PHL POVERTY TRAP: A solution?

[drbubb]

PHL POVERTY TRAP: A solution?

Millions of Filipinos are trapped as renters paying out all their salaries in food, rent and help to relatives.

After a decade or two of working hard at 6 day weeks, they may have nothing but debts to show for it.

The big drop in Bitcoin and other cryptos recently may have demonstrated that it is very hard to escape poverty by speculating on things like small shares and crypto currencies.  Often, by the time you hear about how "hot" they are, the easy money has already been made already.  And before you can exit, you might get hit by a vicious selloff.

I feel nothing but compassion for those caught in the poverty trap, and have been pondering if there might be a way out.  And I have an idea borrowed from a Canadian billionaire I once met.  Someone who started with nothing, and came to own an entire city block in the city of Toronto

The idea is a little complicated.  I will take a stab at explaining it here.  Basically requires 2-5 people to cooperate in renting, and paying a little over the market, to allow one member of the group to become an owner-occupier.  The tenants sign a special lease that may allow them to build flexibility, and maybe some future equity if they continue to rent the space.

A Canadian billionaire I met built this condo in Toronto.  He started with nothing but some friends who wanted to share the rental of a property

I started thinking about this when my partner was telling me about a work mate, who had worked almost 20 years in the same company, and had no savings and no assets to show for it.  She expected to be handed some money when she left the company, but that would only be enough to payoff her debts and walk away with a modest lump sum.  Property ownership seems like an impossible dream.  Is there any alternative to the Philippines DEBT TRAP?

[drbubb]

INVESTIGATION at a Meet-Up

DISCUSSION:

We can talk about the Concept of escaping from the Poverty Trap.   Can you and others think about how many friends you might get to Rent a shared property?  How much they might each pay?  And what the minimum period of Lease they might sign?  That might be at the starting point in working through a Realistic example. 

( This might require some excellent persuasion, organization and management. There is NO FREE LUNCH.  But cooperation, might get a "bargain lunch"/  haha. )

( Rooms: Bed, Mattress, Private Bathroom, Microwave, Mini-Fridge, Air-Con & Storage )   This one is advertised below P5,000 a month:

Would you pay a little extra (over market) to live in a space like this, if you were building up some equity in the property?.  This may represent the lowest RUNG in the ladder, and there are steps above it    This one is advertised below P5,000 a month:

> MyTown Listing, under P5,000:  https://www.myproperty.ph/mytown-rio-6-bed-sharing-fully-furnished-unit.html

> More MyTown units: P4400: P4400-nr.UptownBGC: P4500-nr.32ndStBGC: P4150-Pembo:

GENERAL PLAN of ACTION

1. Agree a rental and contractual framework: Number of people involved.  Min /Max rent per Month

2. Develop financial pro-formas, between Partner-tenants and Lead investors

3. Investigate properties that can be acquired to fit the criteria, and provide target returns: 10% 12%?  whatever

4. Get Tenant partners to pay 1-2 months showing their acceptance of the property based on photos

5. Negotiate purchase.  All-in price to include: purchase, commissions, CGT/DST, and a budget for needed upgrades

The Four Fivers, who might be paying P 5,000 each.  

Example: The Three Tenors - what do you need to provide to attract them ?

Based on Target Gross Yield, How much can be paid for a property??

Per Person - -   :  P  5,000 : P10.000 :
Persons --------- :       x 4.    :      x 3.     :

Monthly RENT:  P15,000 : P30,000 :
x 12 months.   :     P 180k :    P 360k :
 > Target: 10% :   P 1.8 M :  P 3.6 M :
 > Target: 12% :    P 1.5M  :  P  3.0 M :
=======
Less: admin.      :   ( 25k )
Less: prop.tax.  :    ( 10k )
Less: 1 mo.Void :   ( 15k )
Less: Repairs.   :    ( 10k )
==. Total Cost. :     ( 60k ) :    ( 60k )
Net Cash Flow :   P 120k  :  P 300k :
Returns for
 >  10% Prop.    :    6.67% :    8.33% :
 >  12% Prop.    :    8.00% :   10.0% :

Maybe you can buy a property like above for P 3.6 Million, but can you get 3pax to pay P10k each?

What is SPECIAL about the Leases signed? - and will special leases attract tenants?

xx

[drbubb]

SAVING HABITS and HOUSING EXPENSES

A Comment on attitudes of Filipinos towards Saving

I think the problem with most Filipinos are that they think that rich people are those living with flashy lifestyle. When they save, it's to purchase consumer debt. Even managers who have large salaries actually spend more than they earn because naturally their expenses grow with their higher income. Instead of setting aside money growing passive income to grow their assets. They are actually earning millions a year but they are spending most of them.

(posted on a Viber chat - my responses follow):

Most people (esp. Americans) spend about 1/3 of their income on Housing.  The trick is to turn that expense into Net Zero, and save the 1/3  instead

My own housing expense is like zero or negative, because the appreciation I have made on my own home(s) exceeds the actual housing costs/

The traditional way, may not be the only way ... to come to Home Ownership.  These habits provide a great base for moving forward.

