Wednesday, February 27, 2013

Arun Excello- My lessons in Real Estate- Moneylife article

My ordeal with a real estate investment in an under-construction property and the lessons learnt I would like to share a real-life experience in real estate investing. In 2007, I had booked an apartment in a premium project called ‘Estancia’, promoted by Arun Excello in collaboration with L&T. The former took care of sales, financing and such while the latter was responsible for the actual construction. It was billed as Chennai’s first ‘integrated township’, located in proximity to an emerging industrial and services hub. Although the project was on the wrong side of the airport, close to the Sriperumbudur area, along with several other projects, the connectivity to the airport by public transport was reasonable. My choice was based primarily on the faith that the construction company, L&T, had an equal stake in the project and, hence, believed it would be completed. Even if it was delayed, I assumed I would get the flat as promised. I now realise that none of these ‘beliefs’ was a contractual obligation or a written commitment given by the builder. Sometime later in that year, I was told that the flats would be delivered by December 2008 and, with a grace period of six months, at the latest by June 2009. Since the builder had promised to pay a penalty of five rupees per square foot per month to me in case of delay, there was some consolation. In other words, delay in delivery would mean that my cost per square foot would be lower by five rupees per month of delay. This was the first instance in Chennai of such a penalty clause by a builder, since closing down of Alacrity Housing. I understand that now it is a standard practice for builders to offer some interest payment, or compensation of some sort, in case of delays. The project was supposed to have six towers in the first phase; I was allotted the flat of my choice in Tower 4. In early 2009, trouble started brewing. Project delays were visible; apparently a lot of NRI bookings were cancelled, after the Lehman Brothers crisis. The builder decided to go ahead with only three towers in the first phase. The foundation for the fourth tower had barely been laid. Thinking that my capital was not at risk, I persisted with my investment, when I should have pulled out of the project. At this stage, I made my first mistake. Around 2011, when a ‘progress payment’ was due to the builder, I was told that the cheque should be made out in the name of a different entity. The initial name was ‘L&T Arun Excello’; now, it was simply ‘Arun Excello’! I found out further that while L&T had constructed the first three towers, the remaining construction was to be executed by Arun Excello. When I tried to make enquiries, I was never told of the facts. The sales people, at some point in time, tried to persuade me to buy a flat in one of the first three towers. But since the flats that were available did not suit my requirements, I refused. I even ventured to make the full payment, provided I was compensated for early payment in a fair manner. Unfortunately, the terms were not suitable as the compensation they were offering was way less than what I had asked for. I skipped their offer. Time elapsed. In January 2013, I was told that they would be giving final possession soon. I was called for an ‘inspection’. On going there, around 40km from where I stay, I found that the lift was not functional yet and climbing 10 floors was a stiff challenge. Still, having done that, I found that they had unilaterally changed the specifications also. They had also changed the parking set up; the partner, L&T, whose name was a major factor in my purchase decision, was no longer there. I sent an email to them complaining about the ‘inspection’, the change in specifications and about their lack of communication about their parting ways with L&T. What I got was a terse reply that my allegations were baseless. They said that they did not invite me for any inspection and that the contract mentions that specifications can be changed without the buyer’s permission. About their parting ways with L&T, there was total silence. The response clearly drove home the concept of ‘caveat emptor’. I had been taken for a ride! Yes, the financial implication of the entire investment is that my liquidity has been destroyed and the final returns on my investment are likely to be lower than the interest on a savings bank deposit for the period. If the project had been delivered on time, I would surely have earned some rental income which would have been higher than the ‘penalty’ for the delay in possession. However, I must say that the project, from a price point of view, is a reasonable one if one were to invest today, and there is less likelihood of prices crashing by more than 20%-30%. The lessons for me are: i) Never trust a builder, however big the name or reputation; ii) Never trust a joint venture; iii) Never book a flat if delivery is not clearly committed, unless you are a pure financier; iv) Do not fall for any sales pitch that is not expressly mentioned in the contract; v) Even if one has to pay a higher price, it makes sense to buy a flat that is ready. vi) Real estate is all about location, location and location. It is better to buy a tiny flat in a prime area rather than a palace in a desert. vii) Liquidity in real estate is a myth. viii) Returns are lumpy, bumpy and uncertain. Anticipation of a location becoming more valuable is a mere guess. Yes, I am aware that most of us book flats at various stages of construction, from launch to ready-for-use. We all want to lock in early because we fear price escalation. Buying the first house is a necessity that demands the least risk. On the other hand, one tends to be less cautious while buying a property for investment. I have come to the conclusion that the measure of due diligence should be no less for a second home than as it is for any other investment. Money has alternate uses and real estate investment is just another form of diversification. There is also a difference between buying a plot of land and a flat. In the case of a flat, one wants to ensure that if one is not going to live there, the rental income will be an important factor of the return; whereas, for investment in land, one has to be patient, speculating on the appreciation in land value alone. While buying a flat, there is also no guarantee about what we see and what we get. We get carried away by ‘model flats’ which often use materials and eye-candy accessories to tempt the buyer.

