Thursday, April 19, 2007

An unsolicited offer (1)

We have received an unsolicited offer for one of our Hong Kong properties. While we usually purchase with the intention of retaining properties for long term income, we recognise that there will be properties which, for one reason or another, should be sold.

Background

While the property's location should make it an easy property to keep rented, we see limited upside - some of the expectations that contributed to our decision to buy this property have not eventuated and the ability to add value is questionable. We also see better opportunities elsewhere. As there is a sitting tenant who has paid the rent on time every month without fail and has never called us with maintenance requests, we are under no pressure to sell or even to make a decision: it's easy to procrastinate when the cash flow is positive and is expected to modestly increase when the current lease expires at the end of this year.

Choices

With an offer on the table, we need to reach a conclusion.

Our choices are:

1. keep the property and defer making a decision until the existing lease expires at the end of 2007. Options then would include (i) negotiating a higher rent with the existing tenant (ii) selling vacant as is or (iii) doing a substantial redecoration and then either renting or selling; or

2. accept the offer. Our annualised IRR would be 11.95%. The IRR calculation (done using a somewhat crude spread sheet) takes into account all revenues, costs and expenses and is based on the negotiated price being at the price offered by the potential purchaser. It is pre-tax (although only the rent is subject to tax). This is acceptable if unspectacular.

We could market the property now, but (i) selling tenanted residential properties is harder than selling vacant ones and (ii) the time taken to market may be longer than the purchaser is willing to wait.

(Provisional) conclusion

Current thinking is to try and negotiate a better price and then to accept the offer. However, we need to do more research on (i) comparable sales and (ii) alternative investments before calling it a definitive conclusion. While the sale prices can be obtained easily enough that information needs to be supplemented by additional information such as (i) interior fit out and (ii) outlook. We have some ideas for alternative property investments, but need to to some more homework before committing to them.

Of course, the other factor is that the "offer" is an oral expression of interest. Unless and until it is put to us in writing it is not an offer at all.

5 comments:

Raphael said...

Hi Trainee,

I'm currently considering getting into the rental market, so I wanted to get your opinion on a few things.

My first concern is the potential for interest rates to rise in the coming years. I think some increase is innevitable, but I'm wondering how substantial it will be. For example 1-2% is tolerable, but above that and the holding costs could be substantial.

What do you think are the chances of interest rates rising dramatically above this (given the US economic situation)?

My other thought is, if the US has some tough times ahead, how significant an impact will that have on the Hong Kong economy, unemployment, salaries, and of course rents.

I know I'm asking for a bit of crystal ball gazing here, but I'd be really interested to hear your views.

My current plan is to try and pickup a 2 bedroom place in Kennedy Town, probably in the 2.6-3 million range in a reasonably new building, either The Merton, Ivy on Belcher, University Heights or similar.

Do you have any thoughts on Kennedy Town or these complexes that you'd like to share?

Thanks!

Raphael said...

Woops, should have read, I'm currently considering getting into the property market ;)

traineeinvestor said...

Hi Raphael

Starting with the qualification that I am not a professional adviser - just an amateur trying to self fund his retirement.

On interest rates: I am reasonably relaxed. Some central banks have tightened and may tighten rates further (ECB, PRC and others). Others are currently sounding like they are inclined to do nothing or may even ease. Hong Kong is a bit different in that the HKMA does not actually set interest rates (although it can influence them) and we have a "peg" to US$ which implies that HK interest rates should not deviate too far from the US rates. Given the amount of liquidity in Hong Kong (one of the most liquid markets in the world), the link to the US$ and the fact that HK's economy is robust but not over heated, I can see interest rates going up or down, but would be surprised if we get a big (more than 2%) movement in either direction. I appreciate that this is a bit vague, but given the number of influences (internal and external) and the "all in or all out" mentality, it represents my own expectations. Of course, for a property investor, an increase in interest rates from 5% to 7% would be pretty damaging to my cash flow. Equally, it may provide some good opportunities should it happen.

HK has had three good years in a row and I am optimistic that the current economic strength can continue - and that is the basis on which I am investing my own money.

I like Kennedy Town. It is a bit quieter and less crowded than Mid-Levels and the transport is easier than from Happy Valley to use two comparisons. We looked at some units there back in Feb, including Ivy on Belcher which is a very good building. I have not looked at The Merton or University Heights.
The two negatives about Kennedy Town are (i) prices lifted a bit after the announcement of the MTR extension. If the MTR extension is delayed or cancelled (and over 5-6 years a lot can happen) that may have an adverse impact on prices and (ii) there are plenty of small old buildings and a few potential building sites (including one which MTR intends to develop) so the potential for new supply is quite real.

In short, I like the area but have mixed feelings about the potential supply of new units. The trade off is that it is cheaper than Mid-Levels and the yields are marginally better.

Raphael said...

Hi Trainee,

Thanks for your response! I think a 2% rise is still OK, but if rates were to go to 10%+ then it'd take a bit of a bite out of my income. I guess the chance of that is small though. (I think I've been influenced by too many pro-gold, world depression predicting pessimists that seem to lurk on every forum these days).

Thanks for all your comments on Kennedy Town. I agree that there will be quite a few new developments in the future, like the site next to the Merton (ex-crematorium and abatoir) that will get developed in 5 years or so. That said, the development of high quality building in the area may not be such a bad thing as it will bring up the quality and status of Kennedy Town in general. Most people I talk too are still shocked that you can pay 3M+ for a place in K-town (I guess it has had a bad reputation in the past?).

Naturally increased supply of units will also cause prices to drop, but if the area is redeveloped as a whole, it's probably not a bad thing. In the year I've lived there I think about 30 new restaurants have opened, about 4 new Circle-K's / 7-11s, 5 new real estate agents...

I was wondering if the MTR has already been factored into the prices, probably it has but the rental yields in Kennedy Town are still extremely good, at least in my view. 4.5% rental yield with 4.85% mortgage sounds great to an Australia who is used to 3% rental yields and 7.25% mortgages :)

I'm optimistic on the future of K-town, with Cyber-port around the corner, and Shung-Wan in the Central direction, it seems that, given it's proximity to central, the prices are still extremely low, and it's surrounded by other more expensive suburbs.

Also, I tend to be a bit of a value investor, so I'm not too concerned with market prices as long as the rental yields are good.

Well, that's just my 2 cents, thanks again for your advice!

traineeinvestor said...

Hi Raphael

Perhaps I was a bit too negative. We do like Kennedy Town a lot and are considering making our next investment in either Kennedy Town or Mid Levels. We think we will get a better yield in Kennedy Town than Mid Levels. But a lot will depend on what is available when we go looking.

Prices did lift after the MTR extension was announced. Given that it is still 5-6 years away (at least), I would expect that the market reflects the risk of delay - meaning that it may not be fully factored in but that a delay could have a short term negative impact. One thing is to do an analysis of prices per square foot for properties in Kennedy Town and other MTR stops which are similar in terms of environment (possible North Point or Quarry Bay). I have not done this yet.