Return on Investment in buying a house
Let me share with you my thoughts on ROI when deciding to buyapartments or a house for end use or for investment.
I recently had an American doctor for a client who asked meto find a piece of land somewhere south of Manila. He wanted to build their home on it and we talked about his ideal housewhenever the topic comes up during out trip one day. It was a long trip so I picked up several ofhis ideas of an ideal house.
He says, “You know Ody, my wife and I plan to retire soon soI 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 whatthey had been discussing so far before coming to the Philippines. And then he said, “The only guideline thathas to be followed is that it has to have a high resale value so that when oneof 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 thatin 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 byforeigners but all of them unfortunately had them designed according to theirown 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 totalinvestment.
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 thepurchase. How much additionaltransportation do I need to pay as a result of the purchase and living in thathouse? How much will I save in terms ofrentals that I pay now in my rented apartment and how much do I have to pay interms of taxes and maintenance expenses such as anay treatment, repainting androof repairs? The net positive value maybe called net earnings. If the net resultis 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 priceplus expenses related to the purchase such as transfer tax, registrationexpenses, notarial fees) less the expected resale value of the property. The resale value (RV) is however very hard todetermine since it depends on the demand for your type of house in thefuture.
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 zerovalue at 30 years old if made of wood and at 35 years old if made ofconcrete. This means that you havebetween year zero to about year 20 upon which you can sell your property for astill reasonably substantial amount.
Secondly, if (and this is a big IF) the house is designedfor the future meaning that if it will still be in demand in the long yearsahead, you can just simply get the depreciated value of the house at the yearyou estimate you want to dispose your house. If you want to be technical about it, you can further compute itspresent value. For practical purposes,don’t mind the present value.
Thirdly, the good news is that land generally tends toappreciate over the long term simply because land is a scarce resource (notunlimited). For purposes ofguestimating, you may assume the cost of land will remain the same until itgets disposed.
This doctor for example bought a piece of land for say P6Mand constructed a house over it for say P9M for a total investment ofP15M. He is familiar with the trend inthe US and hoped that the Philippineswill more or less follow the trend there and therefore had the house designedaccording to that trend. He estimatesthat 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 year20 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 (P15Moriginal 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 savingsand costs.
Instead of buying a house his option is to lease a similarhouse for at least P600,000/year. Because he no longer needs to lease a house, thiswould 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 P560,000per 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 consideringthat this is for end use, I say this is a good enough proposition. Nobody else can appreciate this better thanan end user. The doctor and his wife canscuba dive everyday and enjoy their retirement for the rest of theirlives. Knowing his circumstances, in myopinion this is the best investment that the doctor can ever make.
If I were a pure investor, would I invest in thisproperty? Considering that I would needto spend for property management on top of the maintenance cost, I don’t thinkthis is a good investment because I have many other options that will generateeven higher ROI.
So for buyers out there who want to squeeze every cent outof their investment, please consider first and foremost the resale value of theproperty before deciding to buy.