Monday, February 25, 2013

Dear FM, A plea, as usual..

Dear Finance Minister, It is that time of the year when you execute the wishes of your political bosses in the matter of distribution of money that the government does not earn or own. It is in line with the so called socialistic approach of the Congress party under various members of the Nehru family. You take away money from honest tax payers and give it away to sections of society who you think are relevant. You say that you are alleviating poverty, but I have a right to think that you do this in order to try and protect or grow your vote bank. The GDP numbers do not bother us as much as on the ground inflation does. We are struggling to cope with increasing food prices, increasing transportation costs and rents that take away a big chunk of the salary. The public servant is fortunate that their employer lavishes them with living quarters through their sinecure and somewhere along the way they manage to get land as well as a few homes. The lawmakers have “amended” the constitution to such an extent that we now have sections of society fighting and protesting to get ‘notified’ as ‘backward’. Nowhere in the world would someone fight to be classified as being backward. Now you have made a ‘start’ to stop the leakages in our PDS system, the ‘subsidy’ to fertiliser and kerosene etc by using what forty one other countries have done, by ‘direct cash transfer’ to those whom the government will identify as ‘needy’. Alas, other countries that have done this have had the database of their citizenry in place before they distributed money. Here, we are putting the cart before the horse. A country like ours, with porous identification methods will never get counted. I hope that perhaps some stealing from ration shops and falsification of books by fertiliser companies will stop. Of course, if a few of our elected representatives and those in government employment get hold of some of the money, no surprises. Indians are used to sharing money with the ruling class. I have no issue with this on you. I am resigned to the fact that the government will dip its hands in to the pockets of citizens who earn and pay taxes. Naturally, you cannot touch those who earn, but do not pay taxes. It will be the salaried class that will be the most ‘patriotic’ givers. Companies will pay taxes after the promoters and the executives have had their fill first. We are well aware that no one joins politics or public service merely for the legitimate salary that it offers. A family could make a decent living out of the wages that is on offer, but hardly build legitimate fortunes. Yet, each time we now see the ‘declared’ assets of politicians who stand for elections, it is obvious why they love all your expenditure schemes as well as the authority given to them, which is obviously on sale at a price. And once in a way, some public servant who falls foul of the system, gets ‘raided’ and obscene amounts are found with him. It is another story that we never know the endings of those gentlemen with riches far beyond their circumstances. We can only hope that one fine day, the law will catch up with them, once law itself is cleansed. You do some more arbitrary things that need to be stopped immediately. Stop giving concessions to lobbies of industries. By giving a tax rebate to IT industry, you are only lining the pockets of a few businessmen. It is because of your selective favours that we Indians have a unduly large share of 4% of the world’s top 500 richest persons. Of course, in this 500, politicians are not counted. We do not want you to give tax concessions to builders, who in any case corrupt the system and have made housing in to an unaffordable word. We do not want you to give any breaks to any industry, for it simply lines the pockets of a select few. For a moment, please step back and estimate how much of revenue sacrifice is made by giving huge concessions to a handful of businessmen. If the same amount were instead passed to the poor (here you can classify them whichever way you want since you need the votes next time around) there would be better distribution of money that you dob from the tax payer. I do not buy the argument that any business needs ‘incentives’ to survive or thrive. Entrepreneurs are hungry and clever and do not build businesses solely on government protection. They merely use government protection to multiply their returns. You do this because you obviously ‘collect’ something in exchange for the party you represent. In effect, you are using the revenue sacrifice by the citizens and sharing it between the party and a handful of businessmen. The cognoscenti and the foreign investor (whom we have to please to extend our illusion of solvency) rail about subsidies to the farmers and the illusory subsidy on oil and gas. None of them realise the magnitude of ‘forbearance’ on revenue that is accorded to industry each year through tax holidays and several other tricks. Surely, the amount that a handful of businessmen get, far exceeds the few hundreds of rupees that the entire populace may apparently enjoy. If you scrap the plethora of exemptions that are available, tax collection and compliance would become easier. I do not understand why the Income Tax Act cannot be written in under ten pages, in simple clear and unambiguous language. Do this one reform and you will bounce back. Scrap each and every exemption or deduction. No one wants it. They only create illusions of growth and employment. For example, Infosys or TCS would still be around even if you did not give them any tax breaks. They would have created exactly the same number of jobs that are there today. So, please do not give in to temptations of collecting money for your party and give concessions. In any case, you have sufficient spending under various development programmes and infrastructure projects, which contribute significantly to accumulation of wealth by certain persons. And the Indian citizen accepts graft in many things as a way of life, whether it is speed money or grease. What I say above goes against my grain. I am a fan of meritocracy and capitalism. However, I have realised over the years that it is futile to expect the world to be run on merit. Parasitism is for real and people in power are there to propagate it in the name of socialism and alleviation of poverty etc. I cannot change the politician. What I am seeking is just a better redistribution of what largesse is misappropriated. Going by what wealth we see announced by so many politicians and the life styles of those who are public servants, they do not have to worry about the next few generations on the monetary front. However, some of us on the other side are not so blessed. It would be a good gesture if you left something on the table for the meek (only in the holy book do they inherit). R. Balakrishnan

