You should check the balance of income and expenditures and the remaining debt of your properties immediately.
There are cases where you cannot pay off the loan even if you sell.
“It’s fine because rent comes in every month.”
The investment condominium you own with that mindset might actually be generating a monthly deficit, and when you try to sell it, you might find you cannot pay off the remaining balance of your investment loan—not a residential mortgage.
Right now, what owners need to be aware of is this dual risk.
During the long era of low interest rates, there were times when investment plans could be made based on relatively stable construction and maintenance costs.
However, while interest rates, management fees, and repair reserve funds are rising, it is not easy to raise the rent for existing tenants. Even for properties that were profitable at the time of purchase, the balance of income and expenditures could deteriorate rapidly.
Rent increases slowly, while expenses rise first
The surge in construction materials and labor costs also affects condominium management outsourcing fees and large-scale repair work costs.
If the management association reviews its long-term repair plan, an increase in repair reserve funds may become necessary.
On the other hand, rent cannot be raised just by the owner’s wishes. There are existing lease agreements, market rates in the surrounding area, and the tenants’ ability to pay, so even if a rent increase is realized, it is often a gradual process. As a result, the increase in expenses outpaces the growth in income.
A monthly surplus of 10,000 yen turns into a monthly deficit of 11,000 yen
Let’s compare the changes in income and expenditure using an investment condominium with a monthly rent of 90,000 yen as an example.
The timing and extent to which interest rate hikes are reflected in repayment amounts also vary depending on whether the loan is fixed or variable and the repayment conditions.
Actual income and expenditure must be checked for each property.
Even if the rent increases by 3,000 yen per month, if the increase in loan repayments, management fees, and repair reserve funds exceeds that, a monthly surplus of 10,000 yen will fall into a monthly deficit of 11,000 yen.
This is a calculation where the annual balance deteriorates by 252,000 yen, from a surplus of 120,000 yen to a deficit of 132,000 yen.
Increases in repair reserve funds also affect the selling price
The increase in expenses does not just reduce the monthly cash flow.
Buyers of investment real estate prioritize profitability after purchase.
Even if the rent is the same, if the management fees and repair reserve funds are high, the price the buyer can pay tends to decrease.
Increases in management fees and repair reserve funds also affect the profitability expected by the buyer.
The following table is a simplified comparison of the profitability of the same property before and after the rise in costs.
Taxes, vacancies, rental management fees, etc., are omitted, and
the actual price will vary depending on location, building age, management status, demand, etc.
If we evaluate the profitability at a 5% yield,
there is a difference of 2.64 million yen,
from 18 million yen to 15.36 million yen.
Furthermore, if the buyer’s required yield becomes 5.5%, the valuation after the cost increase is approximately 13.96 million yen.
If the change in required yield due to rising interest rates is also added, the downward pressure on the selling price may intensify.
“Selling it won’t solve everything”: The danger of negative equity
If your balance of income and expenditure goes into the red, you will likely consider selling.
However, the amount you can sell it for and the remaining loan balance you must repay are separate issues.
In cases where the selling price is lower than the remaining debt, or even if the selling price is slightly higher than the remaining debt, there are times when you will lack the funds to pay off the loan after deducting sales expenses such as brokerage fees.
For example, if the loan balance is 16 million yen, the selling price is 15 million yen, and the sales expenses are 600,000 yen, the net proceeds from the sale will be 14.4 million yen.
Unless you bring in 1.6 million yen from your own funds, you cannot pay off the loan.
If you cannot prepare your own funds, you may not be able to proceed with a normal sale.
Even if the sale price exceeds the remaining loan balance, you cannot rest easy. If the “net proceeds” after deducting expenses such as brokerage fees do not cover the remaining debt, you must make up the difference with your own funds. It is not as simple as saying you can just sell if you are in the red.
What should you check on your properties right now?
First, you should check:
1. Actual income and expenditure for the last 12 months,
2. Current loan balance and interest rate conditions,
3. Revision history of management fees and repair reserve funds, and future long-term repair plans,
4. The difference between current rent and market rates,
5. The price at which it could actually be sold and the associated selling costs.
It is especially important to calculate based on a “price that can realistically be sold” rather than a “desired sale price.”
Please verify with numbers whether the net proceeds after deducting selling expenses from the estimated sale price will exceed the loan balance.
You should also simulate your income and expenditure in the event that interest rates rise further or repair reserve funds are increased.
Just because you are in the red does not necessarily mean you should sell immediately.
Decisions vary depending on the room for rent adjustments, borrowing conditions, holding period, tax burden, and future repair plans.
However, it is essential to grasp the current situation before putting off a decision.
Even as times change, the basics of an “exit strategy” remain the same
In my book, “90% of Real Estate Investment is Exit Strategy,” I have conveyed the importance of not dismissing real estate investment across the board, but rather making decisions by looking ahead from before purchase through operation to sale.
Buy low, manage income and debt, and do not buy if the conditions are unreasonable.
And do not lose sight of the exit.
This is not a novel theory, but a classic investment fundamental.
Problems that did not surface with somewhat loose income plans during the era of low interest rates are now becoming apparent due to rising interest rates and maintenance costs.
That is precisely why it is better to check your properties sooner rather than later.
Not just monthly rental income, but how much it will ultimately sell for and what will remain after repaying the loan.
The success or failure of a real estate investment can only be judged by looking that far ahead.
*The amounts and yields in the text are hypothetical for explanatory purposes. They do not guarantee or predict the profitability or sale price of individual properties.
Author: Takashi Teraoka / Representative Director, Anesis Planning Co., Ltd. Author of “90% of Real Estate Investment is Exit Strategy,” among others.
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Anesis Planning’s First-Time Investment Condominium Sale
Anesis Planning Co., Ltd.
Takashi Teraoka
Phone: 03-6665-6877
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