The other day while on my late evening walk, I passed Prestige Apartments located in Chandol in front of Kundalini Health Club.  Of the 46 units with an advertised starting price of 1.5 crores each, I only saw lights emanating from one. I thought to myself. "here was an example of another white elephant that have been sprouting up in various parts of Kathmandu valley".

I went back home and did a quick research to find out how many real estate developments were on-going or had been completed in the last couple of years. Based on information at www.housingnepal.com, I was able to assemble an incomplete list of 45 ongoing and completed real estate developments in the valley.  They comprised of 8,936 units of which 2,070 were stand alone homes and the rest apartments. The average of starting prices was 71 lakhs and the average of the maximum stated price was 1.40 crores. The prices ranged from 13.8 lakhs for a 548 sq ft unit at Eastern Apartments to 3.65 crores for a 3,546 sq. ft. apartment at Sterling Patan.  If all the apartments were sold at the advertised average price, the total value of these developments would be 70.76 billion rupees which at 89 rupees to the US dollar amounts to almost 800 million USD.

A few days ago, I also received a call from one of these developers who wanted to sell me an apartment in one of their developments.  While I terminated the call pretty quickly since I had no interest in purchasing an apartment, it might be interesting to see what the economics would be for me if I were to be serious in making an investment in one of these apartments.  Since I already own a house any investment I would make in a second  apartment or house would be purely for investment purpose. At the minimum I should be able to rent it so that the yield I would get would be equivalent to the housing loan rate that I would have to pay if I were to finance my purchase through a bank which in the current market is somewhere around 12%. Let us assume that I would want to buy the median apartment of the starting range of my sample list which happens to be a 725 square feet apartment at Sano Bharyang in a housing development called United Society being built by United Builders and valued at 39.9 lakhs.  For simplicity let us assume that this is 40 lakhs. To get a return of 12% per year my collectible rent would have to be at least 40,000 rupees per month (The equivalent monthly mortgage payment on a 12%, 20 year loan of 40 lakhs, is 44,043 rupees.)

Given this economics, should I be investing in apartments. For me the answer is very clear and it is big NO.  It would be highly unlikely that I would be able to have my new investment be occupied by a tenant who would be willing to pay 40,000 rupees per month plus the extra management fees continuously for the next five years let alone the period of the mortgage were I to finance it using a housing loan.  For the highest priced apartment in my sample list, I would have to be able to lease it at 365,000 rupees per month.  How many people in Nepal including expatriates could afford or be willing to pay these type of rental rates based on their earning capacity and in a market where there is more supply than demand?

There are other reasons also why I would be hesitant in investing in apartments in Nepal in the current context but I will leave that for a later time.  Simple risk and return analysis indicates to me that investment in apartments and even stand alone homes in Nepal does not make sense.  There is no connection between the stable earnings power of the real estate investment and the value of the investment. One might argue that 12% is not the benchmark one should look at since one will not get that type of interest from a bank deposit.  True but the risk characteristics of a deposit and a real estate investment are very different the latter being more risky and illiquid than a deposit and hence should attract a higher return.  Besides if one was to finance the purchase of a home, it is the housing loan rate that one would have to pay and hence that is the minimum return that one would need from the investment. So for housing investments, the housing loan rate or mortgage rate is the benchmark rate that one should use.

One might argue that one invests in real estate for capital gains.  True, but what is capital gains?  It is essentially the realization today of future gains that one expects from the property. In this case it would be the ability to generate larger returns by increasing the rental rates in the future but we all know, except for certain prime properties and scenarios where there is excessive demand relative to supply, as real estate investments age, their returns decline besides exacting increasing investments to maintain the property.  For the same rent, people or businesses will prefer to lease new properties if they have the choice so old properties and homes will always be facing a downward pressure on their lease rates.

While real estate investments are part of an asset class that people should consider investing in, like all investments it should be subjected to due diligence and a good understanding of associated risks and returns should be obtained prior to putting one's money into it.

Most of the real estate developments in Nepal are not targeted to the average Nepali. Most of the end investors in these properties are people who already own homes and other real estate investments.  Vacancy will be a big issue for many of these real estate developments turning them into white elephants that will be losing value every day.  The only silver lining that I see is that, should tourism prosper, some of these developments may be good candidates for hotel conversions albeit at much reduced values. The sad part is that with 800 million USD, Nepal could have added in excess of 400MW of hydro-electric capacity which would have given the Nepalese economy substantially more benefits and its investors better returns while diversifying their risks.

(Dr. Manoj Shahi is former chairman of Rastriya Banijya Bank and can be reached at: manojshahi@yahoo.com)