It’s the -ber months once again! Indeed time flies, when Juan is having fun. Or just too busy perhaps building passive income streams? Lately, the charitable Ilocana and I have been doing some window shopping and road trips, trying to familiarize ourselves more with how the real estate investments work, particularly house and lots, or condominiums, or apartments for sale, possibly for long term rental income or the glamorous AirBnB. Sharing here 5 key lessons we have learned, so far.
1. RIGHTS ONLY, TAX DEC ONLY
If Juan is looking for real estate, Juan will surely encounter relatively cheap offers for a piece of property, and when Juan probes deeper as to why it is cheaper versus comparable properties, the caption reads “rights only” or “tax declaration only.” Which means the property is not yet titled, that is why it is relatively cheaper.
With the limited reading I did, “rights only” would mean the seller has the right to use the property, a right bestowed by the owner, but not necessarily ownership. The government could have given the rights to a vacant lot to certain people for them to use for now, but should the government need that piece of property back, the occupants will have to be relocated, and I don’t think the government will pay them for that property since the occupants did not own it to begin with. At least that’s how I understand it. Care to share your legal expertise?
A title would signify ownership. Some sellers would also say the property is title-ready, which would mean the title is not yet existent (or is named under former owner) but ready to be transferred to the buyer. Or when it was bought previously, the transfer of title was not completed so all they have is the old title, deed of sale, tax declaration, etc, but no new title named under the seller.
Though I find buying properties with rights only very tempting given the lower prices, I am hesitant to do so because I’m risk averse like that. I’d rather focus on titled properties, as I have mentioned in Investing in Real Estate P.R.O.P.E.R.L.Y.
Mind you, some occupants have held the rights to a property for decades and built their homes and families in it, but they were never evicted or relocated. Lucky them. And some people do buy properties with rights only, then they will just process the titling themselves, or keep it as rights too. They are aggressive investors like that. So up to you if you want to take such risks. Banks will also not finance properties that are not titled, given my limited experience.
2. CASH BASIS ONLY
Speaking of bank financing, there are also many sellers out there who will indicate “cash basis only” or “no to bank financing.” Of course sellers will have their own reasons but the top 2 usual reasons are (1) the need is urgent, they can’t wait for the bank process; or (2) they are not familiar how bank financing works.
Basically bank financing (and other financing firms) work like this:
- Bank will verify the title with RD and appraise the property value
- Bank will assess capacity to pay of the borrower/s
- If 1 & 2 are ok, then bank will approve up to 80% of the property appraised value or selling price, whichever is lower. If property is from unaccredited developer or 2nd hand, the ratio can be lower at 70% or 60%.
- After approval, bank will issue letter of guarantee (LOG) to the seller, saying borrower is guaranteed of Pxx amount to buy the property, subject to title being transferred to the buyer’s name.
- At this point, seller will have to give the title and other property documents to the buyer or the bank to expedite title transfer. Seller has the LOG though as security that he will get paid.
- Once title is transferred to buyer, Bank will release the loan proceeds to seller. The balance will have to be settled by the buyer to the seller separately.
Well it is true that bank financing can take a while, like 1 to 3 months from loan application to title transfer to release of proceeds to seller, but the usual bottle neck is the title transfer itself which is handled by various government agencies, not by banks. And of course, in bank financing, the financed amount is max 80% of the appraised value of the property, so there’s also the concern that the appraised value is significantly lower than the selling price of the property.
Bank financing has advantages, especially for buyers which don’t have sizable liquid cash to buy properties in cash, but have steady cash flow in the future. Further, even if the property for sale is on a cash-basis, I don’t think there is any buyer out there who will give the lump-sum cash upfront, then process the title transfer after the fact. It will be more like pay an earnest money or reservation fee, then complete the down payment, then agree to pay the balance in tranches, while the title transfer is ongoing. In that sense, buying in cash vs in bank financing is still very much similar in terms of cash inflow to the seller.
For more on home loan financing, click here – 8 Easy Steps to Get a Home Loan
I’m sure you’ve heard sellers, sometimes agents, saying buying the property can be self-liquidating, meaning the income from the property can pay for itself. There’s truth in that, but not all the time. And you have to track your expenses to really determine whether the property is self-liquidating.
