Property Times

Capitalization rate… why it’s important

In the post-GFC period, yields from any type of investments became increasingly harder to find and, without a doubt, the post-global recession environment saw investors having to take greater levels of risk to generate acceptable and goal satisfying yields.

Dubai’s rental yields have always been strong, particularly when compared to countries where rental income is taxed at high marginal tax rates. With a market that boasts an average gross yield of around 7.0 percent, it has, for some time, stood as a beacon for those who appreciate the significant structural and regulatory development that the market has undertaken which, in reality, decreases the risk perception associated with investing in the market.

But really, what is the true meaning of gross yield? Gross yield is the income on an investment prior to expenses being deducted expressed as a percentage. Simple. But gross yield only measures the income as a percentage of the original purchase price, and does not reflect the effects of significant underlying   fluctuations in underlying asset values such as those that have been witnessed in Dubai during the past 5 years.

Nevertheless, the ration has its uses. It can provide a retrospective view or learning opportunity by revealing how accurately market factors were comprehended, analyzed, forecasted and modelled when planning a particular development; it can highlight inefficient and costly construction methods and techniques; it can highlight future price / revenue adjustment opportunities, new segment or geographic concentration opportunities; it can reveal superior (or inferior) sales, branding and marketing techniques or superior product attributes; it can highlight impending revenue and eventual margin pressure where yields appear a little too extravagant when compared to the market or even highlight where an  industry is with regards to its cycle. Gross yields can also highlight inefficiencies because inefficiencies, unless corrected, must be eventually supported by either gross yield or margin reduction.

Logically, expectations of net yield will always pressure gross yield, and the cost of resources required to generate that gross yield.  In times of tight supply, inefficiencies in construction, administration, maintenance and operating methodologies are hidden because elevated gross yields driven by excessive market demand are more likely to drive acceptable net yields for investors. However, the real test as to effective yield management is when supply exceeds demand.

At Harbor, we are also interested in the capitalization rate (or cap rate) of an existing property. Capitalization rate is the rate of return on a real estate investment property based on the income that the property is expected to generate. The capitalization rate is used to estimate the investor’s potential return on his or her investment. The capitalization rate of an investment may be calculated by dividing the investment’s net operating income (NOI) by the current market value of the property, where NOI is the total revenue derived from renting or leasing the property less all operating costs. Put simply, the Cap Rate = Net Operating Income / Current Market Value.

Given that the capital values for property in Dubai has, in many cases, shown significantly greater volatility than the income being derived from the property, we need to look at the net operating income being generated from the property at today’s value. This allows us to see whether the property’s wealth-generating performance is improving or declining by referring to the cap rate. If the cap rate is declining, it may lead us to conclude that to sell the property and reinvest elsewhere would generate greater income and/or overall wealth even if the gross or net yield still looks impressive.

We also use a cap rates as part of our suite of objectives when establishing a client’s property portfolio.  We will determine the lowest cap rate that the client should accept in order to make the investment worthwhile. Typically, we will suggest a cap rate of between 5 percent and 10 percent depending on expectations of asset value fluctuations going forward. As revenues are typically locked in courtesy of rental contracts for at least 12 months or, in the case of Commercial leases anywhere up to 5 years, the ability to accurately forecast the potential and likely shifts in property asset values will be essential to establishing realistic and achievable cap rates and forming long-term property portfolio strategies.

There is another useful application of the cap rate. When you divide 100 by the estimated cap rate, you arrive at an estimate, expressed in years, which will provide an indication of the payback period of the investment. For example, an investment with a cap rate of 7 percent will have an estimated payback period of 20 years. Caution must be used when using this ratio, however, and it must be reviewed periodically as the underlying asset value, and the revenues generated from the asset will always exhibit different rates of volatility.

Property Times – June 2015

Investors

I have been lucky in my professional life to have met and worked with some very successful investors. While I have found each to be different in personality, style and even investment philosophy, there are some attitudes, traits and perspectives that are shared among the most successful investors I have had the privilege to have met.  Thinking  back  to  many  interesting discussions I have had with these people… some  of  whom  are  my  most  loyal  and respected  clients…  there  are  several statements  that  we  often  hear  in  our everyday professional lives which I have not heard from this group of achievers. This is what separates them from the rest.

