Value of Renovated Real Estates

Transcription

1 Value of Renovated Real Estates An Application of the Sales Comparison Approach and the Income Approach to the Lisbon Real Estate Market João Ricardo Valente Chastre Extended Abstract Supervisor: Professor Carlos Paulo Oliveira da Silva Cruz October 2016

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3 1. INTRODUCTION Alongside the construction crisis came an accentuated decrease in the number of companies and employees in the sector [1]. For a lot of the remaining companies, their business model had to change quite a bit. Most of them had to start remodeling degraded real estates and put them back on the market, either for sale or for rent. But it was not only these companies that started to bet in this business model [6], since the uncertainty regarding national banks and the low interest rates offered to their clients, made those clients with enough capital to invest, turn to this market as they saw a good opportunity to collect a larger profit due to owners having to sell their properties. Accordingly to AICCOPN (2016), in recent years there have been a very big increase in the activity around real estate renovation, and this increase is the main reason behind this dissertation, to evaluate if this kind of investment is revealing to be profitable or not. In this dissertation, the main focus will be: 1. Analysis to the average profits and yields obtained on investing on degraded real estates, and placing them back on the sales or rental market. As secondary objectives we have: 1. Determine the yields when buying already renovated real estates; 2. Profit analysis for different grades of renovation of real estates on the sales market; 3. Yield analysis for different grades of renovation of real estates in the rental market; 4. Analysis of the variation between asking price and sales price, verifying if there is, or not, a timespan relation for this differential; 5. Determine if there is a recent inflation on the Lisbon market, specifically on the Baixa zone. In order to achieve the proposed objectives, the following steps will be made: 1. Calculate the average costs of renovations, considering the results from two companies, Melom and CasaViva; 2. Compilation of a workable database from data collected on the Remax s website, this data contains information on a set of relevant characteristics; 3. Definition of which characteristics are presumably the ones that best indicate price/m 2 ; 4. Calculate the average sales price/m 2 ; 5. Calculate the average rental price/m REAL ESTATE APPRAISAL General Considerations In order to make a correct assessment of the market value of each real estate, there are certain guidelines that need to be followed. And in the best interest of this dissertation two real estate 3

4 appraisal approaches will be considered, the sales comparison approach and the income approach. The first will be used to calculate the sale value for a group of properties with certain characteristics and the second will be used to calculate the yield on properties with the same characteristics on the rental market. Although, for these methods to be applied there is the need to be a reasonable amount of transactions made within the last months or the last few years, otherwise there s a risk that the values obtained won t be accurate [5]. Considering that the market values obtained will be per square meter, regardless of the approach chosen, there is the need to define which type of area will be considered as the appraisal area. In this case, and by the fact that all properties are added to the Remax database with the same format and same characteristics, the chosen type of area as the appraisal area is the private gross area. Sales Comparison Approach As stated already, in this approach, we will be collecting data from a certain amount of properties and compiling it into a workable database, that will contain relevant characteristics from each real estate, namely: district; typology; year of construction; floor; type of view; number of bathrooms+wcs; number of garages; elevator y/n; storage room; backyard; sale value; private gross area; sale date and initial asking price [3]. Since the area to be used is already defined and after the collection of data, there is a need to define majoring and minoring coefficients for the most relevant characteristics which will be defined in the 4 th Chapter. This will be rather useful considering we do not have a base property to work with, instead we are trying to find average market values, and with these coefficients we can adjust to any given property it s real value. The application of this method is quite simple, since it consists on comparing real estates against the database and from choosing the ones with similar characteristics, and assigning to the real estate in study a price/m 2 based on those real estates with similar characteristics. Income Approach Similarly, to what is what is done in the previous method, the characteristics obtained are pretty much the same with the exception for the Sale Value, since in this method we are considering properties for rental and, as such, the price obtained is relative to the rent value, which when multiplied by 12 equals the Annual Gross Income for that property. Once again, and based on these values, majoring and minoring coefficients will be calculated for the most relevant characteristics in order to better adjust each property s value. Based on the Annual Gross Income and the Sale Value of a property the yield can be calculated and it s as follow: 4

