Indians are Over-Indexed to Properties!

Over-Indexed to things which don’t matter !

We did this 4 months before, we will again do it after 6 months. But few budgets leave an imprint and legacy larger than others.

We will touch upon the other aspects of this budget in more notes later but today we wish to just address the elephant in the room.

The big hullabaloo in this Budget is about ‘indexation’ being buried for good. Real Estate and Gold are now brought at par with Equity on taxation (12.5% LTCG) and stripped of Indexation benefits. Albeit the definition of Long Term is 12 months for Equities but 24 months for Gold and Real Estate. Ever since the advent of taxation, Real Estate & Gold has enjoyed favoured treatment.

For those investing in multiple properties (and not using for residential purpose), there is no valid reason for a favoured tax treatment. Government is right in bringing parity across asset classes. In-effect, asset classes have to find place in a portfolio basis merit or return profile and not just basis tax-arbitrage.

Differently put, what was Indexation?

Indexation was a government underwriting that even the worst of your investment calls will appreciate by 4-6% annually. One can argue and say that this was the cost value and not the market value. But finally that cost value also resulted in financial gains (either by way of lower taxes or by setting off losses against other gains). Even if you took the most pathetic calls, without any research or intelligence applied – you were always assured that your money will double in 12-18 years (given the inflation profile of India). And if luck played its hand, you were in with a real deal! This worked like a ‘Fixed deposit’ for lakhs of Indians, with a chance upside possible but with full guarantee that they won’t lose the worth of their money! Club it with other perks of selling one property and buying other to set-off gains, Sec 80C and Sec 54 (deduction of Interest paid for loans) benefits, the setup for property investment in India has always been a fairy-tale story.

Compare this to equity investors. They never enjoyed this implicit guarantee or protection against losses. Infact Equity investors have constantly thrived in an uncertain regulatory environment where the sword of taxes is perennially hanging on their necks.

What did it result in? It resulted in generations of Indians who always believed that Gold and Real Estate are the only two rewarding asset classes. Not because they made huge returns, but because decades of holding gave them virtually tax-free gains. It also made a lot of lazy confident investors. And needless to say, it kept prices high and unaffordable for a large segment of real buyers who wanted a shelter for themselves. When too many investors get in, the real user is the one who suffers. Realty check was much needed.

All this will change for good now. As a nation, we have been ‘over-indexed’ to asset classes which are burdensome, laden with litigations, incur unnecessary expenses pertaining to maintenance etc. In one fine stroke we have been unshackled from the glitter of gold and lure of Land !

If an asset class cannot handsomely deliver over 10% IRR, it won’t make sense under the new tax era of 12.5% LTCG. For assets delivering nominal returns below 10%, real returns will hardly be sufficient to keep the investors interested. Till now incompetent  returns were hidden under the carpet of indexation.

• For those who are completely risk averse and are still scouting for implicit guarantee of preserving ‘real worth’ of money – perhaps FD will be the new avenue.
• For those who are confident of their ability to make the right timing calls – will still continue to be with real estate or Gold, as the case may be.
• For those who are opportunistic investors looking for better buck – will keep rotating between asset classes now that the rotation is tax neutral.

In nutshell, money will get more prudent, calculative and opportunistic. Free lunches and guarantees to preserve your money against inflation is not Government’s job but it has to rest at the hand of investors.

Just to bring that in perspective, all asset classes (Equities, Gold, Real estate) will still enjoy a hugely favoured tax treatment as compared to Salary or Business Income. And that’s one of the big reasons why young India is shunning the surety of salaries or not putting the hard yards for setting their own business but instead moving to the lure of trading. Because the income from investing is still taxed much lesser than salary or business income and gives a huge post-tax advantage. Colour of money is no different if its earned from investing or through business gains. Then why tax that money differently?

We are not justifying this change but just trying to speak aloud the reasoning of government behind some of these changes!

On the ‘indexation’ matter – In the long run, it might just increase fluidity in the property market and people might move money freely and swiftly between different asset classes. Which is good for the overall health of financial markets. We also hope, that it might cool-off the prices for real end-users.

And as a final sobering note to myself, lure of holding physical assets is deeply ingrained in the psyche of Indian investors and perhaps one change wont dramatically shift the scales in favour of financial assets. Nonetheless, it’s a well-meaning step in right direction.