Case 1. You have P5M in cash sitting in your bank account then you bought a property at P5M (+ all fees and taxes). In time, that property appreciated in value (like buying a stock that went up). In that sense, it has paid for itself because in terms of your personal SALN, your P5M cash was just re-categorized as P5M property, add to that the higher value due to property appreciation, you can be net gain (net of expenses). Or if this property is earning you rental income, then it can be self-liquidating in that sense. Your P5M investment is intact (or higher due to appreciation), then your rental income is sort of monthly dividends. Very nice. In this case, buying in cash is a great option but we all know very few of us have P5M just sleeping idly in our bank accounts. What most of us have though is cash flow.
Case 2. You bought a condo at pre-selling, prices went up over time while construction is ongoing. Come turn-over, you avail bank financing, for a 30-year loan tenor (goodluck with that!). You wanted long tenor so amortization is very low, say 8K a month. Then you rent out the property at 18K a month so you have a neat P10K profits every month right? Not so fast!
Well, paying 8K for the loan while getting 18K rental income may indeed seem self-liquidating, but you have to remember that you loaned the money from the bank. As such, you have to incorporate how much of the principal balance you are paying off every month (because majority of that 8K goes to interest for a 30-year loan). Go get a loan calculator!
Likewise, remember that you cashed out for many years during pre-sell stage, so you also have to include that in your investment to compute whether you are indeed getting return on investment (ROI). Compute how many months it will take you to recover the pre-sell amount + your monthly loan repayments.
Case 3. Say you were more financially savvy, so instead of very long term, you made the loan tenor 10 years only. You still pay interest but much less vs 30-year loan. Say your amortization now is P30K while rental income is only P18K. So you’re short of P12K a month. Not self-liquidating anymore right?
But I still own the condo that has appreciated in value, that must count for something right? Well yes, in your personal SALN, you still got more assets than liabilities, plus the rental income, but soon, the condo will depreciate in value and it will be less and less of an asset in your books. Likewise, note that the selling point is it is self-liquidating, but you’re holding real property which is not liquid, so to make it self-liquidating, you will need to unlock the value appreciation in your property by making it liquid — in short by selling it.
So for me, the trick will be, get a pre-sell condo, rent it out upon turn-over (the closer to the loan amort of a short-term loan, the better), then before the 5th year, sell it at market value. I would think you will come out as net gain if you do this considering the rental income plus property appreciation less all loan repayments. Otherwise, once the condo unit market value stagnates or even drops due to depreciation, your loan balance might still be too high, while the rental income might also diminish as well.
But take note that while you’re renting out the property, you are actually not earning, abunado ka pa buwan-buwan. Your only consolation is that the market value of your property is higher than how much you bought it, assuming you sell it before it starts losing value. If you can rent it out at higher price than loan amortization, much much better.
In this regard, I find investing in a piece of land, house and lot, or in an apartment more appealing. Basically same thing, your rental income might not be big enough to cover for your monthly amortization in a loan, but at least you own the land and property for good, then land appreciates in value, the improvements might depreciate over time, but it’s inevitable anyway. Over time, you can increase the capacity of that land by adding more units for rent (from 4-door to two-storey 8 door). It is difficult to do this in a condo sustainably.
Our condo seller friends might argue that you also own the condo unit perpetually, but so do the thousands of other owners in the condo, so when the time comes that the building will have to be demolished, there will be thousands of you to decide on what to do, or thousands to share on the proceeds if majority decide to sell the piece of land where the condo used to sit. But who knows right? This will be decades from now anyway! Let our grandchildren solve it!
Aside from “rights only”, there can be other reasons why the selling price seems too good to be true. Some that we have encountered are as follows:
- Apartment for sale, picture used in the advertisement was the old picture, when we saw the actual property, dilapidated already, or occupied by informal settlers
- Repossessed property in a well known village. Almost half the price. Upon checking, there’s an ongoing case filed by the former owner to the repossessing bank. Worse, there are instances when the former owner is still residing in the property! LOL! But mind you, there those who buy properties even if there is an ongoing case and dispute. I don’t recommend it though for beginners.
- Vast farm land, 500K for 10 hectares! O c’mon! Where do I sign? I’ll swipe my credit card now! Upon asking the seller though, land has been converted by virtue of CARP, already for redistribution to landless farmers. What a downer that was!
