Key to Profitable Investment in Real Estate

In my last blog, I introduced the concept of “Intrinsic Value” of a real estate project and how it is the key indicator for ascertaining the viability – and potential profitability – of investing in that project. In this blog I explain the concept in more detail, with the help of an illustration.

We established in my blog, “Don’t time the market, Price the market”, that there is always a right product available at the right price. And for a prudent investment decision, this price (or intrinsic value) of the product (read Real Estate Project) must be closest to or higher than the offer price. The key question then is, how do you determine the correct price or intrinsic value of a product?

Pricing is policy, Costs are a fact.

Imagine you are the builder of the project you wish to invest in. Now, trace the process from inception to delivery of this project and it will give you a broad understanding of the key cost heads involved. A more detailed study of the project will then bring you closer to ascertaining the present day cost of the project. Let’s examine an actual project in Dharuhera (name of the project withheld to prevent appearance of solicitation) to illustrate the above. As things stand today, this project:

  • Is ready to occupy, thereby has minimum delivery risk.
  • Is priced at INR 2700-3000 per sq ft.
  • Has more than 50% occupancy, exhibiting clear user preference.
  • Has experienced its share of development problems but they are gradually getting resolved.

Establishing the broad cost heads any real estate project has and taking present day costs in Dharuhera as a rough guide, the present day cost of this project (in INR per sq ft) would be:

Hence, the approximate cost builder would have incurred over the four-year development period of this project is INR 2900 to 3000 per sq ft. As mentioned earlier, this project is available at a price of INR 2700-3000 per sq ft. Clearly, the offer price viz a viz its intrinsic value is in the investor’s (buyer’s) favor and a good call to put one’s money in. As a ready-to-move-in product, the risk of waiting is also gone and there seems to be no promoter’s profit.

If a similar project was to be started today at the prevailing costs, a builder would hardly break even at the offer price of INR 3000 per sq ft. and could not justify his entrepreneurial efforts. Hence, this price is not sustainable and bound to increase in not too distant a future. This essentially means an investor entering at this price point is in all probability set to make handsome profits.

Conclusion.

Do a thorough analysis of the input costs of any Real Estate project you are planning to invest in. Understand how much the selling price varies from the (present day) input costs. The higher the difference (selling price less input costs), the less attractive it is as an investment.

Instead of trying to time the market (which most readers would find terribly difficult to do), price a product. It is a tedious but a potentially rewarding exercise. And then make time your friend to see your investments multiply.