Myth of Real Estate Returns

Debunking the myths around real estate returns

Over the next few weeks, we plan to discuss the 3 biggest mistakes that local investors are making right now. Investors could be earning 15% to 20% MORE per annum by avoiding these common errors. Today, we will discuss the first mistake and discuss the subsequent mistakes in separate articles. Mistake number 1: Real estate always offers great returns. While this may be true for real estate developers, it is rarely true for the individual investor seeking to buy and rent real estate. Let’s look at some examples.

Recently, a local newspaper reported on the real estate holdings of a politician. The newspaper stated that the family purchased a property (land and home) for J$3.6 million in 1991. As at December 31, 2018 the property value was J$58 million. Fantastic return? Think again. In 1991, J$3.6 million was worth US$352,250.49. In December 2018, J$58 million was worth US$454,132.03. That is a return of 0.95% per year for 27 years. That is LESS than the rate of inflation in the US over the period (roughly 2%). If you had invested US$352,250.49 at 2% per annum in 1991, you would have US$601,251.59 in December 2018 (or 70% more than the initial investment).

That’s just one example. What’s happening to the broad market? The Bank of Jamaica calculates an index to represent growth in real estate prices in Kingston, and for Jamaica. According to their index, real estate prices ON AVERAGE have risen only modestly between 2013 and 2018. The rate of growth averages 3.3% and 4.4% for residential real estate prices in Jamaica and Kingston respectively. This is comparable to what you can earn on a short-term repo that you can encash at anytime. Naturally, like all data sets, there are outliers. If you bought your house in the 1970’s from your neighbour who was fleeing communism or if you got a deal after OLINT crashed, you bought at a bottom and got a deal. Congratulations. However, you still must discount your return by the rate of inflation and devaluation.

What about renting property for a source of income? We calculate the profitability of a property by taking the rental income less expenses and dividing it by the value of the property. Let’s look at the returns generated by real estate companies listed on the Jamaica Stock Exchange. These companies buy and rent real estate as their core business. The average income yield generated by publicly listed real estate vehicles was roughly 4.1%*. The clear outlier and best performer was the Eppley Caribbean Property Fund which had a yield of 5.9% and a target yield between 7% and 8.3% after proposed property acquisitions. The fund’s exposure to hard currency leases and regional real estate enables it to earn a much higher return than local institutions and individual investors. Outside of this, it is hard to find a published real estate yield in excess of 5%. 

If you like real estate, chances are you would like bonds. Bonds work like real estate but are hassle free, higher yielding and easier to sell. Let’s look at the process: an investor buys a bond. There are no legal fees, stamp duty or transfer taxes to be paid and the deal closes in 3 days instead of 3 months. Similarly, the investor enjoys interest payments from the issuer of the bond during its life. This is similar to enjoying rent payments but skips the lease agreement, any delinquent tenants, maintenance fees and repairs etc. At the end of the life of the bond, the investor receives the principal of what was invested. He skips any further legal work and taxes associated with liquidation of real estate.

Next time you are thinking of buying a piece of real estate, consider a bond. 

*Some returns annualized.