[drbubb]

Here's a realistic way to escape The Trap, this can really work in the Philippines:

TANDEM BUYING : committed tenant gets option to buy

Both parties SEARCH Together... hunting for a bargain.  Both benefit from a cheap price

CASH Buyers usually get a better price.  I normally see a 10% or greater discount for cash buyers who do not need to wait for banks. And this is negotiable, of course.  Having said that, it might take a while to find the right property, where the discount is large enough

The ideal situation might be one where one party has cash, and the second one lacks it at the inception, but can raise the funds needed to buy later, such as after one or two years. This helps the second buyer who does not want to miss out on bargains in a depressed market.  Searching together, they gain control over a property where potential buyer#2, the TOB/ Tenant-Option-Buyer will live in the property until he/she finally decides whether to buy it or not.  Controlling a property in this fashion may give the assisted buyer time they need to build savings and find a bank which will provide an attractive mortgage loan.  It works off the very-real assumption that a Cash buyer who can move fast can often get a substantially lower price than one who needs to go through the slow process of getting a loan approved through a bank. It can take 3-6 months to close a bank financed purchase in the Philippines.  ( Additionally, there may be other reasons why buyer#2 needs more time.)

This could work especially well in a market like that of 2022, where there are distressed sellers who might give as much as a 10-20% discount to a Full Cash buyer. That cash discount gives a higher return to the initial cash buyer - enough to pass on price advantage in great flexibility to the second who should still get a below market price. I have found several sellers like that recently.  They wanted cash in a hurry, and will give a big discount.  I bought one unit and referred another to a friend.  I have not yet tried to approach these bargain purchases as tandem buys.  But I think such an arrangement may work well in the future.

( Here's a Q & A about the idea ) :

Let me try to explain it in a few words: Tandem buyers agree jointly what property to buy, and the final cash price to be paid.  As well as the strike price on a possible resale, under an option granted to the tenant/ who may become buyer #2.  If the original price is low enough, the rent may be around market levels, and the option price below market.  Of the discount-for-cash is big enough, it can leave both parties in a favorable position.

The Tandem buyers are: Cash Buyer, and Tenant-second buyer.  The Second buyer's living requirement will drive the SEARCH, but the property has to be acceptable to both.

Buyer #1: OCB / Original Cash Buyer pays the cash to secure the property, at a discounted "Cash Buyer's" price

Buyer #2: TOB / Tenant Option Buyer rents it, paying 12 months rent upfront. He gets a place to live, and in effect buys a purchase option on the property he rents. (Rental might be a little over market, unless they can secure a very low price.)  At 12 months, TOB has an option to buy the property at a premium to original price, probably 10-15% higher than the original discounted cash price.  Works best, if this original price was a big bargain and the Option price is still well below the Fair Market Value.

This arrangement carries certain advantages for both tandem buyers.  The main ones being these : Buyer#1 has a happy and committed tenant from day1, and the 2nd Buyer is actively involved, probably steering the search to find a property he/she wants. This is a CALL Option for TOB, so he/she is not committed to buy it.   They will be living in it, and furnishing it, before agreeing to Buy.  The decision to buy (or not) comes after a year.  When they have settled in, and may have better access to cash or bank finance.  If the parties agree, there might also be a second option to buy after the second year, if the two parties have agreed to extend.  Albeit, the year two option price might be higher.

( Does this arrangement sound like it might work for you? I asked - I addressed this to a possible TOB, Tenant/ Option Buyer.  Follow is an edited version of the conversation we had.)

Q: #2, TOB will pay 12 months rent in advance like downpayment?

A: Yes, you can think of it that way.  But no more rent to pay after that payment, for first 12 months. That upfront payment might be very approx. 10-12% of the property's discounted price.

Going shopping as tandem buyers, allows the two to seek an excellent bargain in a depressed market like the current one. Finding a seller who needs cash.  There are many like that in 2022.

Q: Original Cash Buyer will have the rental property in his/her name?

A: Actually , The OCB / buyer#1 will hold the physical Title with Seller's name on it, and the right to transfer in the title into his/her name once it is known if the option is not going to be exercised.  If exercised, the title transfer will go to the TOB.  It is anticipated that the CGT/DST will be paid then.  If the option is not exercised, the original buyer will proceed to put it in his name.

Q: It's also like a rent-to-own agreement with TOB?

A: Basically, Yes. But it is an OPTION to Buy, not a contract to buy, though the wording and documentation must fit Philippines legal requirements. So we may need to discuss with lawyers how the documentation is crafted.

BTW, OCB may want to make maybe a 20%+ return on exercise, but maybe half of that will be the upfront Rent payment.  No exercise, means they will keep the property.  TOB can stay on as a pure tenant.  Or a new tenant might be found. 

Q: Ahh, so TOB needs to pay in full the amount with 10-15% higher than original price after 1 year?

A: Yes, the strike price is subject to negotiable of course, but I would expect something like that, ie 10-15% higher.  Remember the two parties go out together seeking an outstanding bargain price.  They might only proceed if they can find a truly outstanding bargain.  I expect some sellers will be so hungry for cash, they might give a 10-20% lower price than a buyer who needs a bank loan.  (Bank loans can take months to process, and that may not be fast enough for the seller.)

