REAL ESTATE AS A BUSINESS?

Joyce, the wife of the OFW whose husband remits to her $300 or PhP15,000 monthly wants to consider just buying real estate as an investment. She understood from our last talk that she should not invest more than PhP7,000 in real estate so that she can spread her risks.

Her cousin, Tina, is offering her a piece of land in her province as an investment. It is 1,000 sq.m. for only PhP400,000. Her cousin is even willing to accept installment payments if she just makes a 10% down payment of PhP40,000. Joyce has the money for the down payment because her husband just received a bonus.

Tina is willing to accept payment for the balance of PhP360,000 at the installment payments of PhP7,000 per month for 5 years or 60 months. This is actually equivalent to paying Tina an interest rate of only 6.24% p.a. for the PhP360,000 balance due. Tina told Joyce that this is a good deal because the property is well located and there are talks that prices will at least double in five years (this means that the value of the property will increase by 14.4% per year) because the area will be developed very soon. Tina can’t wait for the development because she is getting married and living abroad. The monthly installment is something that she wants to give to her parents as a monthly gift because her husband will be giving her the same amount to give to her parents anyway.

My comments are:

In terms of the money involved the deal does look okay if Joyce is able to:

Make sure that the PhP15,000 or at least PhP7,000 monthly remittance of her husband will really continue for 5 years and that she will have no other need for it except to pay for this property.

Investigate with the Registrar of Deeds that the value of property recently sold in the area to be really at least PhP400 per square meter.

Check out that the Transfer Certificate of Title (TCT) is clean and that it really corresponds to the property that was shown to you.

Visit the property to see that it does not have any squatters. Joyce will be paying less than the Php15,000 that she has available monthly so she has the budget to pay for real estate taxes and other expenses to maintain the land free of “talahib” and future possible squatters.

Ensure that the TCT can readily be transferred to Joyce after full payment considering that Tina will already be living abroad. Joyce should consult with a lawyer on this.

Joyce should try to understand if there is real basis in expecting the value to double in five years. She should verify from the local government whether or not there are approved infrastructure developments in the area and how long it will take. “Chismis” can never be reliable. She has to go there herself and check with the Registry or Deeds and the companies who will be developing the area.

However, even plans of big companies can change. Then, she has to make an educated guess if the future increase in value will give her returns that are at least higher than the average annual inflation rate of 7%.

If the property appreciates by only 7% annually, which is the average increase of property values, then the sales value of the property after five years will be PhP 561,000 or PhP527,000 after a 6% capital gains tax. This will mean that the effective return of this investment will only be 5.1%. This is lower than the average inflation rate of 7% and is therefore not that attractive as an investment

I need to remind Joyce that land, as an investment, is generally an illiquid investment. It is something she cannot sell very quickly if she needs cash. In this case, she can only sell the property after she has completed her installment payments and the TCT has been transferred to her. Again, this is an issue that ought to be discussed with Tina and the lawyer before the down payment is made.

In this case, she should be able to sell the land at PhP600 per square meter after five years if she wants to make a return equal to at least the inflation rate of 7%. She must remember that she will have to pay for the transfer of the TCT (about 2% of selling price) after she has completed the installment payments. Also she has capital gains tax of 6% when she sells the property.

If Joyce is able to find other uses for the real estate to give her income, she should include that income in the computation of the returns she has derived from the property. This would of course improve the return on that property investment.

Let us assume that there is a small building on the property that Joyce has been offered for the terms given above. Let’s say that Joyce has the option to rent out space in that building. In such a case, when she estimates her rental income, she should remember that she has to deduct the following from her rental income:

Cost of daily maintenance if there will be more than one tenant in the building as there will be common areas.

20% vacancy rate. This means that there will be no income for about 2.5 months per year.

Cost of major repairs of the building

Possible non-payment of rent by the tenants.

In addition to real estate tax, municipal permits and income taxes.


I also told Joyce, for her information that others also buy real estate to develop into buildings to rent, sell or into condominiums. However, these involve bigger capital and a lot more serious business management expertise.
Article:
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