Property360Digest E-MAGAZINE Issue#3 | Page 18

16 Issue # 3 PROPERTY360DIGEST PROPERTY360DIGEST Issue # 3 17 FEATURED COLUMNIST Ikhram Merican Since writing my book, The Ultimate Guide to Buying Property, I have been meeting and speaking quite regularly to a diverse group of property investors. They range from newbies to seasoned professionals. The more experienced property investors, in general, have found a strategy that suits their temperament and financial capability. This is really important - whatever strategy you employ to invest in property, it must suit YOU. “The essence of strategy is choosing what not to do” - Michael Porter You will see as we go along in this post, that not every strategy may be right for you. For example, you may find one appealing, but it may be very risky for you if you do not have sufficient capital. Always remember... Before listing down the different strategies, I want to stress that this is not a comprehensive guide. It is meant to expose you to the different strategies investors employ. It will not make you an expert. You must do your own research and build expertise before attempting to embark on a strategy that is new to you. One of the safest methods to build expertise is to find a mentor who employs a strategy you like. This mentor can save you a lot in mistakes that I call “tuition fees.” Choosing the So let’s dig in shall we? The “Forced Saving” Strategy I have written about this idea in a post on property investment for employees. It is a long-term approach to property investment that is simple, fairly safe, and does not eat up too much of your time. In this method, your cash-flow may be correct strategy is key In Property Investment negative but you’re not negatively geared. You should never be negatively geared. If you’re wondering what’s the difference, read on. Negative cash-flow is a situation where your total outgoings on the property is more than your total income from it. Your outgoings include mortgage repayments and every running cost (taxes, insurance, repairs, maintenance, agent fees, insurance, etc) but excludes capital expenditure (initial renovation, closing costs, property price, etc). The calculation for gearing, on the other hand, does not include capital re-payments from your mortgage. It only includes the interest portion of your mortgage. So, you can have negative cash-flow but you may not be negatively geared.  Ok, back to the forced saving strategy. In this strategy, the goal is to maximise borrowing so your capital outlay is minimal; and to leverage capital appreciation over the long-term. The rental income you collect must cover your interest payments and at the very least, 30% of your running cost. This combination helps you maximise ROI if there is good capital appreciation. Although your cash-flow is negative here, the combination of proportionate rental income and capital appreciation is building equity for you. It’s like forcing yourself to set aside a small investment every month, for high returns in the future. Hence, the phrase “forced saving.” The annualised ROI from this strategy over the long-term (upon a sale) can average 11%. This is much better than the 4% return that banks would give you. The biggest risk to this strategy is that if you lose your source of income (i.e your job), you may not be able to hold the property for long. Hence, it is very important to ensure that you have savings and that you’re focused on growing your income (read excelling at your work). If you don’t like the long-term approach, the next strategy may appeal to you... The Lease Option Strategy If you can’t get a mortgage and you’re low on capital, this is one of the best ways to get invested in property. It is a very creative method but requires work. However, with more effort comes bigger results. The potential for high returns here in a relatively short-term is promising. How does it work? Let me illustrate with a hypothetical example. You actively look for homeowners who cannot afford to service their mortgages anymore. They have defaulted or are at risk of defaulting. Usually, the property is going for a 2nd or 3rd round of auction bidding. You find one such owner, Mr Jeremy. Jeremy’s property is a double-storey terrace house with a market value of RM500,000. His outstanding balance with the bank is RM280,000 and the monthly instalment payment is RM1,500. The property has a reserve price of RM300,000 in an upcoming auction. You approach Jeremy and tell him that you’re willing to buy his house at RM320,000. However, you will only pay him for the house in 1-year. In the meantime, you will pay his monthly instalments for the period of 1-year. He can live in the house rent-free. You are effectively leasing his house with an option to buy within 1 year. During this 1-year period, you will look for a buyer at RM420,000 (16% below market value). The difference between the sale price and what you have to pay Jeremy plus other costs is your profit. Jeremy agrees and you negotiate commencement of monthly instalment payments with his bank. A lawyer helps you draft an air-tight agreement with Jeremy. During the 1-year period, your costs are as follows: · Monthly instalment to bank - RM18,000 · Legal fees - RM3,000 12-months into your lease option with Jeremy and you find a buyer for RM420,000. After paying Jeremy RM320,000 and deducting your costs amounting to RM21,000, you have a profit of RM79,000. For an investment of RM21,000 (monthly instalments and legal fees), you gain RM58,000 (RM79,000 - RM21,000). That is a 276% return in 1-year! You may ask, why would Jeremy agree to a deal like this? Because it’s a win-win situation. If the bank auction is unsuccessful, there is the risk of the reserve price dropping further. You are offering Jeremy RM20,000 more than the current reserve price plus you’re giving him a place to stay rent-free for a year. This strategy requires that you have a solid agreement and structure in place between yourself and Jeremy. Lease option deals often fail because the owner jeopardises the sale. You MUST have a very experienced lawyer for this.  The best firm for this in Malaysia is Messrs. Elizabeth Siew & Co. I’ve spoken to their managing partner, Sharon, and I find her to be very skilled at these deals. What’s the risk to you here? There is a possibility that you may not be able to sell the property within the stipulated timeframe. In the example above, if you don’t sell Jeremy’s house