“I hate (insert anything) … “

I have rarely heard my successful investors project a negative stance about anything in their professional life. This is not to say that they support every philosophy, concept or idea and they will also not accept an occurrence which is contrary to what they think should have happened. But instead of expressing such a negative emotion as hate, they continue to think positively and seek positives from a situation or take a positive approach to remedying that which they do not agree with. As a result, the dialogue is always positive, creating an environment positivity, proactivity and energy directed towards progress. Taking this approach also helps to create a pleasant, purposeful and fruitful environment in which to work and helps to maintain or even build esteem and confidence among those that can contribute to achieving exceptional results. It promotes objectivity, focus and decisiveness.

“That’s not fair”

The world is not a fair place never has been and never will be, and successful investors understand, embrace and accept that. This allows them to be immune from the negativity that can arise when an individual feels hard done by or cheated.  It  also allows them to plan, create contingencies and  maintain  a  positive  attitude  when a  seemingly  unfair  occurrence  occurs resulting in a greater chance to respond to a situation rapidly and appropriately rather than dwelling on the fact that an occurrence was “unfair”.

“That’s not how it’s done here”

An open mind is essential to develop, progress and eventual success. Successful investors will embrace new ideas and innovation.  To not realise that progress is created from ingredients consisting of past experience and innovation is to rely too heavily on tried and true practices that gradually lose relevance over time. This form of decay has destroyed entrepreneurs, global corporations and even whole economies and societies. With globalization, the world has become a much smaller place. To not embrace, improve and implement world’s best practice and only holding close what you are comfortable is the biggest threat to creating continued success.

“I am a self-made man”

Nobody has ever made it on their own. It was once thought that the iconic, independent, totally  self-sufficient,  unchallengeable, silent-type, hard-nosed entrepreneur who left  metaphorical  bodies  in  his  wake  as he  doggedly  climbed  the  mountain  of success was the role model that should be emulated by all who craved achievement. Many have tried and they all failed. No-one can achieve success on their own.  As a matter of fact, the most successful people I have met have surrounded themselves with successful people and ensured that those people shared in their success. They seek opinions, listen carefully, discuss intelligently, consider alternatives and have their decisions reviewed. They reward those who contribute to their achievements and help them succeed as well for this is also a valuable way to learn and build momentum at the same time.

“That’s impossible”

Successful  people  know  that  nothing  is impossible and hold the belief that every problem  has  a  solution,  some  of  which just haven’t been thought of yet. Anything is possible as long as there is a willingness to  explore,  question  and  challenge  and imagination  is  intensely  applied  and ingenuity  is  rewarded.  Achievers do not complain about obstacles. They embrace them so as to gain an understanding as to how they can be overcome for they truly believe that nothing is insurmountable. Negative words like “can’t,”  “won’t,” and “impossible” are never heard from the mouths of successful individuals. They know complaining will not help them, but actually doing something about the issue at hand will.

“I could have”

Could have… would have … should have. We have all heard these expressions of retrospective folly. Experts in hindsight have no place at the table of successful people and regret is a fruitless and pointless emotion. Successful people thrive on opportunities not lost opportunities. If they cannot make one opportunity work to their satisfaction, they move on and find another opportunity. Regret simply slows down the effective pursuit of the next great opportunity.

“I have no choice”

Victims have no choice. Successful investors create alternative solutions to every problem and will carefully consider all of them. In this way, successful investors are never victims for they create an environment filled with choices. Then it’s just a matter of deciding which choice represents the best way forward. Successful investors know how to create opportunities where normal people think none seemingly exist.  Successful investors believe that opportunities always will exist, but they are hidden in the recesses of our individual and collective imaginations.  The reason why they are successful is largely due to their determination and ability to extract those opportunities, while others are stagnating in the belief that they don’t exist!!

Property Times

Alwadiya

Now that the market has entered its correction phase, the time has come to consider whether you should take advantage of value opportunities that are starting to appear and benefit from the capital appreciation that is likely to accumulate over the coming five to seven years. For those who don’t have the cash readily available, the first step is to organise a pre-approved home mortgage. It’s always best to be in a position to make an offer for a house with your mortgage pre-approval in place rather than expect to arrange your mortgage once heavily involved in a negotiation process.

