In an article published by Apertura magazine on line, Mariano Capellino goes over a relevant issue at the moment of investing.
Read transcription below.
The 5 mistakes that even experts make when buying real estate
By Mariano Capellino, CEO of INMSA.
There is a general belief that acquiring real estate is always a good business. Clearly it is not true. Based on the belief that you are doing the best, you make lots of mistakes.
While analyzing the information to be given to the students at IAE Executive MBA program, real estate course, I collected these mistakes. Surely, thinking that they were reasons for success, but they ended up being reasons for failure in real estate investments:
- Thinking that buying on an “off plan” basis is always a good business.
No, it is not true; it is possibly the most common mistake in Argentina. In some cases, when you buy off-plan, it is possible to pay under the market value, even though this is not always the case. Anyway, even paying a lower amount does not guarantee doing a good business.
For instance, for someone who has bought on an off-plan basis in Argentina in the last 4 years, it is highly possible that only inflation has been covered, at the risk that upon a devaluation of the exchange rate, the value of the property comes down and, therefore, several years will be necessary to recover the investment made in US dollars.
Also, when receiving the property, another problem was found. If the investor intended to rent it to obtain some income, he got the unpleasant surprise that the real net profitability from rentals has been almost null in the last four years.
In short, if the investor bought on an off-plan basis, maybe paying a lower amount, that advantage was diluted as he had to wait for 2 or 3 years to receive the property and could not obtain any positive income from rental. Therefore, this method is not always a good deal.
But, don´t be confused. This is not a problem that only happens in Argentine. The same situation takes place in Miami. Due to the foreign investor´s lack of knowledge and the strong incentive in commissions offered by real estate developers, property is sold on an off-plan basis, especially in Brickell – Downtown, up to 40% higher than the value of the unit finished and brand new.
Punta del Este is another example. Those who invested after the year 2010 and are willing to sell today, unfortunately won´t be able to do so without losing between 20% and 40% of the invested capital. And, surely, they bought the property on an off-plan basis.
Definitely, this is not a good way of doing business.
The key to succeed when investing on an off-plan basis is to start during the market recovery phase, when a new cycle is beginning and then, proceed to exit, before the expansion phase euphoria takes place. Thus, you can benefit from the highest appreciation level of the cycle and reduce the risk of being trapped in the correction phase when everybody wants to exit and there is only one door available.
- Believing that acquiring property in a very good location is a safe business
This is another common mistake. Making a good real estate investment is based on timing rather than on the asset itself. Every type of asset, either class A, B or C – from higher to lower value due to location and construction quality – have their moment.
In general, the units situated in the best locations are the first ones experiencing appreciation after a crisis period because they are highly demanded by foreign investors and high-income people. But when they reach their peak value, they reach a plateau and they are no longer good business and, in many cases, if an oversupply or crisis has been experienced, the values are also strongly corrected.
There are many examples of these corrections. For instance: class-A residential property in the best locations of the Federal Capital City and Punta del Este in the year 2002, in Miami during the year 2009 or Madrid in 2014. They are all cases where the best property suffered a decline in their prices, in some cases exceeding 50% of the peak values that had been reached a couple of years before.
It is true that class-A assets experience increased liquidity during recession periods and they can better resist crisis periods and recover their value faster than class B and C property – e.g. Barrio Norte compared to property in the suburbs-. But in this type of assets is also where the biggest bubbles are generated with higher risk of losing money.
In contrast, if you access at the right moment to class B and C, as these types of property fall more strongly in the event of a crisis, many times quite under their replacement cost, the profitability is usually higher than in class-A property, considering appreciation plus income from rental.
- Believing that construction is a big business
For some time now the construction of apartment buildings has become a fashionable tendency, as the construction of paddle courts had been a boom some decades ago. That´s why many Argentinians have become real estate developers. We all have some friend or acquaintance engaged in construction.
A piece of advice: if you are an investor, do not build. Leave the construction work to those usually engaged in that activity. In general, the benefit of the developer of the project is not too high, but, as there is usually a financing process by banks and/or pre-sales or money has been borrowed for the construction, as they do not contribute with much capital of their own or with very little, thus transferring the risk to buyers or to those who lent the money, the return on investment tends to be tempting. But, if you finance the project with your own money, the risk involved is high.
It has been proved that there is a high risk in learning and strong scale economies are required to be able to build.
Anyway, in order to generate high returns sustained over time, the investor, in addition to dealing with the process and taking risks, should move from the construction of one type of asset to another and from one market to another, so that it is possible to take advantage of the cycles, and this is not an easy task.
One single example is enough: in general, the benefit that can be obtained by an investor in a project may be about 25% on investment in a 3-year term, with the uncertainty that the sales may not be conducted at estimated values and terms. Instead, it is better to take advantage of the cycles of the market and invest where there is an opportunity, under the replacement cost, thus achieving discounts on a finished property at the moment of the acquisition and with high return during the possession period. That means, if you are an investor, making a good investment is more profitable than construction.
- Believing that buying property from banks, auctions or developers is always a good business
Generally, the more sophisticated, unaffordable and tempting a source is to acquire property, the easier is to make a mistake. Those on the other side of the counter are aware of this, and they take advantage of investors’ lack of knowledge to increase their benefits.
Of course, precisely those sources are the ones that make it possible to take advantage but, for that, it is necessary to have lot of experience and technical knowledge, much more than that necessary to conduct traditional purchase operations.
Many operators lead investors to believe that by simply buying in this way, they are getting the property under the market value, but, in most cases, they are buying above the market value and there are public statistics that prove this. Is it a good business to buy property from banks and auctions in USA or Spain? Yes, if you have the experience and competence to do it. Otherwise, the error can be very serious.
- Believing that acquiring a super Premium property is the business of your dreams
Suddenly, it became a fashionable tendency in Miami to build excellent quality buildings, by the sea, with amenities, sophisticated and with amazing views. I know individuals that joined others to buy this type of asset in Miami first and then in New York, thinking that as they were very sophisticated and expensive assets, they would experience constant appreciation and would be easy to sell.
Big mistake. Today, in Brickell zone, if sales pace is the same as that in the first semester of this year, it would take 50 years to sell the finished units and those that will be made available for sale in the next 24 months. How is this problem solved? With a general decline in real property prices, i.e. with pure loss. Something else should be considered: buildings sold on an off-plan basis are sold at 6000 dollars per square meter when today it is not possible to sell property at 4000 dollars in similar buildings, already finished and brand new.
What is even more surprising is that these types of towers are now being offered in Puerto Madero at the incredible amount of 7000 dollars per square meter, i.e. quite higher than the same building in Miami and which still remain unsold.
If you want to live in the best place, with stunning views, excellence services, buy the property it. If you want to invest and make money, think about it 7.000 times.