5 yield = Annual Gross Income Sale Value (1) This indicator is particularly relevant as it can compare to the interest rate given by bank entities and represents how much one recoups, annually, from the investment made [4]. Since we don t have data from the investor s finances and such, the yield obtained will always be considering the gross income which will always be equal to any investor, opposite to what we would obtain if we considering the yield after taxes. 3. REAL ESTATE RENOVATION Objectives In this chapter the main focus will be on the calculus of the average price for the renovations in the city of Lisbon. In order to do so there are some considerations to be made: initial degradation state will be taken into account; final renovation state intended needs to be defined. These are two key variables, and accordingly to the conjugation of both the amount of investment to be done in its renovation will change. Methodology In order to obtain the average values, two companies with online simulators have been considered: Melom [8] and CasaViva [2]. These were the two considered because their online simulators allowed to create an array of scenarios, even though they did not account for all the interventions that have to be made in each property. Specifically, when it comes to budgeting windows and doors, for those, other online websites have been considered in order to cover for all the works and provide a more accurate price for each renovation. Renovation Costs As stated before there were various scenarios considered for each company, mainly taking into account the final result. Considering that the renovation could be done to 5 levels, but only the 3 best would be beneficial, since the first two would have a really poor outcome, these are the main principles considered for each level: Scenario 1 (Level 3 Renovation): Purely aesthetical renovation, considering all doors must be changed, as well all bathroom and kitchen furniture, but recurring to the most inexpensive materials possible for each company; Scenario 2 (Level 4 Renovation): Renovation to both doors and windows, as well as some of the facilities (electrical and water), all the furniture renovated as well with average materials for all the divisions. Scenario 3 (Level 5 Renovation): Renovation with the most premium materials available on each company and considering renovation to all the facilities. 5

6 Considering all the three scenarios and the most common typologies, each with its characteristics in both average areas for each division and number of bathrooms, the results already taking into account the average between both companies - are as shown in the graphic from Figure ,37 800,00 600,00 400,00 200,00-571,98 473,72 461,99 478,01 398,46 351,36 290,36 277,56 240,74 181,81 133,38 109,32 102,96 94,01 T0 T1 T2 T3 T4 Scenario 1 Scenario 2 Scenario 3 Figure 1 - Average Costs for each type of Renovation per Square Meter 4. LISBON REAL ESTATE MARKET ANALYSIS 4.1. Objectives As prior mentioned, there are some main questions that will be addressed, but there are other points that deserve our attention, here is a full list of the aspects that are expected to be answered at the end of this chapter: Average majoring and minoring coefficients for each relevant characteristic; Average sale value/m 2 in degraded properties; Average sale value/m 2 in renovated properties; Average rent/m 2 in renovated properties; Price variation between degraded and renovated properties; Annual gross income obtained by purchasing degraded real estate, renovate them and subsequently placing them for rental; Annual gross variation between the prior and by purchasing properties already renovated and placing them in the rental market; Evaluate differentials between asking price and sale price; Evaluate if there is a recent inflation in the Baixa zone Methodology Since the Lisbon market can be quite heterogeneous, with some prime locations with few properties available, thus making their market value rise by a lot [9], the first approach is to calculate the proper coefficients, since it will allow to better adjust the values obtained for the 6

