Difficult Valuation

[Riley'sLife]

A 45m2 Studio in Rawai, Phuket that is being offered for sale with a 30+30+30 lease.(!!!!) It is in a resort-style compound of 42 low-rise units on two floors with shared pool and lawned grounds, communal vehicle park. Maintenance fees are 64THB per month/m2 including electricity and weekly bedding laundry. (2,900THB/month) -This seems high unless aircon is used 24/7, which most people wouldn’t want.

The landlord is a Thai company “owned” by a Scandinavian. (should that read SCAMdinavian?)

Four years of the first 30 years have expired already, thus 26 years remain. To my knowledge any purchaser would have difficulty enforcing any right to remain in the property beyond the initial 30 year term. If this is correct then a buyer would only have a beneficial interest in the condo for 26years.

This 30+30+30 lease is, in my view, a complete con, and I am surprised that 42 farang have already bought into such a scheme. It appears that there is a high turnover of re-sales perhaps as buyers realise what they have stupidly bought and unload their “investment”.

Despite all this, the Studios still have a value. So, how would you value it? Clearly there is no residual value beyond the remaining 26years, and as each year progresses the value will become less and less until the value is zero.

The monthly Maintenance Fees could also be viewed as a liability affecting value.

Comments anyone?

[lingnoi34]

I would go with the net present value of a reasonable rental payment annuity of 26 years at 6%.

Just my 2 cents.

Where are the RE pros???

L

[choppychugger]

Are any of the condo's freehold?

[glyph]

"Clearly there is no residual value beyond the remaining 26years, and as each year progresses the value will become less and less until the value is zero."

If it is as clear as that, why ask the question? Following your formula: 26/30ths of the value remains.

[Riley'sLife]

Glyph, I think that you don’t quite grasp the problem. If you are suggesting that 26/30ths of “the value” remains you must first address the point of my question which is, - what is “the value”? So my special question to you would be 26/30ths of…………what?

All the condos are sold on the 30+30+30 leases so there is no freehold comparison. I suppose reinstatement value is the closest direct comparison for the actual building, but that leaves the depreciating aspect of value, and the land value undetermined.

I think your annuity concept is a very good approach Lingnoi. However, how have you arrived at 6%?

Rentals are said to be 24,000THB per month for 4 to 5 months p.a. less 10% payable to Landlord, less of course the unreasonably high maintenance fees of 2,900THB /month.

So: say, 4.5months @ 24,000………………= 108,000 THB Gross Annual Rental

Less: -(10% payable to Landlord) 10,800 THB -(Maint 12months x 2900 ) 34,800 THB -(10% Sinking Fund for repair and replacement of furniture, aircon etc.) 10.800 THB ..... All this totals 56,400THB leaving a Balance of 51,600THB

Less Tax @ 12,5% x 51,600 = 6,450 THB leaving a Net Annual Rental Income of 45,150THB

Where is Quicksilva (F.R.I.C.S. ?) when you need him?

I have just asked my Thai wife (Accountant) to calculate this but she doesn’t understand the concept. – or more likely, she can’t be bothered with my stupid questions!!

So, based on Lingnoi’s Annuity concept, what is the value today, of the right to receive 45,150THB for 26 years?

Edited August 16, 2008 by Riley'sLife

[Sophon]

I would go with the net present value of a reasonable rental payment annuity of 26 years at 6%.

Just my 2 cents.

Where are the RE pros???

L

I would put it at less than that.

There seem to be two types of people; people who like to rent and people who like to own.

The people who like to rent do so either because they don't have the money to buy, or because they like the flexibility of being able to move whenever they want. The 26 year lease wouldn't meet either of these criteria.

The people who want to own do so because they believe the value of their property will go up. Or they do so because they want to have a place that is "theirs" and which they can do whatever they like to. Again neither of those criteria are met by a leasehold.

