We share the article released in Apertura.com where Mariano Capellino, CEO of Inmsa, informs the reasons that may prevent you from obtaining proper profitability when investing in real property.
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The error of “falling in love” with a property and postponing its sale time
Major investors in the financial market obtain profitability through the implementation of an active strategy. For that reason, they do not tend to fall in love with any investment and assets are purchased and sold periodically, seeking the best return.
But that is not the case in real property investments. In general, real property assets are purchased and kept in portfolio without rotation for many years even when no value is added to the asset, and, as proved, this action only allows maintaining the property value i. e. protecting owner against inflation.
According to Mariano Capellino, CEO of INMSA, there are certain reasons that generate such behavior and prevent good profitability. These are the 5 most important reasons:
1. On a cultural basis, real property assets have been considered secured assets, thinking that the price of the property will always go up. But it has been proved that the maintenance of property for a long time does not generate any benefits other than protection against inflation. According to public surveys conducted in USA, real property has annually increased value by 3.1% in the last 100 years while inflation grew 3%. Therefore, the real appreciation was 0.10% annually. In Argentina, the real rate was only 1% after inflation, if considering the last 40 years, period during which reliable statistics have been provided.
2. Owners have been led to believe that real property assets, especially Premium ones, never go down and they are always increasing their value. And this is not the case. There are specific examples of real property maintaining or losing value during certain moments of the real estate cycle. Argentina is a clear example of this: from 2010 to this date, practically no appreciation of property has taken place. If we think that obtaining profitability higher than 10% annually is logical – as it happens with an active strategy- in this period, the opportunity to increase value in at least 50% of the capital has been lost.
3. The concept of giving priority to Premium location established by real estate brokers and developers selling property in these areas is validated. But it has been proved that even this kind of assets is vulnerable to contraction and recession cycles. Spain is a recent example of this. Today Brickel, in Miami, is also showing this situation. In this case, the market crisis is such that the developments sold during construction processes are intended to be sold 30% higher than those of the same category already finished and brand new, which cannot be sold today.
4. In order to quickly rotate property, it is necessary, as in any business, to acquire the it under the market price, otherwise, it would be impossible to sell and obtain some profit and really hard to sell it through traditional methods as a estate broker or developer. To do so, they must be acquired at auctions, banks, through insolvency administrators, law firms or finance developments during the idea conception rather than during the construction stage.
5. There is a belief that if some property value is highly increased at a certain moment, this will be repeated. And that´s not true. High levels of value increase do not usually last more than 5 years and they can experience such an important increment again only after several years. So, the recommendation is selling the asset during that period of time rather than re-investing as has been done recently.
But, what should investors do in order to change their behavior? According to Mariano Capellino´s view, there are key decisions that any real estate investor should consider:
1. Real estate assets should be considered as inventories or as a financial instrument which means that there must be an investment strategy to maximize return. For that reason, it is important to acquire the property under the market value and establish an exit strategy, asset sale, based on the returns derived from rentals and asset value recovery. Then, sell it and re-invest in property enabling the investor to obtain the desired return.
2. Assets with a strong potential for value recovery and at a price lower than the replacement cost must be acquired.
3. It is necessary to buy the asset under the market value, as the purchase and sale costs affect profitability when maintained during short periods of time. It is convenient to buy them at least 15%-20% under the market value and this is usually possible through auctions and banks with unpaid mortgage portfolio when the market is low or when the supply exceeds the market demand. Or by financing developments from the beginning when the real estate market is in the cycle recovery stage.
4. The assets must have an efficient operational management during the possession period by adding value either through improvements, getting better revenues stream from business assets or by creating a feasible project in the case of lands.
5. Timing, Timing, Timing. Buying the best location is not the key. The important thing is to identify markets and assets which are undergoing the recovery process in the real estate cycle in order to ensure a strong appreciation during the subsequent 3 to 5 years, as it has been proved that an opportunity window with these characteristics is generally opened throughout a period of 15 to 20 years in a market.
By means of these strategies, you will obtain at the purchase moment the same benefit usually obtained with a developer after investing in a project and waiting for about 4 years plus any related risks. In 20 years it is possible to multiply 5 and 10 times the initial capital instead of obtaining the double of its value if a passive investing process is opted for, as most of “investors” do.
If you want to acquire real estate to live in, you may possibly pay more than it is worth and you keep it during many years regardless of its value until you sell it. But when you invest in real property, you must consider it as a financial asset and seek the best return possible taking advantage of the opportunities in the market. That is the only way to make good capital investment.