7 average yields, and each price/m 2 obtained. In order to do so the original databases will be analyzed so these coefficients can be provided for each market. The Variation Coefficient (VC) ration of the standard deviation to the mean will be used to know if it a good approximation is being obtained. After that all the results shown will be either divided by typology or degradation/renovation level, having into account that these coefficients will need to be applied for a more accurate result for any given property. Having these coefficients and by calculating the average sale and rent values for each typology, degradation level and district, it is possible to conjugate them with the values calculated on chapter 3 and then obtain the average profits and yields Sale Market Degraded Real Estates For this type of market there was the need to make a little adjustment considering the typologies, the main reason being that in old buildings the private gross areas are quite big and do not relate to the areas used in the most common typologies. In order to homogenize this information, new typologies have been attributed to each apartment to best suit the areas for renovated real estates. There s also the need to define how the degradation level was linked to each real estate, since it is a characteristic that is to be assigned by evaluating the pictures and the text on each property, and it goes as follows: 1 Property very well renovated with only the need for very minimal touches in order to face the buyer s personal taste; 2 Property in need of purely aesthetical renovation, perfectly inhabitable; 3 Inhabitable property but in need of some renovation due to use; 4 Property in need of a reasonable amount of work namely in the floors, windows, walls and facilities; 5 Uninhabitable property in need of a lot of works even at the level of both ceiling and structure wise Renovated Real Estates In this chapter one of the most relevant characteristics is the renovation level and as well as the degradation level goes from level 1 to 5, which levels can be defined as follows: 1 Very poor renovation, barely inhabitable; 2 Renovation yet scarce, in need of some mild further renovation; 3 Purely aesthetical renovation, making the property look more modern and updated; 4 Property renovated with good quality materials and/or some facilities changed; 7

8 5 Property renovated with high end materials, all facilities updated, sometimes the building is also renovated. This levels will also apply to the characteristics in the real estates considered for the rental market as the values are independent if they are for sale or rent. Besides the renovation level, District and Typology will be taken into consideration as the three most relevant characteristics and the analysis will be made around those characteristics. Rental Market For the rental market the principles considered are the same for the renovated real estates on the sale market, with the difference that we are considering rent values instead of sale values. As an example of the results obtained, in this subchapter it is presented the VCs obtained for the conjugation of the three main characteristics, for some of the districts, and as shown on Table 1. Table 1 VC values for correlation between District, Typology and Renovation Level Typolo Lev Average/ Standard Typolo Lev Average/ Standard District VC District VC gy el m 2 Dev./m 2 gy el m 2 Deviation/m 2 Alcânta ra Alvalad e Areeiro T2 4 9,46 1,41 14,9% Campoli 3 9,01 1,99 22,1% T1 5 9,65 3,04 31,5% de 4 9,57 2,17 22,7% T1 4 12,25 1,53 12,5% T2 T1 5 8,06 1,57 19,5% 3 8,73 1,21 13,8% Estrela T2 4 11,07 3,56 32,1% 4 8,99 0,99 11,0% 5 8,46 2,18 25,7% T3 3 8,40 0,99 11,8% T3 4 9,21 1,12 12,2% T1 2 9,18 0,60 6,6% Lumiar T3 4 7,22 0,83 11,5% 4 8,30 0,43 5,1% 3 9,08 1,06 11,7% T2 5 11,28 1,24 11,0% T2 4 7,62 1,01 13,3% Olivais T4 2 6,87 0,18 2,6% 5 10,30 0,26 2,5% Arroios T2 3 8,79 1,07 12,2% T3 4 7,74 1,23 15,9% Which will lead to the coefficients and average prices for the Areeiro district, presented on Table 2: District Areeiro Average Price/m 2 Cat. Ci 9.61 Table 2 Average Prices and Coefficients for the Areeiro district Typo logy Average Prices Average Price /m 2 Cat. Cj Level Renovation Average Price /m 2 Cat. Ck T T T District Areeiro Ci Typo logy Coefficients Cj Level Renovation T Ck T T