So, how to go about selecting the right mortgage for you?

You must first envisage your economic circumstances at least two years into the future and ask yourself the question … “Given my projected earning capability and desired lifestyle,  what  mortgage  payment  will  be financially feasible and acceptable to me in two years’ time?”

Why two years’ time?…  because most mortgages interest rates on offer at the moment are locked in for two years, after which you will be subject to likely interest rate increases as after an initial two year period of fixed interest rates, the mortgage reverts to a variable rate.

First of all, estimate your projected earning capability. Be real. We all hope to progress  rapidly  in  our  professional  (a.k.a. financial)  pursuits  but there are generally more people disappointed than delighted with their achievements. And, notwithstanding the latest reports of 5% salary increases for Dubai employees in 2015, history has shown that salary increases generally tend to lag cost of living increases so conservatism in estimating future cash-flows is a must.  Then there is lifestyle. Is there a new baby planned in the near future? … a new car perhaps? What effect will significant family or lifestyle events have on disposable income? Are there existing children who will need to start school in that time frame? All these events will have an effect on disposable income and thereby decrease the financial flexibility to address interest rate shocks. And finally, what is financially feasible may not be acceptable to you or your spouse. How much sacrifice are you and your partner willing to make to service your mortgage? What are you willing to do without and what lifestyle changes are you prepared to make? Once again, being honest with oneself is paramount.

So, notwithstanding correcting markets, value opportunities and cheap finance, cautious financial planning based upon realism and self-honesty is key when planning the purchase of your dream home. Your future happiness could well depend on it. As a general guide, we recommend that not more than 40% of your household disposable income be devoted towards paying down your mortgage. So once you have determined what type of repayment you are willing to commit to, then it’s a case of determining the mortgage amount you can actually afford. This will be determined by the Loan to Value ratio (LTV) you are prepared to accept, the amount of your own cash savings you are prepared to put towards the property, the tenure of the loan and the interest rate that you expect to be paying initially and well into the future.

When talking to mortgage providers, they will help you assess what mortgage is best for you by looking at a number of specific factors such as other debts (including credit cards) you may have, reliability of current and future income streams, the Loan to Value ratio that you would be seeking, the type of mortgage you prefer, your true disposable income and what other assets that you may own. Don’t be surprised if different mortgage providers  suggest  significantly  different mortgage  solutions  for  your  requirements including  repayment  options.  These will include the most common type of mortgage known as the Capital and Interest (Reducible Balance) Repayment Mortgage but you may also consider interest-only payments, part repayment and part interest-only mortgages although these types of mortgages are usually used for very specific investment purposes. Then it’s a case of deciding if you wish to undertake a fixed rate, variable rate or fixed/variable combination mortgage. Once again you need to think long term. If you think that mortgage rates are likely to rise and you would like to lock in a fixed rate of interest for the foreseeable future as long as you understand that once the fixed interest rate term comes to an end, a variable interest rate will apply. In many cases, the variable rate will be greater so planning is essential. If however, you expect interest rates to fall in the near future, a variable interest rate mortgage would make better financial sense as long as you have the flexibility to handle an increase in mortgage payments if interest rates do not follow your predictions and unexpectedly rise. There are a number of items which you should pursue as part of your mortgage negotiations. Try and have the mortgage establishment fees waived. Depending on the institution, this may save you up to AED3, 000. Also request that you are not penalised for paying the mortgage down faster or in its entirety. By law, the mortgage provider cannot charge you more than 1% of the outstanding amount or a maximum of AED10, 000, but you should try to have this stipulation dropped from your mortgage contract.

And finally, make sure your mortgage provider will allow you to utilise the equity being built up in your home as you diligently pay down your mortgage.  This equity will compound if the value of your property is increasing due to favourable economic or market factors. Some lenders will allow you to use this equity as security for further borrowing. This can be very handy if you want to make some major home improvements, buy a new car or perhaps invest in another property. When selecting a mortgage, the key is to know what you need and pick the one that best suits you over the long term.