Coming from a humble little town called Tangkak in north Johor state of Malaysia, OngKL has chances to learn and work both in Johor Bahru and Singapore - a conurbation with 6.49 million still fast growing population - since year 1996. He is now having a chance to contribute back to the community by sharing what he sees, what he knows and what he learns in this wonderful place.
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Investing in real estate is all about financing. Even if you are cash-rich, it is always unwise to acquire a real estate investment with 100% cash. Likewise, if you need to pay 100% cash for a real estate investment, most probably it is not a good investment.
You may say, "I don’t like debt", "I don’t want to mortgage my property", "I don’t like to pay interest to bank", "I hate the commitment to monthly installment"…
Well, there are always good and bad debts out there. In this article we will show you the difference between good and bad debts in real estate investment from two real cases in Malaysia.
In short, good debts give you higher return with lower risk. The more you borrow, the higher the return, and the sooner you will take back all your capital. We call them real estate investments worth borrowing or leveraging.
You will notice that if a real estate investment is worth borrowing money from bank, its return in percentage is definitely higher than investments that are not worth borrowing.
It’s worth the debt
We found a condominium in Larkin area of Johor Bahru in Octorber 2008 selling at $160,000 with existing tenant. Monthly rental income is $1400 while monthly maintenance cost is around $300 (maintenance fee plus sinking fund plus quit rent). If we finance 90% of the purchase price to buy this condominium with interest rate 4.85% with a tenure of 30 years, monthly loan repayment is estimated to be $760.
If we bought the condominium with cash, total capital required would now be $168,000 instead of $24,000, including down payment, legal fee and brokerage. Total monthly net income is $1100 (rental income $1400 less monthly cost $300), that is a yearly income of $13,200.
Though the total annual income is now higher than the case when we borrow 90%, from bank ($4080), the return in percentage of capital investment is only 7.9%!!! That means we would need almost 13 years to get all the capital ($168,000) back, instead of just 6 years if we borrow 90% from bank.
How can it be? We invested with more cash yet we get the lowest return of capital!!
It’s not worth the debt
Now let’s look at another real case of a shop house in Johor Bahru city. The double storey shop house is situated in Jalan Tebrau with 2 loyal tenants of years. Owner is asking for $10,000 while current rental income is $4150. Estimated monthly expenses on maintenance, insurance and tax cost about $200.
If we take up a mortgage loan for 90% of the purchase price with the same interest rate and tenure as the case of Larkin condominium, monthly repayment will be $3850. Although in this case the shop house generates monthly cash flow of more than $100, the return is only 1.3% since the total capital required is almost $95,000.
If we buy the shop house with 100% cash, the expected return is 5.7%. Obviously in this case we can only get higher return without borrowing.
Power of leveraging
From these and other real cases, we discovered that real estate investments worth borrowing can get a minimum return of 7.5% even if you pay 100% cash to acquire them!!!
In such cases, the more you finance, the higher the return, and the sooner you will take back all your capital.
So start looking for real estate investments worth borrowing - investments with higher return if you borrow from bank.
There is no magic behind this and it is not a numbering game. It’s all about the power of leveraging.
However, do remember that NOT every real estate investment is worth leveraging, just like not every real estate investment is worth investing. But when a real estate investment is worth leveraging, just like the case of Larkin condominium, it is certainly worth investing.
We are not talking about overstretching your capital or risking your money in gamble. We are talking about how to reduce your risk by making use of other people’s money (OPM) – the ultimate invsesting skill. You can find out more about OPM from Lechter Michael’s book OPM Other People's Money.
Read more about real estate investment tips at http://reijb.com
We write regularly about real estate investment. Some of our featured articles include:
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