To Buy or Not To Buy - Apartments

Ad in Kantipur of 2013/08/18

Today’s Kantipur had an ad by Vibor Bikash Bank advertising the sale of apartments in Shushri Apartments in Kamalpokhari.   The price for the three types of apartments quoted ranged from 18.5 to 19.2 million rupees.  It also mentioned that 2/3rd of the purchase price could be financed. This blog is to provide you the reader with some analysis so that you can make an informed decision on whether you want to purchase one of these units or not?

I categorize buyers into two buckets: first time home buyer who wants to buy a home and move in and the rest who are essentially looking at these apartments as short or long term investments.   While there may be slight differences in the requirements of the two types of buyer, the analysis that should go before making the decision to purchase would be quite similar.

First you want to get a good understanding of the legal structure of the units being sold in relationship to the entire housing development.  Essentially you want to know the legal set up of the housing development and how the various stakeholders (promoters, creditors, and committed residential owners) rights are defined in the legal structure and how that relationship changes during the various stages of development and ownership transfer.  A study of the legal structure should give you an idea of what you are actually purchasing?  Are you only purchasing the right to live in the specified apartment in perpetuity or do you get proportional ownership on the land on which the apartment resides in some legal form?  This is a very important question especially when the legal realm surrounding apartments in Nepal are not very clear.

Second you want to get a grip on the management of the facility and the costs involved. You want to seek answers to questions such as:  Who is going to manage the facility? What are the common costs including periodic maintenance and how are they going to be apportioned to the residents?  How are these management structure and costs going to change during various stages of occupancy?

Third you want to consider other costs which include property taxes and any insurance costs that might be obligatory in the purchase agreement or which you might consider separately even if it is not obligatory. These are additional operating costs of owning the property.

Fourth, you want to consider whether your disposable income after deducting all your other monthly expenses will be sufficient to cover any financing costs if you choose to finance the purchase through a mortgage.  Even if you were to completely finance it though equity, there is an opportunity cost involved which, at the minimum, is the interest income that you might earn if you were to have left the funds in a fixed deposit. Let us assume that you take them up on their offer and seek financing for 2/3rds of the purchase price of 18.5 million.  This means that you will be taking on a mortgage of 12.395 million.  A 20 year fixed rate mortgage for this amount at 11.0% (current home loan rate advertised by some Class A banks) means you will have a monthly payment of about 127,940 rupees.  In addition to this you will be giving up monthly interest of 55,962 for the equity portion that you will need to put in the property if your anticipated return is the same as the mortgage rate.  Basically you are paying in excess of 183,000 per month to live in the apartment.  This does not include the common and other ownership costs discussed above.

Finally you want to determine whether what you are buying is worth the value that you will be getting by the purchase especially with respect to other alternatives that might be out there on the market.

For the first time home buyer, the alternative includes purchasing an individual home or purchasing land and building a house on it.  The advantage there is that there is clarity on ownership and you have control on the operating costs.  Continuing to rent is yet another option especially if markets do not justify the fundamentals.

For the short or long term investor there is additional analysis that needs to be done on the potential income the property can generate during the holding period and the capital gains the investor can obtain upon exit at the end of the holding period.  At the minimum the rental income should be sufficient to cover the financing cost of the property and the investor must be able to sell the property at the purchase price plus tax at the end of the anticipated holding period of the investment.  Remember whatever the financing mix, both equity and debt have cost.  Usually equity will require a higher rate of return than debt because of its last claim on the asset.  Regardless if you assume your weighted average cost was 11%, then the annual rental income should be in excess of 2.035 million if you factor in the common operating costs, insurance premium and property taxes that will be applied to the property for the units whose purchase prices are 18.5 million rupees.  This is in excess of 169,000 rupees per month.  If you factor in potential vacancy say 25% then the rent has to be in excess of 226,000 rupees per month to come out break-even.  Here we are assuming that the investor will pay the principal in one shot through the sale of the property. If on the other hand, the investor needs to make partial principal payments, then the rental income should probably include that as well which would make the monthly lease rents substantially higher.

Now let us look at the issue of potential capital gains from the property’s sale.  Essentially another investor would be willing to pay a higher price for the property if the new investor believes that the property can be either leased at a higher rent or can be sold at a much higher price during the new investor’s holding period.    How likely this is in the current market situation given the income analysis that has been done above is something that you has a potential buyer need to determine.  When markets mature and in situation where new apartments are coming up and there is abundant supply, the trend generally is for apartments to lose resale value over time.  There might be some exceptions for apartments that are in certain prime locations which are always in demand.  You as an investor need to determine whether the apartment you are buying is such an apartment.

What I have tried here is to provide potential investors in the Nepalese real estate market some insight on how to look at properties so they can make a better informed decision on their investments.  So should you buy a Shustri Apartment? An analysis has been presented but the decision has to be yours.