- Flooded, haunted, selling the land value only, structure will have to be demolished
- Property has been subdivided already, selling the mother title but there are “owners” claiming portions of the property
- 50sqm condo unit loft-type for sale fully-furnished, appliances and furniture included. Very nice in the pics! Earning P20K rental income. Promising! When we checked, either condo has no elevator and unit is on 5th floor, or condo is 15 years old already or both! If selling for P2.5M, buying it in cash will mean it will take 125 months of rental income to recover purchase price or almost 11 years. ROI in 11 years. Worse, longer ROI if availed via bank-financing but banks require shorter loan tenor because property collateral is not brand new. By then the condo unit is already 26 years old, so your gain is actually in the residual value, if you can still sell that property at a good price.
- Price is net to seller. Buyer will shoulder all the fees and charges. By law, capital gains tax of 6% is shouldered by the seller, but either seller just jacks up the price by 6% more, or sell at Pxx price now, then buyer pays for everything. There can be many ways to do this really. Recently, there’s also E-VAT for properties selling for P3.2M or higher. That’s additional P500K. Whew! There are really many expenses involved in just transferring the title, no wonder some don’t bother with the title transfer anymore.
Hey don’t get me wrong. It’s not wrong to get into real estate, especially if you’re in it for the long run. Just don’t expect it to be glamorous like you’re getting more income per month than expenses, especially in the short-term.
5. UNSOLICITED ADVICE
Some advice we got from sellers / landlords, usually we ask them why they are selling, is there something they know that we don’t, that’s why they want to dispose the property? Most just really want to liquidate it, unlock the appreciated value over time. Most need cash. Some more tips as follows:
- Usual reason for selling is the owners are too old now, and they’re tired of managing it. The children or grandchildren who are arranging the sale don’t want the property either. I guess we can’t relate as of now since we’re looking for rental income ourselves. Maybe it really gets tiring after some point, it’s not just rental income you’re getting but the headaches as well of various issues from tenants who cannot pay, who cannot tolerate their neighbors, who don’t take care of the property as much as you would because it’s not their own, or tenants who have unsanitary habits. Worse illegal acts.
- Don’t get too excited with new tenants. You must have “scrutinizing eyes” as Mang Boy would say. Some are too eager to rent because they have nowhere else to go, they have bad records somewhere, or they have illegal activities and need a private place to do it. ASAP. Did you hear about the marijuana plantation found in a rented room? Complete with UV rays, aircon, artificial rain etc? LOL.
- You will be on call by tenants for millions of reasons (especially if AirBnB). Faulty wiring, clogged drainage, flooding, broken windows, can’t locate the area, etc. I might be good if the apartment or property you are leasing is near your place of residence so you can check it out immediately. If not, it might be good to have friends near your property for lease so you have a sort of caretaker, or a pair of eyes who can look after your property while you’re faraway and unavailable.
- Don’t scrimp on the property, keep it well maintained, clean and safe. Tenants are willing to pay a premium if they see that the space for lease is worth it, and that the landlord is reasonable. Also, it makes it look always new and well-maintained.
- Doing AirBnB for your property can be more tedious because you have to clean it and maintain it after every short-term tenant, so proximity or having a caretaker is a must. Plus you shoulder the bills. Compared to renting it out for 1 year, the tenant will have to do the daily maintenance on their own, and they shoulder the bills. AirBnB though can make you earn more (or less) depends on the season and location. There’s upside and downside. Whereas for usual rental, income is fixed and more predictable. But tenants can miss payments too.
- Per some landlords, they prefer AirBnB because the tenants take care of the furniture, because they are there for the short-term only, and they are rated and evaluated by the unit owners. Whereas long term lessors, sometimes, are more prone to misusing the property, as if they own it, destroying the furniture, drilling holes everywhere, tarps and plastics everywhere, clogging the sink and drainage, dirtying the walls etc. So, pick your poison!
In summary, investing in real estate property for possible rental income can be rewarding, and there is a big market out there because commute to work is just hell for most of the time. It has its own share of responsibilities and headaches too, though, and it is not for someone looking a quick bang for the buck, it will not be quick ROI. It is for someone who’s willing to wait it out and sit it out for the long haul. Might as well try stocks if you want high adrenaline income (or loss) potential. Good thing though, property appreciates in time, especially for land properties, so you don’t lose part of the value of your property due to depreciation.
Like in any business or investment, it must be something you like doing and you are familiar with it because it will be challenging, and there will be days that you find it not worth your while or not worth the future headaches.
Have your own landlord or lessor stories? I would like to read about them here!
May you have a richer life!