Monday, February 4, 2013

Of Tax Savings and RGESS

I have seen that salaried people tend to invest in to tax saving schemes or instruments towards the last quarter of the financial year only. Logically, one should be setting aside some amount right from April each year and invest regularly and leave February and March to pay the taxman. I have seen people struggling with cash flows in the months of February and March and in the fight with the taxman, give up on the eligible investments. I am not an expert on taxation. However, what is clear is that if a sum, say, Rs.100,000 is invested in ‘eligible’ securities / investments then that amount could be deducted from the ‘taxable’ salary. In effect if your tax rate is 10% you save Rs.10,000 and so on. Obviously, the best returns come in when the tax rate is the highest. If the tax rate is 30%, then the incremental amount you are spending is Rs.70,000/-. In other words, for an investment that is available at Rs.100,000, you are in effect paying Rs.70,000/-. The newly introduced RGESS is a separate incentive for investing in to equities either directly (provided the stock is part of the 100 share index) or in specific mutual funds launched for this. Since this is once in a lifetime (as of now) exemption, it makes sense to use this only when your income hits the highest tax bracket. And unlike the 80C deductions, here only half of the amount is available as deduction. So, at a 30% tax bracket, it is like getting a 15% discount on the investment. Do not use up this exemption if you are not in the highest tax paying category. To my mind, the 15% discount for a good company stock is welcome provided the price is not too high. I would not use it now. And I would use the money to buy one or two stocks rather than put it in a mutual fund. In the 100 share index, there are some high quality multinational stocks like Nestle or HUL which can be bought. However, I would like to wait for better times (when the markets are a bit less expensive). Since it is going to be once in a lifetime opportunity, why rush in to it at the first year? The other thing about this RGESS is that it is not available if you have dabbled in equities in the past. Only the first timer gets this 15% discount on 50,000/- worth of stocks, ONCE in a lifetime. With the normal 80C, for the salaried, the room left may not be much after the PF contribution of the employer and some term life insurance premium. It is crazy that the GOI still allows deduction on ULIP contribution / endowment policy premiums etc. I would use the 80C fully by putting money in PPF. Life insurance is not a matter of tax deductions. A pure term policy depending on one’s financial situation should be a must. If you are wealthy or do not have any dependents, of course you do not need any life insurance. In India, tradability of life insurance term policies is not yet prevalent. Once it happens, then it is a great retirement investment. Simply buy a life policy with proceeds payable on death only. Sell it off when you are in your sunset years. Till then, life insurance as an investment, does not make any sense at all. All said, savings or investments should not be motivated by tax breaks alone. At some point, a rational government will / should take away tax breaks for investment in stock markets or similar speculative outflows. It is a matter of time before the taxation regime shifts to giving exemption or deduction at the point of investing and then taxing it on maturity or withdrawal. Such a proposal is already in the works. The other issue when we rush in to put money at the last moment is that we could end up locking up our money for unreasonable periods of time. Infrastructure bonds are one such instance. Why commit money for such a long period? There are so many shorter term options. Infrastructure bonds carry default risk, except for the fact that if government owned, the GOI will bail out the company. The only long term investment I would consider is a PPF account. Let us see what the new budget brings in terms of temptations for investments. Surely, the government would like to channelize some of the high savings we have in to spending on infrastructure or other assets for which the government does not seem to be able to find money. This is the last full budget before the next election ( unless we have an early election) so expect some goodies to come in for the salaried also.

