Excellent article written by Mariano Capellino in Apertura.com about 4 mistakes that prove that buying a property is not the same as making an investment.
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4 mistakes that prove that buying a property is not the same as making an investment
Beliefs that make real estate investment become a non-investment process at all.
Investing in real property is still one of the investment alternatives mostly chosen by Argentinians. This will surely be confirmed with the asset declaration system that has been implemented. But buying a property is not the same as making an investment. In general, real estate is acquired but no investment is made at all, even though buyers believe so. These are the 4 most common mistakes which turn an investment into a non-investment process:
- Believing that you may never lose capital when investing in real property
It is important to take into account that when some property is acquired at the market value, the investor starts by losing 10% of its capital because the average cost for title deed proceedings and sale commissions is about 10%.
In turn, if the asset has been acquired during a contraction or recession period and the investor decides to disinvest, he must wait for many years until he can recover value or he must be willing to experience heavy losses. This is a situation that happens in Argentina, but also when acquiring property abroad.
For instance, any investor who acquired homes during the pre-construction period in Miami between 2004 and 2006, experienced in 2009 a 50% drop of the value reached in 2007, and if the investor failed to sell the property in the years 2014 and 2015, period in which he had recovered most of the lost value, he must wait until 2022 to get closer to the values obtained in 2005. That means 17 years at 0 rate and, we are talking about the USA. And, if we consider the opportunity cost rate involved, about 50% of the capital would be lost.
At the same time, if the property has not been efficiently administrated during the possession period, it is possible that due to the low return generated by the rental of these properties, some additional loss might have been incurred by the investor for maintenance purposes. That means that this is not all roses, you must know how to invest, it is not just a question of acquiring a property, even in markets considered safe.
- Believing that return is based only on rental income
This is frequently the case for buyers who acquire properties at the market value and maintain them for many years. Large and sophisticated investors get returns by acquiring assets under the market value and administrating them efficiently in order to generate maximum return from rentals during the possession period and by taking advantage of periods with the strongest appreciation rates of the assets, during the recovery and expansion stages of the cycle, in order to subsequently sell them at the most convenient time, i.e. when rates start decreasing.
In general, also individuals compare the sale price plus the rental income obtained against the purchase price and do not take into account many expenses which significantly reduce the net profitability. When projecting these returns, it is very important to consider commissions in each stage of the process, taxes, remodeling or repairing costs as well as maintenance-related expenses.
- Believing that a successful purchase experience of a property which was then revalued will be constantly repeated
In general, when an investor buys a property and obtains good returns because of the revaluation of the asset over 4 or 5 years, he will naturally seek to repeat the same investment in order to obtain the same result. However, when dealing with real property, this situation is hardly ever repeated.
In general, after several years of strong appreciation in a certain market and type of asset, revaluations start decreasing and, even during correction and recession stages, the appreciation rates become negative.
In order to sustain proper returns, it is necessary to move from one type of asset to another in the same market or directly enter a totally different market during the appropriate cycle stage.
There are countless public statistics in the USA, Spain and other countries in the world, even in Argentina, which prove that when a passive investment is made, i.e. a property is maintained in portfolio for 20 years or more, the real appreciation, after inflation, tends to be 0%. Having said that, there are moments in which appreciations exceed 10% annually and this happens during the recovery and expansion stages of real estate cycles, therefore, the key is to take advantage of such periods and then move on in order to avoid ruining the created value.
Generic examples showing strong appreciations in Argentina: between 2004 and 2008, in Spain between the years 2003 and 2007 and in the USA between 2010 and 2014. Examples of null or negative returns: Argentina: between 2011 and 2015, Spain between 2008 and 2013 and the USA between 2007 and 2010.
- Believing that rental income is obtained simply by considering the rental value and deducting real estate tax.
Actually, when you calculate rental income in addition to the pertinent real estate tax, you must take into account many variables which will finally have an impact on your returns. For instance, vacancy periods, insurance, wealth tax, property tax, maintenance expenses which are paid by the owner in countries such as the USA, as well as commissions to the estate agents, expenses for repairing work and contingencies, administration costs, etc. When including these concepts, the theoretical income generally informed by real estate agents is reduced to half.
On the other hand, it is extremely important to make sure that the rental income and all the above mentioned expenses are consistent with the market value and rental periods must be the minimum ones, because if the property is vacant for more than one month and high costs are involved, the projected rental income is drastically reduced and it may even be null or negative.