Growth & Jobs | Don’t invest more in property than you can get from it!

Real estate purchasers are cautioned not to overinvest when constructing as their investment will not determine the value of the property in the future.

The warning came from a panel of three housing and development experts who discussed the topic ‘Cost vs Value … the Lender’s Paradigm’ at the recently concluded International Realtors’ Conference, which was held at the Hilton Rosehall Montego Bay Resort.

Leading the discussion, Earl Samuels, chief development financing officer at The Jamaica National Group, emphasised that persons should not invest more in a property than they can realise from it.

“Property must be treated as an investment at all times and, therefore, we need to consistently assess the value of it after we invest in it so that we don’t spend more than is necessary. There is nothing wrong with building out a dream, however, the dream should not cost more than the reality, which is its worth!” he stressed.

The financier, who is a former managing director of the National Housing Trust, noted that Jamaica faced a particular dilemma as people sometimes become romantically attached to their properties because of familial or historical ties, and so they over invest in the property.

“These are some of the issues, which, at times, lead to vexation and confusion when owners seek to earn an income, through sale or rental of property, or seek to access more equity from the property than its worth, irrespective of how much was spent to refurbish or expand it over the years,” Samuels said.

He said that when lending to develop or purchase property, financial institutions rely on the value determined by a qualified and experienced appraiser and not only on the cost to construct the property. This allows the institution to determine the amount that could be realised from the sale of the asset.

“Therefore, you may spend millions of dollars on the property, and you say, ‘I want to take an equity loan and use it (the property) as collateral’. What you think is worth $50 million, when Karl carries out the valuation, [it’s a different story],” the well-known financier highlighted, pointing to fellow panellist and chartered valuation surveyor Karl Allison of Allison, Pitter and Company.

He explained that financial institutions lend at the lower end of cost or value, and when using value, he emphasised, institutions determine what is known as the net realisable value. That value is the estimated market value of the property, as determined by the qualified appraiser, minus the expenses that would be incurred to sell the property. Those expenses include realtor commission, transfer taxes, stamp duty, legal fees, and any other cost directly related to the sale of the property.

“Say, the property costs $100 million, these expenses could run you as high, cumulatively, up to 12 per cent or more,” he explained. “So on disposal of the property, you think you are going to get $100 million, but you have to factor these costs into consideration, and as a lender, I also factor those costs into the equation.”

DETERMINANTS OF VALUE

He outlined that market value is often determined by some primary factors, one of the most common and core ones being location, which takes into consideration the environmental and socio-economic conditions of the area where the property is located.

Emphasising the importance of location to value, Quantity Surveyor Dean Burrowes of Burrowes and Wallace noted that a cluster of luxury houses situated in Duncans, Trelawny, for example, versus similar houses in Ironshore, St James, would not attract the same value. The houses in Ironshore would have far more value.

Based on those factors, the experts asserted that value is not constant but changes over time, and efforts such as regeneration can increase property value.

“For example, when Government takes a position to regenerate a depressed area by creating policies and programmes that encourage redevelopment, those initiatives cause property values to rise,” Samuels said.

Using downtown Kingston as an example, Burrowes pointed out that someone who bought property on Port Royal Street for a bargain in earlier years may now be looking at a higher value because downtown Kingston is rebounding.

“The cost is going to be approximately the same, but the values [increase] with regeneration. In fact, I understand you can’t get property to buy down there (downtown Kingston) now!” he exclaimed.

CONSIDERATIONS FOR DEVELOPERS

Samuels said that the factors determining property value are considerations developers need to also bear in mind when seeking financing from institutions for new projects. He said that based on location and market conditions, the projected value could be lower than the cost to build the units.

However, Allison argued that for new developments, cost may sometimes be considered equal to the value of the property.

“It’s not exactly a very true statement, but you can argue it because there is no real obsolescence in the property. Therefore, if the property is brand new, the difference between cost and value would be [that] we’re going to impute an entrepreneurial profit,” he explained.

“Therefore, if the cost is $20 million and the value is $22 million, let’s say they are equal because the $2 million is an entrepreneurial profit. So it’s the only point where the two are equal.”

He cautioned that beyond that point, however, valuators do not factor cost into their appraisal of the property value.