Calculations you need to make before buying

Over the last few months most of my meetings with clients hover around the following question — “Why are rents still holding at higher levels though prices have eased out?”

The classic demand-supply gap theory is holding up well. There is demand but supply isn’t catching up.

There are many units vacant, but still rents are not easing out. There is supply, but not all supply enters the rental market. Many investors prefer to leave the units vacant for reasons such as:

• A better chance to sell to end-users, and end users are interested only if a unit is vacant;

• Owners not wanting to get into a confrontation situation with tenants, whereby the latter do not cooperate with potential buyer viewings;

• Bouncing of tenants’ cheques and/or tenants absconding and the ensuing legal process/expense/time involved, etc.

Income approach for valuation of realty assets

In some areas of Dubai, the price-to-rent ratio (PTR) of 15 was the norm, but with drop in prices and rentals remaining static, it now works out to 12. In such situations, to reach medium- to long-term equilibrium levels, either rentals would have to come down or prices need to start moving higher.

The ratio will return to normal levels... sooner rather than later. I reckon rents should come down as a part of this adjustment process, and this would lead to healthy price levels.

And with a strong PTR base, we can be prepared for the next move higher.

* At a price-to-rent ratio of 1 to 15, it is much better to buy than rent;

* On a price-to-rent ratio of 16 to 20, it is typically better to rent than buy; and

* For a price-to-rent ratio of 21 or more, it is much better to rent than buy.

The above ratio matrix is suggested for the US markets, where long-term rental yields are averaging 2-5 per cent annually. In Dubai, the rental yield historically have been ranging between 6-10 per cent.

This is gross income for discussion purposes and ignoring net yield which would otherwise account for community maintenance fees, preventive maintenance costs, etc. Nor are we accounting for the leveraged yield taking into account a mortgage funding strategy.

Now comes the million dollar question: What’s your view on real estate prices? And before I respond, an annexure to the question should be: Isn’t the market soft and expected to get lower?

I agree with the sentiment that market is soft at the moment. Thanks to the typical summer and Ramadan effect, which is a regular pattern witnessed across businesses in Dubai.

My answer would be: How much lower is your view? If you are expecting a 15-25 per cent drop, it’s worth the wait.

If your view is that prices will drop by another 5-10 per cent, then I suggest it’s not worth the wait. I do understand 10 per cent is huge money.

Real estate is an over-the-counter market play. Unlike exchange traded investment instruments, where you can place an order, and your order is filled when market price reaches your order level, real estate is heterogeneous.

All units are not the same (though layout remains the same).

Most end-users, unlike investors, are very particular, as it’s a dream house which they are buying to move-in. End-users would not just buy any other unit, just because it is a little cheaper than the one they liked, or feels like a compromise on the checklist.

Most times end-users would buy at a little premium, because owners of well-positioned units are generally not desperate to sell.

In a market scenario where you expect realty prices to drop only 5-10 per cent, it’s best to identify what you like to buy. Discuss with your property consultant on the price target and mandate him to smartly work on your offer.

At CityScape Global 2015, developers, brokers and investors will be around to evaluate the market sentiment and pulse. An abundance of mosaic theories will lead to decision-making.

Summer is almost behind us, and let’s walk into the new season with optimism...

Source: Manish Agrawal, CFA, Special to Gulf News

The writer is managing director at Vantage Real Estate LLC.


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