Personal finance: Why investing in urban real estate may not be a good idea

The rental yields are lower than a savings account and your money gets tied up in lump sums.


Kazim Alam January 15, 2012

KARACHI:


Pakistanis love investing in real estate. It is considered a safe, solid investment that yields good returns. Except that it does not. An analysis of the numbers suggests that far from being a reliable investment, urban real estate in Pakistan may be overvalued and headed for a correction.


A critical measure of the health of a real estate market is what is known as the ‘rental yield’: the annual rent collected from a property divided by its total saleable value. This measure suggests whether or not it makes sense to invest in property.

Lower rental yields means that the supply of property is too high and that the real estate market is headed for a correction. Higher yields mean higher rents, which in turn means that housing demand is not meeting supply and that property prices are due to rise.

So what is a good benchmark for annual rental yield? In mature real estate markets, such as the United State or Britain, if average rental yield exceeds the average interest rate on a mortgage loan, then the real estate market is set to continue rising. However, if the reverse is true, property prices are likely to either stagnate or even start falling.

According to a survey conducted by The Express Tribune in Karachi, the largest and most liquid real estate market in Pakistan, the annual rental yield in nearly all parts of the city hovers between 4% and 5%, or even less than an ordinary savings account at a bank and far below the 11.9% benchmark 6-month Karachi Interbank Offered Rate (KIBOR).

A common argument made in favour of property investment is that it appreciates in value over time, delivering a steady return to the investor. Yet the reality is that, after the sharp rise in real estate prices from 2001 to 2004, property prices in Pakistan have risen far more slowly, making the potential for capital gains far lower.

Indeed, if one can earn a 14.5% interest rate on a retail corporate bond, in order to compete with that rate of return, average property prices would have to increase by at least 10% a year in order to be at par. Once again, however, The Express Tribune’s survey of real estate prices in Karachi suggests are far more modest average rate of increase over the last five years of less than 3%.

In essence, the average urban Pakistani property investor in Karachi has been making between 7% and 8% on his or her investment. They would have been better off investing in the Hub Power Company’s stock, which has had a dividend yield exceeding 14% during that period. And unlike property, which has a high transaction cost when you want to sell it (and can only be sold as a whole rather than in parts), it is cheap to buy and sell HUBCO stock.

For those who find stocks too risky, nearly all government bonds have yielded far more than 10% over the last five years.

Not all real estate investments are created equal, however. Within the areas and properties surveyed by The Express Tribune, the annual rental yield on apartments was higher than that on single-unit houses. For example, a house of 120 sq yd in Gulistan-e-Jauhar, which costs roughly Rs4.5 million, is rented out at Rs15,000 a month these days. This means the gross annual rental yield on it is 4%.

However, the average monthly rent of an apartment of 1,200 sq ft in the same locality with the market price of Rs3.5 million is also Rs15,000. Therefore, the yield becomes 5.1% in this case, which is about 20% higher than that on single-unit houses in the same locality.

Analysts say the desire for ‘stability’ in the value of one’s asset runs counter to the basic concept of investment, which means hoping that the asset will generate income or appreciate in the future.

Published in The Express Tribune, January 16th, 2012.

COMMENTS (5)

Sabir | 12 years ago | Reply

In a third world country like Pakistan where the Nawaz goverment has in the past gobbled up public Foreign accounts with impunity..what guarentee does a savings account have ? Thus real estate is the best investment under the present political situation...

abdussamad | 12 years ago | Reply

The author knows full well that the only entity borrowing at such high interest rates is the government of Pakistan. The same govt. that can print as much rupees as it likes to service its debt. Ordinary businesses can't afford such high rates even if banks were willing to lend to them. So interest rates and inflation are an oddity in Pakistan. Rental income is more down to earth.

I do agree that there might be a correction in real estate prices in the near future. That is because of the expected devaluation of the rupee and the resultant inflation that will likely cause demand for real estate to dry up. But only time will tell for sure what will happen. Also its funny how people are calling real estate halal. Sure its halal if you don't get scammed! So much fraud in the real estate business.

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