Of course there will be some people who don't expect to be alive in 26 years, and who don't have any heirs to leave the property to. And there are also people who believe that the 30+30+30 is enforceable and is happy with that arrangement. But I think the target group would be rather limited, and you would possible have to offer a very good deal (meaning a low price) on the property to sell it.

Sophon

Reason for edit: Correcting spelling error

Edited August 16, 2008 by Sophon

[quiksilva]

You need to add the sum of the present values of each future year's potential net income. Make allowances for void periods, and expenses. As well as inflation and rental growth.

6% as another poster mentioned is fine for freehold but far too low for a leasehold interest and especially of this size and style. I'd want at least 10% possibly more.

[glyph]

" I think that you don’t quite grasp the problem. If you are suggesting that 26/30ths of “the value” remains you must first address the point of my question which is, - what is “the value”? So my special question to you would be 26/30ths of…………what? "

I understand the problem perfectly. Following the straight-line depreciation method (and there are others), the value would be: original value X 26/30. Pretty simple. What did the unit originally cost? I don't know, and it doesn't matter. However, since you don't own a unit, and don't plan to buy a unit, I'm not sure why you're so interested in this.

If you think performing the above calculation is difficult, you're going to pass water when you read this. There's another consideration, involving inflation. Let's make the bold assumption that the depreciation over the asset life is exactly equal to inflation - that is, Riley - the averate rate of inflation is exactly equal to the annual depreciation of 3 1/3%. So, in 30 years, the depreciated asset value is exactly equal to the original asset price. If the original price was (let's say) 3,000,000THB, the depreciated value of the asset over 30 years would be about 100,000THB - in TODAY'S value. However, with compounded inflation over 30 years, the value would be 3,000,000THB.

I find it interesting that you've asked for our opinions and, rather than accepting our opinions, you've attacked every response.

[PattayaParent]

" I think that you don't quite grasp the problem. If you are suggesting that 26/30ths of "the value" remains you must first address the point of my question which is, - what is "the value"? So my special question to you would be 26/30ths of…………what? "

I understand the problem perfectly. Following the straight-line depreciation method (and there are others), the value would be: original value X 26/30. Pretty simple. What did the unit originally cost? I don't know, and it doesn't matter. However, since you don't own a unit, and don't plan to buy a unit, I'm not sure why you're so interested in this.

If you think performing the above calculation is difficult, you're going to pass water when you read this. There's another consideration, involving inflation. Let's make the bold assumption that the depreciation over the asset life is exactly equal to inflation - that is, Riley - the averate rate of inflation is exactly equal to the annual depreciation of 3 1/3%. So, in 30 years, the depreciated asset value is exactly equal to the original asset price. If the original price was (let's say) 3,000,000THB, the depreciated value of the asset over 30 years would be about 100,000THB - in TODAY'S value. However, with compounded inflation over 30 years, the value would be 3,000,000THB.

I find it interesting that you've asked for our opinions and, rather than accepting our opinions, you've attacked every response.

And you haven't even mentioned the opportunity cost lost of putting the money elsewhere!!

[quiksilva]

Opportunity cost does not determine the value of any particular investment only whether you should invest in that vs something else.

Glyph straight line depreciation can not be applied to a leasehold interest. The value of that lease 'depreciates' over time due to the nature of the value of money over time. 1 Baht today is worth alot more than 1 Baht in 30 years time.

This is because inflation affects running costs, so it does have an affect but it is not directly applicable to the property interest. Only to items such as cleaning materials etc.

Seeing as what is being measured here is only the value of a lease, the value can only be determined by the sum of the future capitalized net income. (Open Market Rental Value OMRV less expenses).

30+30+30 can not be enforced and actually under the law upon expiration of the 30 year term the lease expires. The private contractual right to renew is only covered by contract law and so can not be considered in a property valuation.

So far as the property law is concerned upon "renewal" the rental for that new term must be paid again.

