), you also pay on actual rents received from tenants. It is possible that in my case the net effect of taxes is a net positive, but at the moment, I don't have the granular data to be able to make this calculation. I will take it as homework to update the numbers, but I can be sure that the net effect won't be much more than 0.42% in the best case, since I couldn't have saved more than 1,50,000 in taxes over the 4 years I paid interest before i became an NRI and stopped getting the tax savings.

(Yes, there is a good chance I could have got 8.1% by just depositing my money in fixed deposits over the time and paid rent to live in a flat.
Yes, 8% is roughly half what the stock market offers in India, where I have passive equity funds returning close to 14% over the same 13 year period.
Yes, 8% barely crosses the inflation rate that Government has been publishing through those years, and is probably lesser than the real inflation we faced in the marketplace.)

I have written about what-ifs, what-ifs (pessimistic)- i.e could this experience have been better off or worse, by running through a few scenarios in a separate post. More on this topic at this blog post on why your home is not an investment.

Tuesday, October 10, 2017

On Richard Thaler

Quotes from Michael Lewis' Undoing Project:

"There was at least one economist who didn’t feel that way, but he wasn’t, at least when he came upon Danny and Amos’s theory, anyone’s idea of a future Nobel Prize winner. His name was Richard Thaler. In 1975, Thaler was a thirty-year-old assistant professor in the School of Management at the University of Rochester with vague prospects. It was a wonder he was even there. He had two deeply pronounced traits that rendered him unsuited not just to economics but to academic life. The first was that he was easily bored, and highly imaginative in his attempts to escape boredom." 
"This was odd, as Thaler’s other pronounced trait was a sense of ineptitude. When he was ten or eleven years old, and a B student, his father, a detail-oriented insurance executive, had grown so frustrated with his sloppy schoolwork that he handed his son The Adventures of Tom Sawyer and told him to copy a few pages exactly as Mark Twain had written them. Thaler tried, seriously. “I did it over and over, kicking and screaming.” Each time, his father found errors—missing words, missing commas. The quotation marks in an exchange between Tom and Aunt Polly confounded him. Looking back on it, he could see that his problem was more than a lack of effort: He was probably mildly dyslexic. But people just assumed he was either careless or lazy, or both."
"Thaler had gone from college straight to graduate school mainly because his father’s life had persuaded him that business careers were mind-crushingly boring, and that he had no ability to work for someone else. He couldn’t think of what else to do but go to graduate school, and he picked economics because “it seemed kind of practical.” Only then did he discover that the field placed a terrifying premium on both precision and mathematical ability—to the point where it seemed that the only people who were allowed to make jokes in their journal articles were the guys who were best at math."
"He wrote his thesis about why the infant mortality rate in the United States was twice as high for black as for white populations. Controlling for all the obvious variables—education and income of the parents, whether the baby was born in a hospital, and so on—he explained only half the difference. He was left with what seemed an unsolvable puzzle. “I tried and failed to explain it,” he said. “I could have made it more interesting if I had had more confidence.” The economics profession responded by rejecting him for every university job he applied for. He settled for a job with a consulting firm. Then, just as he set out on a new path in life, the firm closed an office and let him go. At the age of twenty-seven, broke and unemployed, with a wife and two little kids, Thaler begged the head of the Rochester School of Management for a job, and the man gave him a temporary one-year gig teaching cost-benefit analysis to business school students. Back in school, he set out to write another dissertation. He found another interesting question: How much is a human life worth? He also found a clever way to approach the problem. He compared the salaries for risky jobs—coal miner, logger, skyscraper window-washer—to the life expectancy of the people who did them."
"(The number he came up with was $1.4 million, in 2016 dollars.)" 
"The paper secured Thaler a full-time job, without tenure, at the Rochester Graduate School of Management."
"Thaler thought that was really interesting. He told his thesis advisor about his findings. “Stop wasting your time with questionnaires and start doing real economics,” said his advisor. Instead, Thaler began to keep a list. On the list were a lot of irrational things people do that economists claim that they don’t do, because economists presume that people are rational." 
"The University of Rochester denied Thaler tenure. His future was hazy when, in 1976, he attended a conference on how to value a human life."

Richard Thaler just won the Nobel Prize for Economics.

I know there is a lot of survivor bias to the story and not every B student is going to win a Nobel Prize, but the story tells you that being a B student alone doesn't disqualify you from contributing to society, so long as you are inquisitive and willing to persevere.

Wednesday, September 27, 2017

Questions on ICOs continue to be unanswered

Yet another article, that doesn't even make an effort to answer the hard questions, but just propagates ICO bubbles.

For the record, here is my dissection of the article asking more questions:

"Entrepreneurs seeking capital to build tech startups have long sought out elite venture capitalists on the famed Sand Hill Road in Silicon Valley. Now the many startups developing applications for blockchain technology have another option: They can go online and raise millions by creating digital tokens, for use as currency on blockchain platforms, and selling them in what is known as an initial coin offering, or ICO."

Who are participating in these ICOs? the same people who could participant in a VC round or retail investors? If it is retail investors, how are ICOs fixing the information asymmetry and risk problems associated with an early stage asset?

"For instance, Protocol Labs Inc., based in San Francisco, which recently raised $253 million in an ICO, is building a network with blockchain technology on which digital storage can be bought and sold using the Filecoin tokens it sold in the offering. Protocol isn’t selling storage space; it’s building a market where people can buy and sell storage space."

So, what are coin owners getting? Free access to storage space later? i.e. pre buying what will become a costly asset? But will storage stage actually become a more valuable asset? What's the basis?

Same questions can be raised for Golem factory example.

"The tokens can be bought and sold after an ICO by investors. If a company’s platform is a success, the value of its tokens should increase because there will be greater demand for them."

Why? As in why should the value of the tokens increase even if the company is a success?

Additionally, most companies make revenues & profits in many different forms - so owning shares in the company always worked, because you got a share of all profits, made in any manner. ICOs effectively take away that inclusiveness.

"Doing an ICO doesn’t preclude a company from also raising money through equity offerings. But some startups are switching entirely away from equity funding, says Spencer Bogart, managing director and head of research at Blockchain Capital, a venture-capital fund that both invests in ICOs and makes traditional equity investments in startups. “You can raise a venture round or raise 10 times as much with an ICO and give up no control,” he says."

Right, because as an investor, I love the idea of investing in assets that have scant connection to asset's profitability and I don't need any control to prevent misuse by the founders.

"Whatever the risk, some investors say it may be worth it. That’s because the companies selling coins in ICOs are aiming to develop technologies that could be fundamental to entire industries, as, say, email or file storage or computing power are today."

Oh come on, why would using ICOs make it any more likely that the founders would solve "fundamental problems". If someone tells me file storage marketplace is a fundamental problem, then I want to smoke the same weed they are.

Administrative note

All tech posts have now moved to http://tech.shreeni.info or you may subscribe to its RSS feed. In due course, I shall be moving it out completely, so if you follow my tech posts, please shift to following that blog.