Friday, March 12, 2010

Buying and profiting from Property - A Sound Investment Strategy


Recetly I bought a book "How to profit from Asian Properties" by Andrew Moffat.In it, there are many illustrations and data of how one can make money from property provided one is diligent in preparing himself in investing and most likely holding on to this major asset. The key point made in this book is the answer to the question : "Why invest in a property ? " There are several,however, one must understand the following principles / circumstances :

1. Your first property is something which is a necessity, so when you buy is more or less irrelevant, you will still need a roof over your head and your family too. If you bought low and sold high, you will still need to buy high to own your first
home so it doesn't make you profits unless you sell and downgrade to a smaller home
or rent.

2. A property is a solid asset built using bricks and mortar (cement), unlike stocks, bonds, insurance, unit trusts and the like.Though its cycles will swing up and down, its value will hardly ever be zero. The rest of the asset classes can technically failand their value fall to zero. See recent bust of Lehman brothers linked derivative funds like Minibonds and DBS High Notes for examples orwarrants
Not so for property.

3. A property is not as liquid (ie. can be bought and sold easily and can be cashed out) as the other assets,instruments or investments like stocks, insurance and unit trusts, as it takes time, months or even years to sell and buy (time is set aside for foundation and construction of the said property, plus a time line to get the Temporary Occupancy Permit of TOP).

4. An apartment or house, is a fixed commodity, and its value is subject to the valuation based on age of the apartment or house, the lease structure (freehold versus leasehold 99 years in Singapore, land area, price per square promixity to
amenities like shopping centres, wet markets,supermarkets, MRT train stations,good schools and most importantly accessibility to all of the above, in short, its about 'location,location location'.

5. Best of all, a property is yours to keep forever, once you have paid off the mortgage on it. It is a hedge (bet) against long term inflation which normally is about 2%, so spread over 20 years, the property value normally should have
appreciated by more than that. Additionally, if one is renting out the apartment, the rental income on the property should cover most if not all of the mortgage payments.

6. Key point is that as an investor, if you can afford to pay the 20% downpayment for the house or apartment, and get a tenant to rent it from you that is not the end of the story. In a down cycle, the country will be in recession, many foreign nationals and companies will pull out and these tenants will be the first to go. So if you are stuck with an empty house or apartment,with no tenant prepared to pay what you ask for, you have to take 1 of 2 possible causes of action :

a) lower your rental expectation and get a lower rental. This may be as much as 20% to 30% than your original asking price.

b) fork out the money for the mortgage for the duration (up to 1 year) until you find a tenant. This is very critical.

7. There is this 'trap' which many owners fall into. It is called 'negative equity'. Say you bought this nice new apartment for S$ 1 million and you put a S$200,000 dowpayment on it and it is valued at $1 million. So the bank lends you S$ 800,000.
You take a mortgage loan of S$800,000 spread over 20 years at 3% interest per year. So that works out at S$ 5,200 per month. You manage to find a tenant who is the GM of an American company based in your country's capital.He agrees to pay S$ 5,000 per month and all is good. This rental covers your mortgage and you need to pay only $200per month to cover up the shortfall.

Suppose, another Financial Crisis hits (God forbid), and the economy stalls, foreign investment pulls out, your tenant GM gets recalled back to the States, and he pulls out of the tenancy agreement leaving you with a mortgage to pay of
S$ 5,200 per month. You can't pay becuase you are stuck as your income exactly equals your expenditure and that includes paying for your first house plus your other household and children's expenses. Worse things may befall you in the downturn, you may lose your job and whatever you can squeeze to cover the 2 mortgages from the salary, now its totally gone.

Worse, you advertise for 3 to 6 months and no one comes forward with an offer. There are many desperate rentals out there because many tenants have gone home. So you owe the bank S$ 32,000 in back mortgage.

Even worse, the value of your house /apartment drops to now $750,000 because of the crisis. (What goes up does come down !!). Your bank manager friend is nowhere to be found and you get calls from the bank's receviers to

a) Pay S$ 32,000 in back mortgage (6 months) PLUS interest

b) Pay another S$ 50,000 as exposure - the house is valued at S$ 750,000 and you owe the bank S$ 800,000.

So you sell the house / apartment at you guess it, $750,000 and now you owe the bank S$ 82,000 !!!

You will be forced to make good the loan, and you either, take another job, work out a 2 - 3 year payment plan or even sell your abode, the house you are residing in.

So in the end, you are either made a bankrupt, or you have no roof over your head, or you are worse than if you had NOT started investing at all !!

This is the ONE 'trap' one must avoid at all costs.

So now for the good news, YOU MUST TIME YOUR PURCHASE RIGHT. BUY 'LOW' AND SELL 'HIGH'.

a) say an investor, invests $200,000 in a property worth S$ 1 Million (20% downpayment), if everything goes OK, in a stableand growing environment, he would be able to get a tenant to rent it at say S$5,000 for a yield of 6%.

The yield is calculated based on how much rental the property can fetch in 1 year as compared to how much it was purchased for, so S$60,000 divided by S$ 1 million is 6%.

b) Furthermore, if the investor is lucky, he will see his property appreciate to $1.5 million in 5 years or less and if his tenant stays with him, he can aim to either

- sell the property for a quick S$ 500,000 profit. This is more than 200% of the amount invested of S$200,000 in 5 years.

He can then take back his initial capital outlay of S$ 200,000 and with the S$ 500,000 profits use that later (wait for the next bust cycle) and buy 2 properties worth S$ 1 million and so it multplies from there on.

- aim to continue servicing the loan and maybe in 10 years, the property would be would $ 2 million. In essence, that would be 500% in 10 years. !!

Nothing in other asset classes matches these outstanding performances.

THINGS TO TAKE NOTE OF :

Property like stocks are dependent on the country's economic performance in Gross Domestic Product (GDP), unemployment. So in short, when thecountry's GDP is good, people get good paying jobs, bonuses, stock market is performing well and of course the property market will be rising at rates of anything from 2% to 10 or even 20% per year. So all propety prices will rise in tandem as every seller wants to make good profit quickly.

So in short, you can make profit in a short time,perhaps something like 20% * Depending on what is the level of the property price * This is what I would call a SUBJECTIVE OPINION. But in the long run, your property investment should yield easily 100% to 500% of the original purchase price. It totally depends on when you BUY and when you SELL.

But, in a poor economy, like the recent Worldwide Financial Crisis,yes the property prices may fall 10 - up to 30 or even 40% in 1 to 2 years but these sellers are normally desperate cases who are forced to sell to pay back business failures or other asset failues. Most property investors, if they are savvy, will have rental income from the property which should give them the buffer to 'hold' during these lean times and pay the outstanding mortgage.

So the bottom line for this is, in a poor economy, yes there will be more desperate sellers, but the actual sales transacted will be few, as compared to a booming market.

As an engineer, I view the property curve in terms of boom bust cycles but always rising up at a certain angle. Provided Asia can continue to sustain the momentum and growth path for say the next 20 - 30 years (some say 50 to 100), then we should all buy property (that is being able to sustain it during the good as well as the bad) at every 5 to 10 years of our lives.

It is the fastest way to wealth, but do your sums first.

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