If you’ve evaluated a pre-launch real estate project - you would have interacted with developers and agents who tell you how ‘perfect’ it is. Premium quality, exclusive price, located in an upcoming locality, major infra projects in the future, etc etc.
But when you’re looking at real estate from an investment PoV - something that is less often discussed is the need to also plan your exit strategy in advance.
Here are a few commonly-used strategies:
1. Buy a pre-launch project and sell at the time of possession.
Pros: This is the period where you get the highest CAGR, because of the risk you’re taking by investing in an under-construction project. The CAGR in 2-4 years of construction usually ranges from 8-10% (translating to an IRR of 15-20%), but can be as high as 12-14% if the micro-market picks up.
Cons: Under-construction projects can be delayed, or worse, stalled. This makes the choice of developer extremely important - it is always preferable to invest in a Category-A developer to minimize these risks. Additionally - selling exactly at the time of possession requires a buyer exactly around the time of possession. If the project doesn’t turn out to be desirable for end-use - you might struggle to find a buyer - reducing your final returns.
2. Buy pre-launch. Keep a price target to sell before possession.
Pros: A short-term strategy ensures that your cash isn’t locked in for a long time. If you time your entry and exit correctly - you can generate IRRs as high as 25% in just one or two years.
Cons: Getting this strategy right involves finding an undervalued project, availability of the right unit, and predicting that buyers will find value in investing in the project halfway through construction. This is a high-risk, high-reward strategy that only experienced investors usually get right.
3. Buy a pre-launch project, take possession and give it out on rent. Keep the option to sell open-ended.
Pros: You can capture the (higher) price appreciation that comes during the under-construction phase, as well as the rental yield (2-3% pa usually) + (moderate) appreciation after possession. Also - rental income means you will get cash flows that will help pay off your EMIs.
Cons: This is a long-term investment where your cash will be locked in for several years. Along with the risks of investing in an under-construction project, you will also have to invest time, effort and money to furnish your property, find tenants, take care of repairs, etc. This will reduce your overall yields.
4. Buy a ready-to-move project and give it out on rent. Sell whenever required.
Pros: There is no risk of your project getting delayed or stalled. Additionally - you will have more information on which projects in an area will give you better rental yields as the micro-market would have developed significantly since the beginning of the project. Rental income will also help your cash-flows - helping you pay off your EMIs faster.
Cons: To rent out an apartment - you will need to spend anywhere between 10-20% of the value of the flat to furnish it and make it attractive for tenants. This will be an additional upfront cost, which will also depreciate over time. Also - if you do not have long-term tenants - you will also need to incur broker costs, and rent foregone if the property is vacant. TruEstate recently conducted a poll about preferred exit strategies in its community of 1,000+ investors. Nearly 50% said that they plan to sell their investments at the time of possession, while 33% said that they prefer to keep their property for rental yield and only sell if required.
You should also consider the following two factors when deciding your investment strategy:
1. Leverage is your secret weapon when it comes to real estate.
Calculate your IRR (Internal Rate of Return) along with your CAGR when comparing strategies. Real estate gives you access to debt at a cost that’s lower than any other asset class - this translates to a comparable or higher IRR as well.
Maximise your loan duration to minimize your cash flow. Target an IRR of 15-20% to ensure that your real estate returns are at least as good as mutual funds or stock markets. Keep an eye out on interest rate trends to ensure that you’re getting the lowest interest rates for your loans.
2. Don’t ignore macro cycles
Irrespective of what strategy you select, remember there are larger macro-economic cycles that are impossible to avoid.
For eg - if your real estate investment has been giving you a CAGR of more than 10% every year for more than 2-3 years - there’s a strong chance that it is unsustainable. Do not hesitate to exit your investment if you strongly feel that it has reached the peak of a bubble.
When you are taking debt, any sudden downturn will be doubly bad for you. Housing bubbles tend to pop when interest rates start to peak, so keep an eye out on that trend.
If the bubble bursts - for a while you’ll be paying high interest rates for an investment that is yielding a low or even negative return.
Remember that there are city-wise cycles as well. Try to understand whether the current cycle in your micro-market is more supply-driven or demand-driven.
Final Thoughts
To conclude - thoroughly analyse your investment in real estate with a data-driven focus - just like you would for any other asset class like stocks or mutual funds.
TruEstate curates, advises and manages a community of 1,000+ real estate investors in Bengaluru. If you would like to be a part of our community, find out more <a href="https://chat.whatsapp.com/L6ATHEfN9bGApZ5sBo8gUW" target="_blank" style="color: blue;">here</a>.
