In your quest to choose the best property for your budget, it’s a good idea to arm yourself with an important principle in real estate: THE PRINCIPLE OF LOW PROFITABILITY.
Let me explain this in common language: OVER IMPROVEMENT and UNDER IMPROVEMENT in real estate to be avoided as much as possible.
Excessive Enhancement: An enhancement that is unsuitable for the site on which it is placed due to excessive size or cost.
Low Improvement – An improvement that is unsuitable for the site on which it is placed due to poor size or cost.
Based on years of experience and knowledge of numerous successful real estate developments, the general rule of thumb is 30% of lot value and 70% of home value, give or take. So, for example, if you have a 50sqm low-cost housing lot valued at around P300,000 and you put up a house worth 700,000, that would be fine. Let’s say you want to further improve the house to make it worth 1 million, that’s still fine, but keep in mind that there is a principle in real estate which is THE PRINCIPLE OF DEMINANT RETURNS. Which means that the improvement that can generate profit will be only up to a certain level, beyond that level, it will become a loss. Let’s further assume that you want to add a third floor to your 2-story house with the same lot value and perhaps the total value of the house would become 3 million pesos, this could be an excessive improvement as the ratio between the value of the lot and house is now distorted. The owner who overimproves may not realize it while he is still living in the house, but when the time comes he has to sell the property forever due to changing situations in the family, he would not be able to sell it for a profit.
For example, a homeowner from Dalaguete Cebu asked me to sell his house with a lot area of 2,000 square meters for 15 million. And the reason for the sale is that he separated from his wife and wants 50% of the property. He said that the lot would go free because only P15 million is the cost of the house. It is such a big and beautiful house and in fact when you build a house like that today, 15 million pesos would not be enough. But for a rural area like Dalaguete Cebu, the lot is very cheap and built a house as big as 15 million. After years of offering the property, no one bought it even for a 10 million offer. He spent so much on such a big house thinking only about how he would be happy with his home, and when his living conditions changed and he no longer needed the house, he realized that it could not be sold for get benefits. This is an example of OVER IMPROVEMENT in real estate. He lost several million due to OVER IMPROVEMENT.
Even some subdivision developers fall into the OVERUPGRADE trap. For example, developers developed subdivisions that were either low-cost or higher-end that were closer to the mid-level classification, while installing a nice pool and clubhouse. Eventually the owners were unable to maintain the pool and it became a pond. During rainy days, you can see frogs swimming in the pool. The subdivision is located in the inner part of Mactan Cebu. The owners of this development are unable to sell their property for a good profit due to the lack of maintenance of the subdivision plus the fact that the cost of buying the home is high due to the cost of excessive improvements by the developer. Another example is a developer who developed a residential subdivision in Talamban Cebu City consisting of about 50 townhouses with prices ranging from 5.5-6.5 million. In fact, the quality of the materials used and the design are very good. However, they did not consider the barangay road connecting the subdivision to the main road to be too narrow and nothing can be done about it. It is still a 2-way street but it is narrow just under 4 meters wide. They didn’t consider that prospective locals who have that $5.5 million to $6.5 million budget won’t be comfortable navigating that narrow path to an interior location no matter how nice the house. It’s too much improvement for such a low place caused by a narrow path. Result? Of the 50 houses ready to occupy, only about 5 were sold. All the others are still waiting for buyers even though the houses are already built.
On the other hand, a buyer or owner should also be aware that there is also UNDER IMPROVEMENT, an improvement that is not suitable for the site on which it is located due to poor size or cost. This can also cause real estate investment losses.
For example, the owner of a house called me to sell his property in Córdoba with a lot area of 1,300 square meters. He built a 150 m2 bungalow at the rear of the lot, leaving more than 1000 m2 of the lot as the front of his house. The husband is a foreigner married to a Filipina but after years of living together they quarreled and decided to separate and sell their property for a 50/50 share. The wife wants to sell the house and the lot for 7.5 million pesos because it is the real market value of the property. I agree with the wife’s argument that the house and lot are valued at 7.5 million, but the property has been on the market for 3 years and there have been no buyers. Because? It is due to UNDER IMPROVEMENT. Potential buyers like the house, but the 1,300-square-foot lot area is too much for them, making the property well over their budget. They could have added semi-detached houses to the front of the 1,000-square-meter lot for a profit, but given their situation, they cannot undertake that plan due to their conflicts. All they want is a quick sale and share the profits right away. Unfortunately, they still have time to wait, since they couldn’t even agree on the final price. The husband wants to sacrifice himself by selling it for 5 million but the wife insists on 7.5 million. As for how they will approach this conflict, it will be a legal case. But that is another story to tell.
Author:
Manuel Jr Arengo
Real Estate Broker License No. 0007808
15 years of experience in Real Estate