Costa Rica Real Estate Investing. Renting as a business.

If you are considering renting your real estate as a business in Costa Rica, please always remember that this requires care, calculation and consultation.

A common question of those who have disposable income is: Is it more profitable to build apartments or a house to rent, than to invest in stocks, bonds or some other bank transaction that generates interest, without the need to resort to the arduous task of developing a construction project?

Since this is such a large subject it will be dealt with in two parts.

In the first part, the theoretical framework for the technical/financial calculation for rentals will be explained. In the second part, advice will be given about building that will ensure the profitability.

In real estate, the amount of rent is generally estimated at 1% of the market value of the property.

This empirical method helps the buyer/seller of properties but in no way is it a reliable much less technical way to ensure a rental amount large enough to recuperate part of the owner’s investment.

Methodology

To calculate the amount of rental for a property, a methodology approved by the Pan-American Union of Associations of Assessors (UPAV) and by the Costa Rican Institute of Assessors (ICOVAL) is used. It is based on principles of economic engineering applied to civil engineering.

In this methodology called “Return on Investment,” the result is the net monthly benefit that the investor must receive for the money invested in the property at a real rate calculated according to inflation and the basic passive rate of the Central Bank.

The payback time of the investment so that the operation is amortized and profitable is affected by the real rate. The procedure also allows the calculation of the nominal rate of the annual rent, which compared to the 12-month nominal rate of the National Bank  as a bank reference  must have a higher yield.

Depending on how risky the operation is, that yield must be higher than investing in a state bank with almost no risk.

In rentals it is difficult to have high nominal rental rates for two basic reasons: the real rate of investment is subject to the basic rate and this is subject to the cycles of the domestic national economy and to supply and demand.

The greatest advantage of this procedure is that it is not subjective. The results are reached by mathematical formulae and by the economic indexes data of Costa Rica at the time of the study. Therefore it is a reliable methodology and assumes experience and knowledge.

Real Estate Investing in Rentals Step by step

In short the procedure involves:

1. A physical assessment of the land and a physical assessment of the building.
2. To assess the building, you use the Ross-Heidecke method in which variables such as obsolescence, age of building and maintenance are taken into account, in addition to depreciation, given that the quality of maintenance lowers the depreciation percentage in similar buildings.
3. Calculate the Capitalization Factor. To make this calculation you need economic indexes of the country: basic passive rate of the Central Bank, devaluation compared to the dollar and the active rate of the National Bank for investment in business and services. In addition, calculate the percentage of increase in annual rent.
4. The Capitalization Factor decreases if the real rate of investment increases and it decreases if the cost of money for investment increases.
5. Finally, the total amount of the assessment of the building is divided into the Capitalization Factor to get the amount of net monthly rent, which is equivalent to what the owner really receives. Depending on the percentage of expenses (maintenance fees, service payments, unrented spaces), the amount of rent is calculated, which is the final monthly value the tenant must pay.

An example:

Take as a reference the existing variables in the national economy with the capitalization factor at 98, projected inflation at 14 percent for 2005, a commercial rate of construction at 22.75 percent, a basic positive rate at 15.75 percent in July of this year, and an annual rent increase of 10 percent.

If the property value (land, plus construction, plus equipment) is ¢30 million, then a monthly rent high enough to recuperate the investment should be ¢306,120.

The variable that most affects rent value is inflation since it reduces the return on money invested in real estate.

On the other hand, the percentage of monthly rent is not necessarily 1 percent of the value of the building; this percentage varies according to macroeconomic conditions in the country.

Results indicate that the higher the Capitalization Factor, the lower the minimum rent needs to be for the desired return.

Finally, it is important to mention that rental values, in general, are usually lower than theoretical financial results since they change according to supply and demand.

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Andrew Makarik

to@welovecostarica.com

Andrew Makarik is the main editor of WeLoveCostaRica, a fan of this sunny country. He is also a loving husband and a has a lovely daughter. By being a devoted family man and the biggest Costa Rica fan, he wants to make more people feel at home there. WeLoveCostaRica unites people and helps them find new home or a new travel destination. This website is a friendly community where everyone can find not only information, but also new friends and travel pals. Andrew is also passionate about IT and programming, so he himself maintains a friendly atmosphere in this cozy environment of WeLoveCostaRica.com.