Property Decay: What You Need To Know As A Sub-Sale Buyer

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Note from Khai Yin: today’s GoodPlace Homebuyer Guide is contributed by James Lim, a professional valuer who also brokers sub-sale property deals on the side. To contact James, either submit a request at our Contact Us page or email me directly.

Malaysians seem to (like to) think that prices of property always go up. As a valuer, I have the experience of seeing how prices of property in the sub sale market go up and down. I am therefore in a position to take the “10,000 ft helicopter view” and see how property prices trend over time. While it’s true that in general property prices tend to trend upwards over time, it seems that most potential investors would completely ignore the fact that over time, a property can indeed lose value.

The fact is that you can make more money if you understand the factors which make a piece of property depreciate in value over time. Most amateur investors that I meet don’t really think about this. I am a valuer by profession, and I have found that the savvier buyers would never fail to quiz me with very insightful questions about how obsolescence affects the prices of the properties that they want to buy.

Alas, property valuation is both an art and a science; while it take lots of (qualitative) judgment there are some textbook (quantitative) frameworks that one can follow to come up with a fair valuation of a property. Unfortunately, many of these frameworks can be (admittedly unnecessarily) complicated for the laymen. As such, methodologies like Khai Yin’s (download his guide) are oftentimes good enough for home buyers… indeed, this is another example of the manifestation of the 80/20 rule that Khai Yin has talked about in the recent weeks.

The F.E.P Decay Framework

Property value depreciation is driven by “decay” across three important dimensions:-

  • Functional (F) decay
  • Economic (E) decay
  • Physical (P) decay

Let’s now examine each of these types in detail, and how they affect the value of a property.

Functional Decay

Functional decay is said to occur when a property’s ability to “function” for the purpose it was built is deteriorating. This can be a result of the deterioration of the property’s physical characteristics, or due to external changes (i.e. the property’s environment).

Some examples of functional decay:-

  1. A 20-year-old office building in downtown KL which is not broadband enabled. While the physical condition of the building is still tip top, installing new fiber optics can be impossible.
  2. A petrol station which will soon be “out of the way” with the development of a new flyover bypassing it.
  3. A mid-of-the-range condominium next to a college in Subang Jaya which is typically rented out to students, but the college is to be relocated to Cyberjaya.

In many cases (about 70-80% in my experience), functional decay is relevant to commercial rather than residential properties.

Economic Decay

Economic decay is related to the financial aspects of a property – typically for maintenance (ongoing) and renovation (once every couple of years). Just like the “Comp Method” associated with evaluating a property’s fair market value, the bog standard approach that is normally taken is to estimate how much it would take to restore the property.

For example, an investor (or a consortium of investors) considering the en-bloc purchase of a property block would usually start by figuring out if it’s worth renovating the block, or to demolish it altogether. Essentially, this is an exercise of calculating the effect of economic decay (maintenance and renovation costs over time) vs the one-time costs of developing a new building.

Physical Decay

Physical decay can be thought of as the “wear and tear” of a property. This is unavoidable, but yet most investors will almost never consider it when they buy a piece of property in the sub-sale market.

For example, a glass roof for your porch may be more expensive to install but it may last longer than, say, a polycarbonate awning which may be flimsy and needs replacement a few years down the road. Therefore, it’s always a question of trading off between the higher upfront cost vs the maintenance as well as the replacement cost.

Obviously, the construction materials used by the developer will have a strong impact on the physical decay of a property over time.

Buying A Property? Look For Signs Of Present (And Future) Decay

For the astute buyer, keeping an eye on property decay is important because it impacts both the ongoing maintenance costs of the property as well as its price appreciation upside over time.

The first step that you can take when evaluating a property to acquire is to identify the biggest decay factors (using the F.E.P framework above). Note that some of these factors may well overlap (since functional decay will almost always result in economic decay). Then, with this list of decay factors, plan how you can rectify the decay, bearing in mind that you’re merely trying to slow down a process which is irreversible.

Secondly, try to anticipate what will become important a few years or even a decade or two down the road. Internet broadband installation cables is an example of a functional decay factor which has become increasingly important. Decay factors such as these will continue to change, and it’s up to the investor to come up with innovative solutions to slow down the (inevitable) decay in order to preserve the upside in value appreciation.

About Khai Yin

When I am not writing for GoodPlace.my and helping my readers find properties though the DealMatcher service, I spend time doting on my three kids: Wenyi, Qinyi and Eian. My personal stuff, some published essays and contact details can be found at khaiyin.com

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