Real estate vs banks

Real estate vs banks is the million dollar question everyone is asking now a days in Pakistan . Since last year the banks interest rate has increased upto 12 to 13 % where as real estate growth in most cases is rather slow. So is it not wise to keep your money in the bank rather than investing it in the real estate market and exposing yourself to a certain level of risk?

This depends on a lot of factors the most noteable out of them is your risk appetite. However in this article we will only compare and evaluate the investment potential of these rather than personal preferences.

Safety & liquidity

Keeping your money in bank is obviously more safer than even investing in real estate. Besides safety it also offers more liquidity and your money is always available to you in terms of cash. In real estate however you are exposed to a certain level of risk and besides that decreased liquidity in a slower market.  This safety and liquidity is the only factor where banks come on top without a question.

Capital gains

With higher risk comes higher returns and the obvious winner here is real estate. There are two kinds of income that can be generated from real estate:

  1. Purely capital gains
  2. Rental returns (fixed income) plus capital gains

Let us delibrate on both these types of incomes which can be generated from real estate and compare them with interest from Bank.

Purely capital gains

If you are investing smartly you can earn more than 20% per annum in real estate some thing which is impossible when it comes to banks. Our 1 crore challenge revolves around the same idea as well. Now it may seem that there is not much difference between 12 and 20% , however when we apply the compound formulae the results will surprise you.

While the difference of just 8% seems negligible to start with but over time it becomes a mammoth. A 12% per annum will only give you 29 crores in 30 years over an initial investment of 1 crores where as the same investment will give you a whopping 2.3 billion at 20% in real estate.

The difference is even more remarkable if we calculate at 30% which may be very hard to achieve consistently but it is still a possibility with real estate and you can accumulate 26 Billion from just 1 crore in 30 years.

Rental income plus capital gains

Now let us draw the next comparison and for this we will assume that you will get 5% annual rental yield with 20% increase in rentals every 3 years. Although there are some areas which are giving higher rental yields such as luxury apartments with 7 to 8 % rental returns as well. If your rentals increase by 20% every three years we can safely assume that the capital gains also increase by 40% every 3 years. For easier calculation we will calculate this on a period of 9 years.

Mr. A who put his money in the bank made 2.7 crores in 9 years from now.

Mr. B who invests in rental earning real estate makes following:

  • Rental returns of 54 Lacs in 9 years.
  • Capital gains of approx. 1.74 crores ( Calculated at 40% every 3 years)

Now you will think that Mr. B total net worth will be initial capital plus rental returns plus capital gains in 9 years which amount to 3.28 crores. However that is not true because the rental income unlike bank interest can be taken out and invested further in real estate so the actual formulae for total gains will look some thing like this :

Rental returns + capital gains on rented property + capital gains on properties purchased from rental income

So to make it easier lets assume that this time Mr. A and Mr. B invested 5 crores each in a bank and real estate respectively and see how things may turn out for each of them.

In 9 years Mr. A will end up with only 13.7 crores.

Mr. B will end up with following assuming that he further invests his rental income at 20% per annum capital gains:

  • 2.7 crores of rental income as under
    • 25 Lacs per annum for first 3 years ( reinvested in real estate for 8,7 and 6 years)
      • 1.07 + .89 + .74 = 2.7 crores
    • 30 lacs per annum for next 3 years (reinvested in real estate for 5, 4 and 3 years)
      • .74 +.62 +.51 = 1.87 crores
    • 36 lacs per annum for last 3 years  (reinvested in real estate for 2 and 1 years)
      • .51 + .43 = .94 crores
  • 8.7 crores of capital gains
  • 5 crores of actual investment

So Mr. B will end up with 19.21 crores after 9 years. This figure is significantly higher than the bank interest.

Yes, in real estate everything is not a 100% so while you do have a chance of earning less than the above example you also have a chance of earning more if you invest wisely. However at an average we can safely assume that we will easily earn quite a bit more from what we get from the banks with a very high probability of earning a lot more.

Tax benefits

Your income on real estate in terms of capital gains is non taxable if you sell your constructed building after 4 years or empty plot after 8 years. However income you earn from banks is taxable and depending upon your tax bracket it can save you millions over years.

PKR depreciation

There are a lot of constructed buildings which do not loose value over time such as commercial buildings or luxury apartments which have a lower depreciation over time. When the PKR depreciates the cost of construction goes up thus increasing such properties in value as well. Even plots cope up with PKR depreciation over time but that effect may not be very visible and often just get confused with a normal market high. Thus investing in real estate is a hedge against PKR depreciation.

However when you keep your money in bank you do not get any of such benefits.

The counter argument

This blog would be incomplete without putting the counter argument in perspective. The counter argument usually revolves around the idea that real estate is too volatile and a lot of people keep losing there money and achieving 20% annual growth is subject to a lot of risk. As Steve Jobs once said that we can not connect the dots moving forward but we can connect them going backwards. So lets evaluate two people one of whom invested in real estate 10 years ago and the other put his money in bank and although at that time the interest rate was not as high as 12% but we will give that benefit to the banks and calculate it at 12% annual.

We cannot connect the dots moving forward but we can connect them going backwards.

Steve Jobs

Assuming that both these people invested 1 crore and we will further limit our real estate investor that throughout these 10 years he cant trade so he has to remain in one single area through out this period.

Mr. A who invested one crore in bank made a total of 3.1 crores till 2019.

Mr. B who invested in real estate made 5 to 6 crores till 2019 depending on where he invested :

  1. Phase 6, 2 x 1 kanal plots at 50 Lacs each in 2009 are now atleast 5 crores.
  2. Phase 8, 3 x 1 kanal affidavit at 33 lacs each in 2009 are now atleast 5 to 5.5 crores.
  3. Phase 9, 7 x 1 Kanal affidavit at 15 lacs each in 2009 are now atleast 6 crores.

You can calculate these averages for other areas as well by comparing prices in 2009 vs 2019. It is possible that some areas did not give as high return as the ones I quoted above but even the worst areas can easily beat the 3 crores made by keeping your money in bank.

So my question is that if you have a chance of making twice as much money as the bank can offer even today why keep it in the bank anyways?

The obvious

No pain no gain, real estate is not as simple as keeping money in banks and you need two key ingredients:

  1. Consistency and faith in your plan.
  2. Efficient portfolio management.

This is exactly where our 1 crore challenge kicks in, think about it, you can make twice as much in real estate than in a Bank even if you do not actively manage your investments. So how much can you achieve if even this investment is managed properly and efficiently. We have constantly been achieving 30 to 40% for more than 2 years in a row now in a market which is supposed to be bad for real estate.

The final verdict

Investing in real estate is without a doubt a better choice and will give you much better returns than keeping your money in banks. Even if you require steady income rentals are a much better option with a good potential for capital gains. Real estate capital gains are not steady and happen in cycles, so a property which  has not gained in 2 years may gain 100% in the 3rd year. It is therefore hard to enter into a trend or predict it with 100% accuracy but we can surely manage and trade within these cycles to get even higher returns.