A dear friend of mine was of recent telling me about how he is into buying and selling houses for profit. He reasoned that since 2008, the equity market has not returned any decent sum of money for him and so he was better off parking the money in a place which could earn him some decent returns.
He quoted property prices in his locality to prove that he was right.
There is a limit to which I could argue with him because he was footing the bill on this occasion but like a good citizen of this country, I tried to explain to him the tenets of financial planning and what asset allocation and goal based investing meant. He was laughing at me.
Note that in this article I am referring to ordinary investors who buy and sell houses to make profit, I am not really referring to real estate agents who are in the business of flipping houses without transferring the property in their names.
Real estate is illiquid, get that !
First things first. Real estate is a very very illiquid investment avenue. For the new comers, it means, it is very difficult to sell a property, commercial or residential, and covert it into cash. If you have a lot of money parked into real estate and want to sell the house, then it could take months and years to roll it off.
Naturally, since you are in the business of buying and selling houses for profit, you will not sell at a price which is way below the market value nor will you go into a distress sale – this will get less number of buyers for you. It is human tendency to mentally hang onto a selling price and not go beneath that.
The takeaway is that to make a profit in this business, you might find yourself at the short end of the stick when you want to sell.
The taxation could over kill you
When you buy and sell houses for profit, many people forget about the long term or short term capital gains from the transactions that happen. As long as it is long term, it should be fine and one can take some measures to save tax from the government.
But if it is short term capital gain, then no tax deductions are available to you and the gain will be added to your income and taxed accordingly. This can seriously dent your profits from buying and selling houses. One needs to factor in the net profit after all expenses and taxes are paid before getting to the final figure on profits made.
Since taxation takes away a large portion of your profits, ensure that you understand how to factor that in before selling.
Diversification goes for a toss
All your money into real estate means you are a classic case of a person who does not believe in diversification. It means you will always bloat of property in your portfolio.The appreciation of the asset, which is often on paper, also helps the percentage of property in your portfolio bloat at it seams.
The net result is a portfolio with 90% allocation to real estate !
The only investment class that can beat inflation is equity and this is the only avenue that makes sense for long term investing. So it will be wise if you can understand the nuances of how not to put all your eggs in the same basket and adopt a asset allocation strategy that is in line with your risk taking capabilities.
Diversification is the very basic building block to a robust portfolio, you miss that and you will miss the opportunity to embark on a journey of right investing.
Do you have the time for it ?
I mean, you need to run around and show the houses to so many buyers. If you are an office going person with a 9 am – 6 pm job, do you really have the time to show the houses to around 25 clients before someone says “Yes !”.
Of course, you can out source the job to a real estate agent and leave the headache to him, but he will want a meaty 2% cut on the sale price of the house. That is a dent in the profits for you – does it really make sense buying and selling houses for profit ?
Which goal is the property tied to ?
Now this is an interesting one. If you have more than one house, you will stay in only one and so the rest of the properties need to be tied to a future financial goal – in layman terms, you might have either bought it for retirement or for giving it away in estate planning or might want to give it to your son-in-law (lucky chap !).
Whatever be the intent,why are you rolling it off then ?
It was meant to be for a certain purpose but investors get carried way when they see the property prices appreciating. They then think that they can roll off this current unit and buy another one and make a second killing ! Often, the strategy turns sour because you cannot always be lucky. The investor, without realizing, is doing strategic buying and selling of an asset – almost similar to trading a scrip on the stock market. Would it not be better to stick to properties if they are appreciating well rather than rotate them ?
Any thoughts, dear readers ?
Interesting topic. Its too tough for common man to take timeout from his regular work schedule and do this side business. I had come across a couple of them while house-hunting. Another option would be to invest in new properties via brokers. Brokers have tie-up with builders and at a time they can get around 10 people to invest in these apartments, they get discount too for bulk bookings. And then after a year or so once the price appreciates they can sell it. Of-course we need to pay brokerage but no hassles involved.
You wont believe it but many people I know do it because they want to invest money and not because they consider it as a side business.
They just don’t invest it any other place, only property and then get into the business of rolling it over and over.
Well if they want to invest money then its better to go via brokers. Big brokers have good contacts with builders. For eg. i know a broker who knows one of the directors of Nirmal Group and he gets investors to invest in the builder projects. They get good discounts(at least 400-500 per sq. feet) since they invest in bulk. But you need huge capital(50 Lakhs to 1 Cr.). Once the price appreciates to their liking they quietly sell it. In 2008 when i was house hunting the broker called these investors and asked whether they were willing to sell their flats but no one of them were willing as they were expecting price to go higher.
That is a scam as well. It only makes sure that the units are sold out before launch !
Trusting brokers blindly just to avoid hassles could be very dangerous for the investment. The amount of illegal land encroachment that is happening, I’d never make such a huge investment through a broker.
A very good article raising some very good questions. I don’t think a person who is in a 9-6 job [anyways it is on paper only these days] should be getting into such business. It is too risky and demands some serious time if you are looking to make good money out of it.
At the same time there are people who know builders/agents and they just invest whatever surplus money they have hoping to get good returns in a short span of time. To be frank I have seen people actually reaping profits from it. But like you said not everyone is lucky all the time.
This business is too risky and I’d never advise anyone to get into it primarily because the asset allocation would go for a toss and you’d be riding only on your luck, which is temporary, and nothing else.