Falling interest rates sweeten real estate deals
By Dr. Johnny Noet Ravalo
INQUIRER.net
First Posted 09:34:00 12/12/2007
Questions:
At present, interest rates are so low that the net interest income we get is almost nothing. Is there some investment out there that we can consider without really taking tremendous risks? — Ysah
My wife and I now have a one-year-old daughter. We live in a rented place and budgets are tight but workable. My wife and I have to negotiate our lease almost yearly and that uncertainty is getting difficult to bear with our young baby in mind. We have a small piece of land but it is far from where we work and we cannot borrow much from a bank to build a suitable home of our own. Would you have any suggestions? — Mike
These two questions show us the two sides of the interest rate story that policymakers face.
As a would-be borrower, Mike welcomes the idea that he and his wife can take a housing loan from a bank with a cheaper amortization. The low interest rates will allow Mike and his family to invest in their own home by stretching their budgets a bit.
For Ysah, though, the low interest rate regime is a problem. This is not only because the interest income (net of 20 percent withholding tax) are also low but quite literally the benefits may be so low that some people may actually prefer to consume the income instead of saving it. This situation invites a very real economic problem where the ramifications are severe and they cut through every economic activity.
It is possible to use the current low-interest rate reality into a probable investment option, one that Ysah and Mike may both consider.
With traffic perennially bad and gasoline prices going upward, buying a condominium or apartment unit much closer to the office to avoid the hustle of traffic and the migraine of gasoline bills has become an attractive option.
Perhaps smarting from the lessons of the last housing boom that got cut by the 1997 crisis, developers are getting creative with their financing schemes. Now these units — mostly still unfinished — are no longer just traffic or gasoline relief. They can be investment options.
It is now common for developers to offer a 3-part financing package. A 10-10-80 deal would mean that you put in a downpayment of 10 percent, another 10 percent of the gross price is to be amortized over a fixed period of time and the balance of 80 percent of the gross price is to be paid once the unit is turned over to you after the fixed period. One can also get a 20-10-70 arrangement and the fixed period is usually between 24 to 36 months.
Let’s play with some hypothetical numbers. Let us say that a unit is being offered for P5 million on a 20-10-70 package over a 24-month period. If you get this, you pay P1 million (20 percent of P5 million) up front as down payment and pay P20,833.33 monthly for 24 months (10 percent of P5 million divided equally over 24 months). The balance of P3.5 million is due on the 25th month.
If Mike takes this option, he is saying that (1) he can provide P1 million right now and (2) can reasonably pay roughly an additional P21,000 a month for the next two years. But what about the P3.5 million at the end of two years? The “bet” he is implicitly making is that he can be eligible for a loan in two years for this amount.
Is this a reasonable bet? This will depend on Mike’s specific circumstances, but if he were to build a house on his property right now, he will most likely have to borrow anyway and it will be for the full value of construction (although prudential banking norms will limit his borrowing capacity to a percentage of the value).
Taking this route helps Mike to buy two years of leeway to improve his borrowing capacity (say, through office promotions) or winning the lotto (just kidding!). He also has the leeway to decide what to do with his piece of land whether to hold on to it, use it for financing the first two years or use part of it for financing the balance of the deal which is due on the 25th month.
This option gives Mike an option to deal with the uncertainty of annual rentals and fulfill his wish to have a home for his family. But all that is still subject to doing the calculations and deciding if the offer is worth it.
And what about Ysah?
Since these types of packages are often offered while the building is still being built, the expectation is that the market price of the property — subject to having a credible developer, of course — will appreciate. For Ysah then, this could very well be a option for an investment.
Her principal will essentially be the down payment and the monthly amortization. The investment question is whether the market price will appreciate once the unit is turned over to her and whether that appreciation is larger than the gains she would have gotten had she invested the principal elsewhere.
Like Mike, Ysah is not exempted from doing some number crunching. Like Mike too, there are risks involved when she ventures into this investment option. But that is precisely the nature of the investment beast: the returns to be expected (or any realized loss) comes out of risk-taking. In the absence of this risk-taking, Ysah gets back to principal-guaranteed savings deposits.
Let me be very clear: these packages are NOT sure-fire investment options. These are options under the present reality of low interest rates, both for someone looking to have a home and for someone looking for investment options. They are, by no means guaranteed-to-work possibilities.
(Have a question for Dr. Noet? Email personal_finance@inquirer.net)
(Noet Ravalo is a macro-financial economist by practice and profession. He was chief economist of the Bankers Association of the Philippines until 2002 and has since been doing consulting work for multilateral and foreign agencies. His current engagements are with the Bangko Sentral ng Pilipinas and the PDS Group. Over the past 12 years, he has been asked to provide technical inputs to both the Senate and the House of Representatives on various economic and financial legislation, some of which will have big impact on Filipinosí personal finances.)
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