Your real returns from investing in Indian real estate

Recently I met a good friend who was in town on vacation. We’ve known each other for over 15 years, first meeting when we started our jobs fresh out of college, colleagues for about 4 years and flatmates for a couple of years. Since he lives on the other side of the world, we meet on average once in two years. Aside from the telltale signs of grey (mostly me) and a few added kilograms (mostly him), our interactions are the same; relaxed, with a decent amount of poking irreverent fun at each other.

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After the customary catch-up around life and assorted things, he mentioned having come across ‘The Calm Investor’ on his facebook feed. With a smile he said “So it wasn’t enough that as a management consultant, you share the assorted crap you learnt at B-School to corporate clients, that you started a website on equities?” He went on to say how equities and the stock market are good for excitement but “the real money to be made in India is in real estate.” A statement I thoroughly disagree with.

To add some context for the reader, this friend had started investing in real estate over 10 years ago, had over that time bought and sold a few apartments. In fact, just on that trip, he had sold an apartment in the suburbs that he’d bought seven years ago. Therefore, there was some basis for his faith in real estate investing. He told me that a friend of his was a note investor, and he would sell real estate notes to avoid the struggles of traditional bank mortgage loaning. Many investors buy and sell notes as they can achieve a higher cash flow without the degree of risk associated with the stock market. If you want to look into buying real estate notes there are a lot resources online for you to examine when it comes to real estate investing.

As a lifelong real-estate skeptic, I’ve heard many anecdotes of spectacular returns from real estate investing, but few actual data points. So, I asked him about his latest transaction. And it’s worth bearing in mind that these trends may well translate internationally, so if you’re interested then it may be time to contact your local realtor like realtors Greensboro.

He’d bought an apartment for ?55 (5.5 Million) back in late 2007, for 25% down and the remaining on loan, and sold it in early 2015 for ?1.25Cr (12.5 Million) for a handsome gain of ?70L on his original investment, more than doubling his money.

The Calm Investor | The myth of real estate investing

Some analysis, albeit simplified to an extent, shows that the return on this investment, while healthy, is not the kind of blockbuster return one hears of all the time from real estate. Here’s why:

You pay “rent” on the borrowed money

That we have to pay interest on borrowed money is hardly a revelation. Except, it’s the amount it adds up to over a period of two decades that is often underestimated. A loan of ?41.25L will result in just interest payments of ?59.25L as cost of rent for the money borrowed. This is in addition to the ?41.25L principal that needs to be repaid to the lenderThe Calm Investor | The myth of real estate investing

Therefore, what you pay for the apartment is not just the down payment but also the interest accumulated over a long period that needs to be factored into your calculation of returns.

This “rent” (interest) is front-loaded

So you’ve been making the monthly payments on your loan for a year on your 20 year loan. At the end of the year, you get your statement showing loan outstanding, and you’re shocked to see that instead of being reduced by 1/20th or 5%, looks like you still owe almost the same amount minus what looks like 1% of the original loan amount!

This is because of the concept of equated monthly installments (EMI) of ?41,878 where the total amount (principal + interest) is distributed over the loan tenure. Chart below shows monthly payments broken out by interest and principal repayment components.

The Calm Investor | The myth of real estate investing

A large part of your payments in the initial year go toward the interest component on you home loan and it’s only in the latter half of the loan tenure that the principal component dominates.

You have a chunk of principal to repay depending on when you sell

This means that selling your investment after a few years still means a large part of the principal needs to be repaid. Here’s how much you would pay to the lender on a 41.25L loan, if you sold your apartment at the end of each yearThe Calm Investor | The myth of real estate investing

Finally, the return

Given the transaction consists, not of one buy and one sell transaction but several intermittent payments, an excel function called XIRR helps us determine the return on this real estate investment.The Calm Investor | Investment Returns

An investment in real estate, with a down payment of ?13.75L, 20 year loan of ?42.5L @10.75% interest, resulting in monthly payments of ?42k that is finally sold after just over seven years for ?1.25Cr has given an annual return of 12.7%

Not a poor return over that period of time but also not the kind that will put equities and other asset classes to shame. Therefore some key points to consider when it comes to real estate investments:

  • Large unit sizes of each investment means regular investors have to put all their eggs in one basket. The above example is from a successful case of spotting a developing locality, developer who was able to get all the right clearances and finally, a suitable environment for the sale
  • Leverage to borrow the 75% of the value introduces a large element of risk. Rising interest rates up the payments to be made which are likely to rise just when salaries and corporate earnings face downward pressure
  • Yield in the form of rental income has been ignored in the above example, simply because rent as a percentage of property value in India tends to be among the lowest in the world, and almost cancelled out by other costs like stamp duty, registration, maintenance that have also been ignored here
  • Bottomline (from the point of view of an equity investor with next to no experience in real estate investing)
    • Buying property in most cases is unlikely to “blow doors off hinges” when it comes to returns
    • Returns from real estate can be steady and comparable to equities, given the skillset in identifying properties with potential upside
    • The added stress of debt, illiquidity and the concentrated nature of property investments offer additional disadvantages compared to other instruments

Quote from the Forbes India article

“In the best-performing locality of Colaba (Mumbai), the average 10-year return was 8.07 percent with the lowest being 2.09 percent (1996-2006) and the highest being 14.37 percent (2003-2013). The returns are far more volatile if you take a lower time period of five or eight years.”