Q:  So Both need to agree on which property to buy?

A:  Probably TOB will be the main one choosing the Property, but it must also be acceptable to OCS, since he/she will stick with it, if/when the option is not exercised.

/ Example:  This makes sense because big bargains can be found now in the current market.  We designed the idea around a studio that I found and a friend  bought recently at just 2.9M, which is below the approx. 3.8M zonal valuation.  A second buyer who jumps in on a deal like that would still have a bargain, they had an option to buy at 3.2M or 3.3M, after one year.  Zonal valuation on this property was increased just a few months ago, and so it is unlikely that such a low price will be available next year.  It took a few months to get the property decorated and rented. And it was rented at about P20,000, near an 8% gross yield.  The tenant has no right to buy. A tenant who helps choose the property and gets a rent to buy, might be expected to pay a higher rent, such as 1% a month, P29,000.  Or somewhere in between 20,000 and 29,000.   The rent would be agreed before the purchase, and the original buyer could use the upfront rent to reduce the amount of cash he needs to buy. /

OCB will be equally eager to find a good property, because OCB may be left with the property, if the Option is not exercised.  They have a mutual interest in getting the lowest possible price.

Q: What are the main advantage for buyer#2- TOB?

For TOB: 1. THEY choose the property,   2. Take advantage of the huge discount to cash buyers, without actually having the cash, at a time when prices are distressed,   3. Get a place that they are happy to live in, and a chance to live in for a year before deciding to buy or not.  4.  Save on CGT, as compared with two separate transactions, fully completed

You think you are better off to wait?  I doubt that, since very possibly the cash bargains of today, may not be around in 12 months time.   In fact, it totally depends on what you can see and find in the current market.  It makes sense to pursue this, if there are truly outstanding bargains available.  If you cannot find a good one, then wait.  I think you will find bargains.  I helped my friend find one, and she bought it, 27% under zonal.  Another friend is in process of buying a unit with a near 11% gross yield.  It is also under zonal by a meaningful amount.

...

( Still pondering other issues, like...)

Future Rental increases

What if I won't have the cash to buy in 1 year,  would it still be enticing to become a TOB?

I don't know what will happen in the future. The principle reason for me to change my living situation is if the location is better than mine and/or if my rent is lower.

A. 

This needs some deep thinking:  Right now most Renters are completely un-hedged against rising rents, if they do not own.  That was why I bought my first property, all those years ago.  I wanted to protect myself from rent rises in the future.  In the end, the cheap and tiny flat I bought proved to be an excellent investment, since rent were shooting up at 10-20% per annum.  And NY Condo prices began to appreciate rapidly as rents rose.

[drbubb]

ANOTHER QUESTION on Tandem buying

"Interesting and great to see that this idea has pushed through..."

Q:
What is the embedded financing cost for the tenant? It has to be rent + financing in order to make sense for the seller because otherwise he has an opportunity cost of not getting the money right away. Financing the unit is also an additional incentive to buy after 2y because otherwise the money is gone.

A:  There are some difficulties in answering that question:  

1.  How do you value & take into consideration the "extra discount"  that was likely obtained, because the purchase was originally negotiated as a cash purchase?  (My view is that there may often be enough price savings to pay for ALL of the extra cost embedded in the Option Price to buyer#2.  If not, maybe seek another property where the discount is larger.)                  

2.  How do you value the option?   Surely it is not correct to value it at Zero.  (If you value it fairly at 10% plus, then there might be no extra finance cost. Option values depend on strike and implied volatility.  If the 2nd Buyer has to wait. The same price may not be there, in fact the option strike price might not even be obtainable. Addition advantage for TOB is:  If the market slides, the 2nd Buyer can seek a different property to buy.  That flexibility has real value in a highly volatile market.)                                  

3. Renting a property where you have an option to buy encourages different behaviour.  So if you compare this situation to a straight tenancy, you are ignoring the "positive feedback loop" which might benefit both parties - when it comes to buying furniture, and taking care of the unit, upgrading it, etc                                    

4. After one year, the option might be extended, even if this flexibility is not written into the contract. The deal cut to extend then will probably look different than if the first year had not happened.  If the TOB insists, some form of agreed extension might be written into the original contract.

 ==   In short.  If you try to work out an "imbedded finance cost", You will likely have to make some assumptions that ignore or undervalue some of the advantages implicit in the deal.  Okay to do that, but you need to understand it is a narrow way of looking at the deal.

BTW, the initial questioner has come back with further questions about how the Option/Rental period might be extended.  Under a 1 year deal, the upside for Buyer#1 is capped for 1 year, at maybe 20%*.  What would the want in return for capping it a second year? Above market rent?  Increased strike price?  Maybe a little of both.

/ in my example, the purchase price is 27% below zonal valuation.  So capping the 1 year return at 20% would be a meaningful curtailment of the return.  The main advantage to Buyer#1 - OCB is having a committed tenant from day1. /