What's this property's ROI?

Let me share with you my thoughts on ROI when deciding to buy apartments or a house for end use or for investment.

I recently had an American doctor for a client who asked me to find a piece of land somewhere south of Manila. He wanted to build their home on it and we talked about his ideal house whenever the topic comes up during out trip one day. It was a long trip so I picked up several of his ideas of an ideal house.

He says, “You know Ody, my wife and I plan to retire soon so I would like the house that I will build to be as ideal as it possibly can.”

He and his wife then began talking out excitedly about what they had been discussing so far before coming to the Philippines. And then he said, “The only guideline that has to be followed is that it has to have a high resale value so that when one of us is gone and the other that’s left behind decides to sell my house, it will still have commanded a good price. This means that it has to be so designed that in 10 or 20 years, it will not be difficult to sell.

He continues on to say that they already saw a lot of luxury homes for sale designed by foreigners but all of them unfortunately had them designed according to their own idiosyncrasies that no one else would buy them.

Resale value increases ROI. The higher it is the higher the ROI. Let me explain this to you.

What exactly is ROI?

ROI is net earnings or net annual cash flow over total investment.

Let’s talk of net earnings first.

End users (owners who use their house for their own use) would want to determine savings and additional costs related to the purchase. How much additional transportation do I need to pay as a result of the purchase and living in that house? How much will I save in terms of rentals that I pay now in my rented apartment and how much do I have to pay in terms of taxes and maintenance expenses such as anay treatment, repainting and roof repairs? The net positive value may be called net earnings. If the net result is negative then you have a zero ROI.

That takes care of the numerator: Net Earnings.

Now comes the denominator: investment.

The total investment is the purchase cost (selling price plus expenses related to the purchase such as transfer tax, registration expenses, notarial fees) less the expected resale value of the property. The resale value (RV) is however very hard to determine since it depends on the demand for your type of house in the future.

This is where it becomes a bit more complicated. What factors do you need to know to “guestimate” the resale value?

First of all whether you like it or not, houses depreciate. Unfortunately, a house is considered of zero value at 30 years old if made of wood and at 35 years old if made of concrete. This means that you have between year zero to about year 20 upon which you can sell your property for a still reasonably substantial amount.

Secondly, if (and this is a big IF) the house is designed for the future meaning that if it will still be in demand in the long years ahead, you can just simply get the depreciated value of the house at the year you estimate you want to dispose your house. If you want to be technical about it, you can further compute its present value. For practical purposes, don’t mind the present value.

Thirdly, the good news is that land generally tends to appreciate over the long term simply because land is a scarce resource (not unlimited). For purposes of guestimating, you may assume the cost of land will remain the same until it gets disposed.

This doctor for example bought a piece of land for say P6M and constructed a house over it for say P9M for a total investment of P15M. He is familiar with the trend in the US and hoped that the Philippines will more or less follow the trend there and therefore had the house designed according to that trend. He estimates that he may have to sell the property after 20 years.

How much might the resale value be? The house will have depreciated by 4M by year 20 and the land may have increased but he assumes it to be the same at P6M. The resale value would be P3M (9M minus 6M) for the house and P6M for the land for a total of P9M.

His investment (denominator) would have been 6M (P15M original cost minus P9M resale value). This takes care of the denominator of the ROI formula.

For the net earnings, he would have to consider his savings and costs.

Instead of buying a house his option is to lease a similar house for at least P600,000/year. Because he no longer needs to lease a house, this would have been his savings if he opted to buy a house. On the other hand if he bought the property, he would have to spend P40,000/year for maintenance cost netting him P560,000 per year in earnings.

His ROI therefore would have been 9.3%.

Is this good or bad? Well you can compare this with other investment options but considering that this is for end use, I say this is a good enough proposition. Nobody else can appreciate this better than an end user. The doctor and his wife can scuba dive everyday and enjoy their retirement for the rest of their lives. Knowing his circumstances, in my opinion this is the best investment that the doctor can ever make.

If I were a pure investor, will I invest in this property? Considering that I would need to spend for property management on top of the maintenance cost, I don’t think this is a good investment because I have many other options that will generate even higher ROI.

So for buyers out there who want to squeeze every cent out of their investment, please consider first and foremost the resale value of the property before deciding to buy.

That's it! Philippines will not go into recession!

The representative of the independent Bangko Sentral ng Pilipinas Dr. Francisco Dakila Jr , Economics Ph.D. and U.P. Magna Cum Laude working for the Center for Monetary and Financial Policy announced in the 25th March 2009 convention of the Philippines Association of Realtors Board, Inc. that the effect of the global recession on the Philippines has been contained.

BSP is now back to its normal work in the Monetary Board where medium to long term monetary policies are being worked out. This is unlike in the U.S. where under the survival mode the focus is very much still on reversing the contracting economy (estimated to be -2% GDP by 2009) by injecting into the financial system a stimulus package of $700 B.

Although the U.N. has estimated that the Philippines GDP will grow by 3%, the Bangko Sentral ng Pilipinas own estimate is that the GDP will grow within the range of 3.6% to 4.4% in 2009. Compare that to GDP growth of emerging economies of about 3.5%. Filipino businessmen and economists know that the Bangko Sentral ng Pilipinas is an independent branch of government deciding on its own authority and not from dictates of the executive branch of government where announcements are perceived to be self serving.

The reasons for this according to Dr. Dakila are as follows:
1. Non-performing loan ratio has been trimmed down over the last 10 years from double digit ratio to only 4% as of today;
2. Limited exposure of the Philippine banking system to failed U.S. financial institutions;
3. There will be a growth of Balance of Payment this year because the reduction of import costs will outweigh the reduction of exports;
4. While remittance of OFWs will not decrease, neither will it increase because of new markets opening up to skilled Filipino Migrant Workers balancing out lay offs caused by recession in their host countries;
5. P330 Billion stimulus package coming from government and private financial institutions;
6. By risk aversion, the Philippines is perceived by investors to be less risky than emerging economies;
7. Bank Reserve requirement has been reduced only this March 2009 from 10% to 8%. This effectively releases P60 Billion into moneys available for loans and investments.

The bad news is that though our GDP will grow, it will do so at a slow pace until the U.S. economy has recovered. Dr. Dakila says he thinks that the Philippines GDP will grow by 7% when the time comes albeit longer in coming than we would have wanted. He said that back in 2006 he actually thought that the Philippines would grow by this much in 2007 but then the U.S. real estate bubble burst. The rest as the saying goes is history.