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Tuesday, September 29, 2020

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. 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. It seems like there are very few other buyers in the market. While it may seem that in such times, you get good deals to let me share why this is not the case.

The primary risk with buying finished property at 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 conceptualized grand projects with over 100 units in each building. This is a tough task and requires maybe significant compromises to fit the consumer’s wallet – either in price or in the quality of end product delivered.

With the slow down in sales, many developers will go bankrupt and never complete their projects. The not so unethical ones will delay completion and try and front load bank repayments and free up other assets that 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. They have 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. Which means to buy land in a mature locality where you can wait for the land to appreciate. They 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?

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