Vivek Kaul: Real estate, data, stories, and stories that sound like data

In fact, I have just finished reading a very interesting piece by the economist Ajay Shah in the Business Standard newspaper. In this piece Shah writes: “If we generously assume each individual uses 100 square metres totally (across residential and commercial), the land required for the full population of 1.4 billion people is 4.2 per cent of the Indian land area."  

In fact, he had written something similar in a piece he wrote for The Economic Times in May 2013, in which he had said: “If you place 1.2 billion people in four-person homes of 1,000 square feet each, and two workers of the family into office/factory space of 400 square feet, this requires roughly 1% of India's land area assuming an FSI of 1. There is absolutely no shortage of land to house the great Indian population." (That’s a cumulative advantage for you, or the trouble of remembering random things you end up reading.)  

The point that Shah is making is that India has enough space to house its millions. So, the argument around India’s huge population driving up housing prices doesn’t really work. And that being the case, on an average, real estate as an investment doesn’t make much sense.  
It’s a perfectly logical argument to make—something I have been doing for many years—but the trouble is that people don’t make investing decisions looking at data. They make investing decisions hearing stories or what sounds like data but really is a story.  

Like when I am in Delhi later this month, I am likely to be told that home prices in Dwarka—an area where my father’s extended family lives—have gone up by ten times in the last 22 years. So, what used to cost ₹25 lakh in 2002 now costs ₹2.5 crore. (Of course, the underlying idea would be to tell me all over again, beta, you missed out, but I had told you so.)  

Now, on the face of it, this sounds like perfectly good data. But is it? How much does the compound annual growth rate or the average yearly rate of return work out to? Around 11% per year. Isn’t a rate of return of 11% per year good enough? Perhaps, but not really. Why? Because it does not take a few very important factors into account.  

1) The quality of construction of many of these properties is pretty bad. In fact, last November, I was in a cab going from Dwarka to Humayun’s Tomb, which was built in the 1560s, four centuries and six decades back. Pretty much every second building in Dwarka was under a canopy and being repaired. And many of those buildings were not very old. The irony that we were driving to Humayun’s Tomb, which still looked so good after all these years, did not escape us. Of course, all these repairs cost money and thus bring down the rate of return.  

2) There is property tax to be paid every year and a maintenance charge to be paid every month. On top of this, if the home has been bought on a home loan, then there is home-loan interest to be paid.  

While talking about real estate as a good mode of investment, people tend to ignore these important details. Why? First, no one maintains so much detailed data to be able to do the math. Second, the math on its own is not very easy, unless you know how to do it on a worksheet. Third, the human mind thrives on stories and not data. Fourth, everyone likes to see themselves in good light.  

As Morgan Housel writes in The Psychology of Money: “It’s possible to statistically measure whether some decisions were wise. But in the real world, day to day, we simply don’t. It’s too hard. We prefer simple stories, which are easy but often devilishly misleading." 
Given these reasons, it’s just easier to subtract one large number (the buying price) from another larger number (the selling price) and conclude, voila, that a lot of money was made by investing in real estate.  

Which is why if you ever end up meeting any real estate agent in Gurgaon and offer them any kind of logic or data referred to above, they are going to look at you with a mild smirk on their face and say: But babuji, what about DLF The Camellias? (For those who do not know their Gurugram, DLF The Camellias is a very expensive apartment complex based in this satellite city, where the prices have gone up at a very fast pace.)  

Now, this is an excellent example of what is known as the survivorship bias, something I haven’t talked about for a while in this newsletter. As Kit Yates writes in How to Expect the Unexpected—The Science of Making Predictions and the Art of Knowing When Not To: “Survivorship bias… depends on observers focusing too heavily, and usually unknowingly, on the items that make it through some, often unseen selection process, at the expense of those that do not."  

Jason Zweig explains survivorship bias in the context of investing in The Devil’s Financial Dictionary as follows: “As time passes and companies or asset managers go out of business, their returns disappear from many databases, making average returns appear higher in hindsight than they were in reality… Unless the returns of the losers are counted, the long-term average performance of stocks, mutual funds, hedge funds, and the like will tend to be overstated by an average of 1 to 2 percentage points annually."  

While a difference of 1-2 percentage points annually doesn’t sound very high on its own, it can make a huge difference over the long term.  

Yates offers his favourite example of survivorship bias, that of cats falling from buildings and surviving. As he writes, a study from the 1980s found that 90% of cats falling from high-rise buildings survived, leading to the belief that cats have an extraordinary ability to survive such falls.  

