Investor’s Query: Both the growth avenues of investment, real estate (residential house/apartment/commercial space) & direct equity portfolio generate some income in the form of rental yields and dividends respectively. But don’t you think rental yields are more stable than dividends. Example, residential house/apartment worth Rs. 1 crore can earn a rental yield of Rs. 25,000/- per month but stock portfolio of Rs. 1 crore might not earn that much dividends! Don’t you think real estate is the definite winner here?
Gerard Colaco: I’m afraid not. Dividend yields on stocks are much more stable. Rental yields on real estate are very misleading, because what you see is certainly not what you get!
First, no one sets off expenses against the rental yields, so what you are looking at is the gross yield. When property taxes, repairs, maintenance costs including civil works, plumbing and electrical repairs, periodic painting, renovation, contribution to common expenses and sinking funds (in case of apartments and commercial premises), expenses in rental documentation, etc., are taken into account, rental yields on residential apartments for example, can fall by 30 to 40%, if not more.
Second, you are assuming that the property will always be tenanted. But in real life, there can be months when a property lies vacant. The present period is a good example. Because of the excessive stock of properties, it is increasingly difficult to get tenants for apartments and houses. And because of the economic slowdown, it is very hard to get tenants for commercial properties.
Third, you are assuming that all tenants are satisfactory. In fact, they are not. Right now a client of mine who has let out two shops told me that over the last three years both his tenants were highly unsatisfactory. They did not pay rent and he had to engage the services of a lawyer to evict them. These costs and losses must be taken into account to arrive at the true rental yield.
The second and third points above expose the instability of rental incomes. On the other hand, in a well-diversified portfolio of sixty or more stocks, there is no question of the portfolio not producing a dividend.
Fourth, it is absolutely wrong that dividend yields on stocks are not stable. In fact, they are very stable. It is stock prices that are volatile, not stock dividends. For example, from January 2008 to April 2009, in the wake of the global financial crisis, stock prices fell by 60%. But stock dividend yields fell by 10%, over the next year. But the year after that, they were back to their previous levels and thereafter, actually increased. On the contrary, the problem in the property rental market has been continuing for the last four years.
I would say that real estate is the definite loser here.