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Buyers and sellers, be aware of the principles of diminishing returns in real estate

In your quest to choose the best property for your budget, it is recommended that you arm yourself with an important principle in real estate: THE PRINCIPLE OF DEMINUBLE PROFITABILITY.

Let me explain this in plain language: OVER IMPROVEMENT and UNDER IMPROVEMENT in real estate that should be avoided as much as possible.

Excessive Enhancement: An enhancement that is not suitable for the site on which it is placed due to excessive size or cost.

Low Improvement – An improvement that is not suitable for the site on which it is placed due to its size or poor cost.

Based on years of experience and knowledge of numerous successful real estate developments, the general rule of thumb is 30% of the value of the lot and 70% of the value of the house, give or take. So, for example, if you have a 50 square meter lot earmarked for low-cost housing valued at around P300,000 and you list a house worth 700,000, you would be fine. Suppose you want to further improve the house to be worth 1 million, still fine, but keep in mind that there is a principle in real estate which is THE PRINCIPLE OF DEMINING RETURNS. Which means that the improvement that can make a profit will be only up to a certain level, beyond that level, it will become a loss. Let’s further suppose 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 relation between the value of the lot and the house is now distorted. The homeowner who over-improves may not realize it while he still lives 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 the lot would be 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 such a house today, 15 million pesos would not be enough. But for a rural area like Dalaguete Cebu, the lot is very cheap and he 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 how happy he would be with his home, and when the conditions of his life 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 trap of OVER IMPROVEMENT. For example, the developers developed low-cost subdivisions or a higher level that approached the mid-level classification, installing a nice pool and clubhouse. Eventually the owners couldn’t maintain the pool and it turned into a pond. During rainy days you can see frogs swimming in the pool. The subdivision is located in the inland part of Mactan Cebu. The owners of this development are unable to sell their property for a good profit due to the subdivision’s lack of maintenance plus the fact that the cost of purchasing 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 priced between 5.5-6.5 million. In fact, the quality of the materials used and the design are very good. However, they did not consider that the barangay road connecting the subdivision to the main road was too narrow and nothing can be done about it. It is still a 2-way street but it is narrow to just under 4 meters wide. They didn’t consider that prospective local residents who have that $5.5 million to $6.5 million budget won’t feel comfortable going down that narrow path to an inland no matter how good the house is. It is an excessive improvement for such an inferior 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 losses in real estate investment.

For example, a homeowner called me to sell his property in Córdoba with a lot area of ​​1,300 square meters. He built a 150 m2 bungalow in the back of the lot, leaving more than 1000 m2 of lot as a front for his house. The husband is a foreigner married to a Filipina but after years of living together they fell out 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. Why? It is due to LOW ENHANCEMENT. Potential buyers like the house, but the 1,300-square-meter lot area is too much for them, putting the property beyond their budget. They could have added townhouses to the front of the 1,000-square-meter lot for a profit, but given their situation, they are unable to undertake that plan due to their conflicts. All they want is a quick sale and an immediate share of the profits. Unfortunately, they still have some time to wait, as 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 deal with 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

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