In fact, people even thought up some physics to explain this survival. As Yates writes: “The usual argument is to suggest that cats’ ability to arch their backs allows them to – parachute-like – reduce their terminal velocity (the final speed an object reaches when the force of air resistance upwards is enough to counter the force of gravity pulling downwards – not the other sort of ‘terminal’), leading to more favourable landings."  

However, there was a simpler explanation. And that was survivorship bias, as the study only included cats that were well enough to be taken to the vet, not those that died on impact. Or as Yates put it: “As one of my lecturers put it to me when explaining survivorship bias: ‘You don’t scrape many dead cats up off the pavement and take them to the vet’." 

So, DLF The Camellias is like the cat that survived. There were countless flats that were promised but not delivered in the National Capital Region, and prospective buyers lost lakhs or rupees in the process. I wonder why not one real estate investor likes talking about this phenomenon of builders taking money and disappearing or never delivering on time. 

Further, there is more to this survivorship bias. Now, Gurgaon may have been a money spinner when it comes to investing in real estate in NCR, but that’s not true about NCR as a whole. Try buying an apartment built by the Delhi Development Authority (DDA) in South Delhi. Chances are you will get it at a price much cheaper than what it was fifteen years ago.  

And unlike investing in stocks, there is nothing like earning an average rate of return by investing in real estate, given that most people can’t afford to own a real estate portfolio. So, it really depends on what you end up investing in. Also, a wrong investing decision made while investing in stocks or mutual funds can be quickly corrected, unlike in real estate.  

                                                                      ***** 

Stories are stronger than data, especially in the case of Indian real estate, where practically very little data exists, unlike in the case of stocks. Take the case of the NSE 500 Total Returns Index (TRI), which is a good broader representation of the Indian stock market, has data starting from 1 January 1995, and which takes dividends given by companies into account while calculating returns. It has gone up 37 times in the last 30 years and given a return of around 13% per year. A large part of these returns has been tax-free.  

In times of need, a part of the portfolio of stocks can be sold to meet an investor’s needs. In comparison, one has to sell the whole house one has invested in and cannot sell just the drawing room or the bedroom, something that people who believe in investing in real estate don’t seem to take into account or talk about.  

Of course, black transactions are not possible when investing in stocks, given that the end-to-end transaction is reflected in the banking system. This is a major reason that still makes real estate an attractive proposition for many, given the difference between circle rates (on which stamp duty has to be paid) and market price in many parts of the country, though those who benefit from this difference and earn black money, are never going to tell you about the same.  

One impact of people looking at stories (10 times in 22 years) is that real estate has been turned into a financial asset, leading to people buying homes and keeping them locked, in the hope of giving it to their children or selling it at a later date. And this creates a problem. (Now—and I will get a lot of hate for saying this—if real estate is a financial asset which people are looking to flip, then why shouldn’t it be taxed like a financial asset?)  

While India may have a lot of land to house its people, it doesn’t really have enough economic opportunities. These opportunities are limited to around a dozen of its biggest cities, which are proper economic clusters. These are the cities where formal jobs are concentrated, along with the informal jobs that emerge as a result of them.  

This automatically leads to greater genuine demand for housing for people to live in such cities. As John Kay writes in The Corporation in the 21st Century—Why (almost) everything we are told about business is wrong: “Land [or apartments for that matter] is valuable because it offers proximity to commercially valuable collective intelligence." This is an impact of concentration of economic opportunity only across a few cities.  

Now, many individuals looking at real estate as a financial asset only adds to this demand and makes the overall situation more dire than it should be. What doesn’t help is the nostalgia of non-resident Indians (NRIs) who buy homes and keep them locked. 

The storification of real estate, along with the inability and the lack of reluctance of people to look at logic or do the math, makes things difficult for those who want to buy a home to live in it. Of course, all this leads to more homes being built than are lived-in and that adds to pollution both directly and indirectly, making October heat in Mumbai worse than it used to be.  

To conclude, as Zweig puts it: “When forming expectations of the future, investors should make sure their picture of the past hasn’t been distorted." Storification of real estate does precisely that. Which is why it is important to take into account the regular expenses that have to be incurred to own real estate, along with the higher risk that one takes on by investing in it.  

Of course, nothing of that sort is going to happen—at least not at a level where is starts to make a difference to the Indian economy as a whole. As Morgan Housel writes in Same as Ever—Timeless Lessons On risk, Opportunity, And Living a Good Life: “The influence of a good story drives you crazy if you assume the world is swayed by facts and objectivity—if you assume the best idea or the largest numbers or the correct answer wins." And that’s not how the world works.