Pass backs of commissions on mutual funds

(From a recent issue of Moneylife- IFAs are angry and so are some others with me for this article, because I am promoting an activity that is considered illegal and unethical. I do not find anything unethical in this. The distributors started and propagate this practice. Instead of admitting and stopping this , they blame me for writing about this. ) Mutual Funds: Direct plans & pass-backs 9 comments+ COMMENT R BALAKRISHNAN | 29/01/2013 03:05 PM | Commission-free ‘Direct Plans’ for mutual funds may turn out to be less attractive than they appear Direct Plans, under which you can buy mutual fund units directly from asset management companies (AMCs), have just come into force. They charge you less (since there is no distributor commission involved), which means higher returns. But, for this, it is important to have an understanding of the commission structures, the pass-back mechanisms, etc. Remember, most distributors will pass back commissions in some form or the other. You should add it to your investment, to arrive at your total returns. The practice of pass-back of commissions is a vexed one. At the outset, let me make it clear that I am a proponent of pass-backs of commission by intermediaries to the investor or anyone else who facilitates the investment. I see nothing wrong with it. Unfortunately, some AMFI (Association of Mutual Funds of India) members thought that they could increase the retention of commission for their ‘associates’ by prohibiting the distributor from passing back commissions. Did it prevent any pass-backs? Or did the intermediaries find ways to simply ignore the circular? Or did intermediaries use the excuse of the circular to deny pass-backs to some investors? The answer is a yes, to all of the above questions. Pass-back of commissions is normal. The same is the case for company fixed deposits. In fact, the habit of pass-backs is so entrenched, that I recall that a reputed corporate group would give ‘taxi fares’ in lieu of commissions to those who directly invested in the company’s fixed deposits. The taxi fare would be equal to exactly ½% of the amount invested. Direct Plans are OK for some companies. Most do not like Direct Plans because it seals one route of siphoning money. Many corporates used to ask brokers to give the pass-back in the form of ‘donations’ to their pet charities or by asking for air tickets, holiday vouchers, hotel stays or foreign trips for their families. Some companies go to the extent of asking the broker to provide ‘soft’ support like Reuters/Bloomberg terminals (which cost a couple of thousand dollars a month), buying laptops, mobile phones, etc. In many cases, the corporate would negotiate the commission with the AMC and then ‘route’ it through the intermediary, who would get to keep a fraction of it. Now, with Direct Plans, they will have to find a new justification to avoid it. Perhaps they will engage ‘advisory’ services for investing in mutual funds. Or they can simply play one mutual fund against the other and get some direct kickbacks from the fund houses themselves. Pass-backs have even taken the form of AMCs buying ‘Sodexho’ passes and distributing them to the key officials in investors’ offices. I recall meeting treasurers of financial institutions for investments in some specific funds and, finally, when the investment was made, it would bear the stamp of some unknown broker whom I had never met! This broker had an ‘arrangement’ with the executive in the financial institution! They could easily have given it to me directly. Their return would have been the same. In a Direct Plan, they would get a higher return, since there is no broker. Direct Plans for equity funds should be cheaper by at least 100-150 basis points, since that is the range of commission paid to distributors. If mutual funds only cut total expenditure by ½% to ¾%, it makes sense to go through the distributor and take the pass-back from him. AMCs will try to cheat by reducing the total expenses by less than what they pay as selling commission. I heard, recently, that a fund house was paying around 5% upfront for an investment in a tax-saving fund. If they have a Direct Plan, it means the difference has to be an average of at least 1-½% each year (assuming three-year lock in). If not, they are taking the investor for a ride. Check your numbers before plunging into any Direct Plans. A distributor may offer you a better option and a higher total return.