A Layman’s Guide to Real Estate Investment (2) : Capital Gains
How To Get Capital Gains on Property in These Tough Times
When the first publication of Castles lifestyle rolled out in 1999, price for a plot of land in Lekki Phase-1 was around N2m. Today, in 2018, the same plot is slightly above N200m. So anyone who paid for the plot in 1999, would have made N198m profit on the transaction. The N198m, in investment terms, is called capital gains.
Capital gains is the difference in the value of the property now compared to when you bought it. Rent as we discussed last week is what the property owner gets from someone who uses the property for a while. Major difference between rent and capital gains in cash-flow terms is that you can continue to enjoy revenue (rent) by giving up possession of the property for a period. You don’t give up ownership of the property. But for you to enjoy the cash from the increase in the value of the property, you have to sell.
The point that you have to sell to enjoy the capital gains* is very important when we are considering real estate investment. This is because as a general rule, property tends to appreciate. So even if you buy property as your home or for rental income, the value will go up. As you don’t intend to sell these properties, that is outside of our consideration here. We are looking at a scenario where you buy property with the express intention of reselling at a higher price.
What factors do you have to consider when you are buying real estate to sell at a higher price subsequently?
First is how long do you want to hold the asset before selling? Accepted wisdom is that the longer you hold, the higher the price. So if you want to hold for a short period, say between a year to two years, then there must be a factor or factors that will make the price move in such a short (for real estate investment) time.
One is shortage of supply. If only one plot of land is available in a desirable estate and you have the money, you can reasonably expect that within two years someone will buy the property at a premium. Another factor that can make property desirable is if some deficiency is going to be cured. So, plots of land around the route of the new rail line in Lagos which suffered from poor transport links to the city centre, will become more desirable when the line is complete.
Another instance is that a land with a ‘mere’ Letter of Allocation, seen as an inferior title, will be cheap but as soon as the Certificate of Occupancy on the property is complete, the price will spike. So for quick transactions, there is some skill. For long term, say about 5 years, buying in areas that are not well developed and so reasonably cheap, is a good way to invest. As soon as development reaches the area, the price would have gone up and you can sell. Locations like Ibeju Lekki and the Mowe Ofada axis are good for this kind of strategy. Having said that, four years ago, land in Lekki 1 was trading at around N150m per 1,000sqm plot and today, such plot is going for N200m to N220m.
Land or developed property
Second factor you should consider is whether you should buy land or developed property. Developed property means you can enjoy a hybrid return of rents during the holding period and also enjoy capital gains when you sell the property. This means that you have to invest more money as developed properties generally cost more than bare land. You also have to get into the management of the property during the holding period. It also appears that it is generally, easier to sell land and the returns better than developed property.
Transaction cost is the third factor to take into account. Buying and selling land is not cheap. Agency fees can be anything from 5% to 10% of the price of the property. Perfection (Governor’s Consent and Land Registry registration) could add another 10% as fees. When selling the investor is also subject to Capital Gains Tax on the profit he had made on the transaction.
Rate of return
In the good old days up to 2010, property values could double in a year. In 1999, a 675sqm plot of land in Victoria Garden City sold for N1.7m. Three years later, it was N12m. But those days have gone and property price rises are more conservative now. It is up to the investor to check if the capital gains he expects to make are commensurate to other investments like shares, Treasury Bills etc.
Notes *One way you can ‘enjoy’ capital gains without selling is borrowing against the increased value of the property. But in this scenario, we are looking at the simple concept of making a return on your initial investment.