9 Economic Analysis between Renovated Real Estates and Market Value Gross income and gross profit in both rental and sale market With the results from the previous chapters it is possible to calculate the results, and here we have 2 scenarios, one when we start from properties with a degradation level from 1 to 4 and for those with a degradation level of 5, which will need a higher amount of works and to which renovation costs will be majored in order to better reflect the real costs for those type of real estates. In the charts from Figure 1 and Figure 2 both these scenarios will be represented for the sale market: 31,2% 32,0% 36,8% 27,2% 40,0% 28,4% 28,5% 30,0% 15,9% 21,4% 19,7% 25,1% 22,1% 21,7% 20,3% 18,7% 20,0% 14,0% 11,2% 10,0% 0,0% -5,3% 0,0% T0 T1 T2 T3 T4 Level 3 Level 4 Level 5 Total -10,0% Sale Scenario 1 Sale Scenario 2 Figure 2 - Average gross profits for sold real estates In Figure s 2 chart, on average, the second scenario has a better return on the money invested, although, there s a higher amount of uncertainty associated to it since the renovation costs aren t as accurate as the first scenario since they are obtained applying a majoring factor 3 for a renovation of level 3; 2 for a level 4 renovation and 1.5 for a level 5 renovation nonetheless for the keen eye this represents a better opportunity. Especially if considering T0 as a whole represent a deficit and T3 and level 3 renovations go as higher as 14% gross profit. So, independently of the level of degradation T1s, T4s, level 4 and level 5 renovations are the characteristics on which the profit is higher. 6,9% 7,9% 7,1% 7,5% 7,1% 7,5% 7,0% 7,7% 7,5% 6,9% 6,7% 7,0% 8,0% 6,7% 6,9% 6,4% 6,9% 6,2% 6,0% 4,0% 2,0% 0,0% 0,0% T0 T1 T2 T3 T4 Level 3 Level 4 Level 5 Total Rent Scenario 1 Rent Scenario 2 Figure 3 - Average yields for rented real estates 9

10 When it comes to the rental market, as shown on Figure 3, it is visible that all the yields are pretty close, although unlike what happens on the sale market, the level 3 renovations are where the investment has one of the highest returns, 7.5% regardless of the scenario, so this is probably the best bet when it comes to the rent market. Although in average the T1s have a higher yield, but on the sale market they have a great return as well, so in this case is up to the investor to choose which type of investment he wishes to make. Investment in renovated real estates For some investors, the ideal investment is to buy already renovated properties that can go immediately in the rental market, which represents two advantages: 1 - not having to go through the uncertainty of how the renovation will go; 2 - the ability to generate money as soon as they are bought. Table 3 represents which are the yields for this type of investment for any given pair of Typology/Level of Renovation: Table 3 Average yields for the renovated market Yield Level 3 Level 4 Level 5 Average T0 10.9% 4.7% 6.2% 6.6% T1 5.4% 5.6% 5.0% 5.3% T2 5.2% 5.5% 5.3% 5.3% T3 5.6% 5.7% 5.0% 5.4% T4 5.1% 5.0% 4.5% 4.8% Average 6.2% 5.3% 5.2% 5.5% On average the yield drops about 1.5% from 7% to 5.5%, with almost all values being lower than the ones obtained before, exception made for the T0 with a level 3 renovation which yield is situated on the 10.9%. Variation between Sale Value and Asking Price When searching websites for real estates, one might detect properties that are thought to have values way higher than what they are worth. So it would be to expect that the asking price for real estates considered would be quite off the sale value. But as we can see from Table 4 and Table 5 that is not exactly the case: Table 4 Variation between selling and asking price for degraded real estates Sale Value < Asking Price Sale Value = Asking Price Sale Value > Asking Price Amount Average Variation -13.6% 0% 3.2% Total Average Variation -11.6% Standard Deviation 9.8% 10