Two things going for real estate investing are that it enforces financial discipline required to pay monthly EMIs which otherwise might have been consumed and that real estate forces buy-and-hold due to large ticket sizes and by being illiquid.

Additional Reading:

Advance learning on income from house property – https://www.incometaxindia.gov.in/
Real estate fixation – Outlook Money
Return is king in real estate – Forbes India

12 thoughts on “Your real returns from investing in Indian real estate

  • May 14, 2015 at 9:32 pm
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    Hi,
    I’m also a firm believer in Equities. However, people buy real estate because they have to “settle” .
    I noticed that you didn’t factor in the rent for flats. Also, some people buy land instead of flat and sell it. The returns for land are much more compared to flat.

  • May 15, 2015 at 8:16 am
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    Thanks Anil. I mention rental yield under key points to consider but did not consider it in the returns calculation because in most major cities in India, this yield is quite low once you consider costs like maintenance and other charges. Agree that investing in land is a completely different ball-game.

  • May 25, 2015 at 9:46 pm
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    Hi,
    Thanks for the wonderful post.
    Any investment return can’t be ignored from the point of taxes and other transaction cost (like brokerage commission in case of buying/selling etc.).
    Equities come with zero taxes (in case you are selling after 1 year) whereas any gain in property is added to your income (if you are not investing the proceeds in other residential property)
    It is the same fallacy which we MBA faces at the time of negotiating salary. Actual figures are far from reality (when taxes, bonus and other benefits etc. eat major part of take home).

    Cheers
    Abhishek

  • May 25, 2015 at 10:39 pm
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    Good point Abhishek. I ignored rental yield from real estate and in turn also ignored taxes, stamp duty and other miscellaneous costs. Thanks!

  • May 26, 2015 at 11:45 pm
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    Excellent article. Could you account for the misses (rental yield, tax calculation, etc.) and provide a more realistic scenario. I have been debating the worthiness of buying a house at home, and a more realistic scenario will help me convince my family.

  • May 27, 2015 at 10:50 am
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    Thanks Kumar. The key number in the calculation when including rental income is how much is it compared to the EMI being paid. My estimate based on where I live is the ratio is EMI / Rent = approximately 4 to 4.5x
    So in the example I have considered:
    Starting Rent income / month would be ~ Rs 10,500
    Maintenance and other costs including taxes: 15-20% of this income
    Annual 5% rent inflation

    Incorporating the above assumptions, I get a return of just under 17% / annum (which compares favourably with equities long term). But do keep in mind that this is based on one example and not based on aggregate data. Hope this helps.

  • October 21, 2015 at 10:02 am
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    This being a great informative post regarding investment in real estate. I think such articles are really useful for the people to get the knowledge about real estate investment and plan things accordingly.

  • December 5, 2015 at 5:21 pm
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    I dont agree with – “”An investment in real estate, with a down payment of ₹13.75L, 20 year loan of ₹42.5L @10.75% interest, resulting in monthly payments of ₹42k that is finally sold after just over seven years for ₹1.25Cr has given an annual return of 12.7%””

    Read our article https://www.property81.com/Advice/Investment/Real-assets-outperform-paper-assets.php

    Like any investments, you need to make smart move. You can make more than 30% easily when you do right things in real estate.

  • December 12, 2015 at 12:53 pm
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    “can make more than 30% easily” – any investment option that makes that statement is either delusional or lying.

  • August 26, 2017 at 10:38 am
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    Exceptionally well written. Its only when we put a Annual Return to any investment can we make out if its a sensible investment or not. The below was sent to me by a financial advisor (on similar lines as your article above) and makes so much sense.


    The fallacy of Large Numbers !

    A bungalow in Nepean Sea Road, South Mumbai was bought for around Rs.1 lakh in 1917. It is now going to be sold for Rs.400 crores. The value of the bungalow has multiplied by whopping forty thousand times in 100 years.

    Real estate is always discussed in terms of how many times it has multiplied. Rarely anyone calculates XIRR or annualised returns. 40,000 times in 100 years when expressed in terms of XIRR is 11.3%. Not a bad return at all. But nowhere as glamorous as saying 40,000 times.

    Many tell me that the property they bought 25 years ago has multiplied by 10 times. Sounds fantastic. But the annualised return works out to 9.6%.

  • August 26, 2017 at 10:56 am
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    Thanks Sachin! And this is without considering the hassle of maintaining a physical asset!

  • June 5, 2019 at 4:00 pm
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    Totally agree, thanks for the post. Investment in real estate is fraught with risk and uncertainty in India, and equity is a much better option. The only reason to buy real estate would be if you want to use it.

What do you think?