[steveromagnino]

this 30+30+30 leasehold structure does have some value to it; perhaps not a full 90 years but I for one would be VERY happy to go around and buy up a few leases at 29 years based on most of the people's opinions expressed here if there was any chance that the lease was likely to be renewed, since I would be getting it according to some at 1/30th of the value paid with a good chance of getting another 60 years!

OK, that said Quiksilva's rental yield approach is going to work for the rational investor; however being a resort town we can safely assume that many of the values of this sort of property are nothing to do with rental yields.

The issue of opportunity cost is the WACC approach in a discounted cashflow BTW (the other part of calculating the yield); we discount the value of future cashflows by the compounded cost of the money we put in.

Simply: sum of cashflows approach

I buy a condo and it has a lease of 30 years. my WACC is 10% (which I could earn investing in say my portfolio of stocks where my money was prior to this), and it will be worthless at the end

I receive rent for each year of baht 20,000 at the end of the year net of the body corp/insurance, and there is no planned increase in the amount I receive

How much should I pay?

year 1 20,000 / (1+10%)

year 2 20,000 / (1+10%)^2

year 3 20,000 / (1+10%)^3

etc etc

year 30 20,000 / (1+10%)^30

total value of future cashflows in today's money = 188,538 baht. Therefore paying anything less than this I make more than 10%, any more than this, and I make less.

HOwever, this is rediculously simplistic and makes little sense.

Option 2 - use a discount multiple of freehold vs. leasehold

In Ratchadamri area, St Regis is 180k per sqm. Similarly specced 185 Ratchadamri sells for 300k per sqm. Therefore, discount of freehold to 30 year lease is something like 40% discount at initial price. From there, value of lease falls in a straight line for each year until it reaches zero.

Makes more sense, questionable whether people think in terms of straight line. And questionable whether it will indeed be zero at the end; could make it fall to some other number if you think there is a chance that the lease gets renewed; e.g. 50% chance of renewal = 0.5 X full value of another 30 years + 0.5 X 0

Option 3

Market value - track what other people have paid; this is the true number of what it is worth. You could apply some sort of discount factor to the lease element.

The 64b per sqm per month seems quite reasonable considering it includes power and laundry; typically condos run at between 30-45b per sqm for the basic stuff excluding power and laundry; however how well the complex is managed....who knows?

End of the day, if yout want a bargain, offer a bargain price, but the value and the market price are one and the same IMHO as it is not primarily a commodity investment product; I bet most of the people living there bought just as a place to hang out and do whatever.

Edited August 18, 2008 by steveromagnino

[quiksilva]

My thoughts on these

Option 1 - The sum of cash flows approach is the accepted standard of valuing leasehold interests. This is because at the end of the day leases are only worth what they can generate in rental income on the open market, after making allowances for growth and inflation. They are a right to inhabit or receive benefits from property for a limited period of time.

Option 2 - This approach is okay for what we call a 'quick and dirty' look at the value but how do you accurately compute the discount factor? There is no accepted standard, and straight line deprecation of a leasehold interest does not factor in all the variables. The value of money over time does not depreciate in a straight line.

Option 3 - Market benchmarks is always the best option but the danger is using comps that may not be very appropriate. Good, timely, relevant comparable data is very difficult to get hold of.

This is why I usually use option 1. Under the Thai property law there really is no allowances for renewal, any option to renew is only covered by contract law, and as such you have to hope that your Lessor at the time of renewal is the same person or entity that you entered into the agreement with. So you must hope that the original lessor has not assigned or transferred the property without making provisions in their Sales and Purchase agreement, for the new buyer to honor all clauses of any active leases.

Strictly speaking then, in legal terms any extension beyond the first 30 year term can not be deemed to be (and therefore valued as) a 'real interest in property'. The law also expects you to pay rent for the next 30 year term.

So buying a 1+30+30 year lease at XX% of the freehold value, as you described, is a very high risk activity. Sure the rewards could be high, but its a bit of a lottery.

Caveat Emptor.

Edited August 19, 2008 by quiksilva