11 Table 5 Variation between selling and asking price for renovated real estates Sale Value < Asking Price Sale Value = Asking Price Sale Value > Asking Price Amount Average Variation -8% 0% 5.8% Total Average Variation -5.9% Standard Deviation 6.2% In some cases, the asking price is even lower than the sale price, and the standard deviation goes as low as 6.2% in renovated properties. Being near 10% in properties in need of renovation, which is expected, as the uncertainty of its true value is higher. Rental Inflation Other of the aspects that are worth analyzing is the fact that there is the belief that the rental prices in Lisbon are rising especially when considering the locations near Baixa or Chiado. But from our database it is not possible to conclude about that subject since there has only been one property rented in the district of Santa Maria Maior, for this to be analyzed, a new set of real estates have been considered independently of the condition they are in which led to the results shown on Figure 4 and Figure ; 4 16,00 14, ; ; 35 14,00 12,00 10,00 8,00 8,68 9,39 9,75 6,00 4, ; 25 2, Figure 4 Rented real estates per year Figure 5 Average rent variation per m/ 2 It is noticeable that there has been a huge decrease in the amount of properties rented, possibly indicating that the rents are too high or that the landlords are looking for other forms of renting, such has the short renting which allow them to get a much better yield when compared with the traditional monthly type of rentals. 5. Conclusion In the light of the main focus for this dissertation, the analysis conducted should highlight 4 scenarios; 11

12 i. Sale market; Degradation level between 1 and 4: the gross profit has an average of 19%, being the ones with a renovation level of 4 and 5 around 50% more profitable than the ones with level 3. The T0 typology is to be avoided, since instead of profit it represents a loss, in average, of 5.3%; ii. Sale market; Degradation level of 5: higher gross profits when compared with the previous, with an average of 25%, although the renovation costs are more uncertain which can have misleading results; iii. Rental market; Degradation level between 1 and 4: average yield of 7.0% with values between 6.7% and 7.7% with exception for the typology T2 with a 6.2% yield, in the rental market it s the renovation level of 3 that represent the best yields unlike verified for the sale market, being from 0.6% to 0.8% higher; iv. Rental market; Degradation level of 5: As well as for the previous point, there is a lower variation, with values from 6.4% - for T2s and 7.9% for T1s. As for the renovation level, the level 3 is still ahead with an average yield of 7.5% against 6.9% in both level 4 and level 5. On a wider analysis on both market for degradation levels between 1 and 4 it s the T4 that represent the highest yields/profits, 7.7% and 37% respectively. From the values presented we can conclude that this type of investment has very attractive returns even for investors that want to turn the way they are investing their savings, by buying already renovated real estates and placing them for rent, even though they get lower yields when compared to the original solution, they are still way higher than the ones they can get for instance by collecting interest from placing the money on the bank. From the assessment between asking price and sales prices it is noticeable that the variation isn t huge, with a standard variation below 10% at maximum, and in some, few, cases the sales value is even higher than the asking price. From the analysis on the Lisbon downtown it is visible that the shortrenting is a reality which is leading to both a further increase on the scarcity of real estates in those zones and in an increase of the rent prices for those properties, which will eventually lead into an increase on the sale price for those real estates. The conducted analysis made on this dissertation, will allow investors inexperienced or not, to have a basis to analyze any given real estate on the Lisbon market, although having into account that a market study only provides values for a limited time frame as the market is always evolving. With that in mind, this dissertation also can lead into further studies on how the market is evolving and evaluate future and past tendencies, in case a trustworthy database is obtained. Or even to evaluate discrepancies between a heterogeneous database and the one presented. 12

13 References [1] AICCOPN (2016), accessed on 10th September of [2] CasaViva, [3] Couto, Paula M. C. M. (2007). Real Estate Evaluation for Household. PhD Thesis in Civil Engineering. [4] Figueiredo, Ruy (2004). Real Estate Appraisal Manuel, 2014 Edition. Valor M2 [5] Henriques, Pedro Manuel Gameiro (2012). Real Estate Appraisal Discipline s Notes, IST. [6] INE (2015). [7] Matos, Marina Teixeira (2014). Operational profitability and real profitability of construction companies. Future perspectives on the Portuguese industry. Master s Degree Thesis in Civil Engineering. [8] Melom, [9] Paulo, Pedro Vaz (2014). Real estate appraisal and construction maintenance Discipline notes, DECivil, IST. [10] Remax, 13