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Are we in the midst of one of the Riskiest times to invest in Real Estate?

If you talk to most people, you will see many suggesting that this may be the time to buy real estate – especially in places like India where it seems some sort of correction is due. However, I wanted to take some time and urge everyone to exercise caution by painting what may be a doomsday situation though I feel this may not be far from the truth.

Firstly, is it the right time to invest in Real Estate when transactions seem to have slowed down and it seems like there are very few other buyers in the market. While it may seem that in such times, you get good deals let me share why this is not the case.

The primary risk with buying finished property in such times is ‘completion risk’. Many real estate developers have borrowed money to acquire land and need to sell at least 40-50% of their total units to break even. As their borrowing cost increases with every passing year and interest accumulating, they need to sell even more – probably 80% to break even. Keep in mind that many developers conceptualised grand projects with over 100 units in each building, this is a tough task and requires maybe significant compromises to fit the consumers wallet – either in price or in the quality of end product delivered.

With slow down in sales, many developers will go bankrupt and never complete their projects and the not so unethical ones will delay completion and try and front load bank repayments and free up other assets which they might have mortgaged in the hope that as they go towards 100% sales, they will get capital to complete the project.

In many other cases, the initial excitement of selling 10-15% of the units was spent in heavy marketing, trade shows and print advertising expenses – with the plan that a few such ads would sell the rest of the 85% units making everything hunky dory. Now with a slowdown in sales, lots of developers are out of pocket with the 10-15% and have not sold the 85% – a double whammy.

What do you do then?

In such an environment it makes sense to:-

1. Buy only undeveloped properties for investment purposes – i.e. to buy land in a mature locality where you can wait for the land to appreciate and are not subject to handing over large sums of money to someone on the promise of him developing something for you.

2. Wait for a while – until sales velocity improves and then only touch real estate developers.

3. Buy secondary completed units – from distress investors where the investor may be in distress but the property you are buying may not be.

Any other thoughts?