There are many forms of investment available in the market, but many people still prefer to put most of their savings in banks, cash value life insurance, bonds, etc.
To get a “guaranteed” return on their “investment”, regardless of how much money the financial institution was making on their investment, and how their retirement dreams were being shattered by inflation and taxes.
The biggest factor that affects our retirement funds is still inflation.
Some predicted that by the year 2050 a loaf of bread at the supermarket will cost RM30. We may still be around then, but the figure illustrates an unwanted yet inevitable living environment where continued inflation may well be heading. Each year, inflation is eating into the spending power of our money at the rate of four to ten percent a year, and it has been doing so since the end of World War II.
However, there is a good news about inflation. Inflation can actually be a friend to real estate investors. When the price of everything is rising, so are rental income and real estate value. If you can invest in real estate appropriately, you will be able to benefit from inflation, instead of letting it eat into your money.
WHY REAL ESTATE IS A GOOD INVESTMENT?
Of all possible investments that are within the reach of the average investor, none offer the combination of outstanding benefits that are available to real estate investors. Banks and life insurance companies recognise this fact, and they invest your money in real estate! While they pay you between 1 and 4 percent for the use of your money, they are making 10 to 20 percent on it.
Why is real estate such a good investment? It offers at least five different returns or ways of making money on investment compared to other forms of investment.
1. Gross spendable income - Cash flow
Investors also refer to this as “cash flow” or how much money you can spend at the end of the month or year after all the operating expenses and mortgage payments have been made. We also call this “gross” spendable because we have not taken income tax consequences into consideration at this point.
We always purchase properties that generate cash-flow. It takes time to find them, but it is well worth the effort. The simplest definition of positive cash flow is that you collect more revenue, usually in the form of rent, than it takes to pay for and operate the property.
A big advantage of real estate over other investments is that it can produce cash flow on a monthly basis. The cash generated by a real estate investment will always be a much larger percentage cash-on-cash return than any other investment. The beauty of a cash-flowing real estate property is that it can help you become financially free. We discussed two real life examples of such real estate property in How to know if a property investment is worth investing?
2. Equity income
This is also referred to as equity buildup or principal reduction. Anyone who has had a mortgage on a home or car recognises that each time a payment is made, a certain portion of that payment is for the interest charged by the lender and the balance goes toward reducing the balance on the loan.
In a real estate investment, this equity income can be a sizeable amount. Although you cannot spend it each month, when the time comes to sell or refinance your property, you owe less on the mortgage, so you will receive more money at closing. It’s like putting money in the bank each month, while this money is helping you to reduce the mortgage loan interest by lowering the outstanding loan amount every month.
3. Making inflation work for you instead of against you - Appreciation
Like inflation, you do not see it but it’s there. Only now, it’s working for you instead of against you. How does it work? Each year, because of inflation, your real estate is appreciating in value. As prices go up, so do rents; as rents increase, the value of your real estate increases. Those of you who own a home, for example, would you sell it today at the same price you paid for it five or ten years ago?
We keep on having babies but God quit making land a long time ago. The supply is limited. What does this mean in terms of existing land values? It means that existing land is becoming more and more valuable each year. It explains why investment real estate, whether in single family homes, apartment buildings, office buildings, shopping centres, warehouses and even vacant land, has become the most secure and profitable way to beat inflation. Existing land in most parts of the country, is appreciating at a rate greater than that of inflation.
4. How real estate stacks up against other investments - Leverage
Leverage is an interesting thing about investing in real estate. It’s more than likely you have heard the term Other People’s Money, or OPM. The concept is simple and powerful.
The OPM concept is using money generated from someone or something other than you in order to start a business or to acquire an asset. While it is true that you can do this to an extent with stocks through buying on margin, the fact is that there is no investment where the application of this tool is more powerful than in real estate.
In real estate the leverage is based on the asset itself and you can get a bank to loan you the money up to 90 percent of the total asset value. Why do banks do this?
Because they can repossess the physical asset itself should you default. Buying stocks on margin, however, allows you to borrow no more than 50 percent of the stock portfolio value. Just try to get a bank to loan you the money for buying stocks – let alone your margin! Instead, you have to buy through a brokerage – at a high interest rate. In other words, when you buy stocks on margin, you are taking the risk. But when you take out a loan to buy real estate, the bank is assuming the risk. - Ken McElroy in “The Advance Guide to Real Estate Investing”
You can see the power of leveraging demonstrated by real life cases in our previous article Why you want to take up a loan for your real estate investment? No other form of investing allows an investor the opportunity to control so much with a small amount of his own cash.
5. An investment that allows you to control
A unique advantage to real estate is that you can control it. In other types of investments, you give your money to a financial advisor and they place it for you in a company’s stock, a bond, or a mutual fund. What happens after that is completely out of your control. You have no ability to make operating decisions for the company you have invested in - you are at the mercy of its managers.
Similarly, you have no control over financial markets when you purchase bonds or futures. You make a calculated guess, and then you sit back and watch. With these types of investments, the only control you have is choosing whether to buy or to sell.
Real estate is different. You purchase a tangible asset and you manage it. While there are still external market conditions that affect your investment, the difference is that you have the ability to manipulate the operations of your investment to respond to those conditions. Instead of being reactive (buying or selling), you are being proactive.
For example, if you are a landlord, you have the ability to manipulate rents based on changing market conditions in order to maximise income. This doesn’t always mean raising rents. The goal is to maximise income. Since it is a dynamic process, that might mean lowering rent or offering an incentive. A property’s occupancy comes into place here.
If you have the highest rents in a market, chances are that potential tenants will rent from a direct competitor. Then all your high rents become lost potential income. The dynamics of real estate requires you to keep occupancy, as well as rents, high.
You have the power in real estate to control the operational performance of your asset more than any other investment.
HOW "LIQUID" IS A REAL ESTATE INVESTMENT?
There is no question that a real estate investment is just not that liquid. This is why you were advised not to invest all of your funds in real estate.
But does real estate really “lock up” your capital the way some investors insist it does? There are many “would-be” real estate investors who choose to ignore the many benefits of real estate because they do not want to be locked into a “long-term” investment position. Instead they invest their funds in six- or twelve-month fixed deposit (FD) or the stock market. Where does this leave them?
They can get their investment out of FD at any time, but the bank makes it very clear, “early withdrawal will result in a substantial interest loss”. But they entice the would-be investor by assuring them, “but your initial investment is always available”.
What about the stock investor? Sure, you can call your stockbroker or use your online trading account to offer your shares for sale… at whatever price they will bring on the market at that time. And, the way the market has been, there will be times that you have to sell at a substantial loss in desperate situations.
Well, the same holds true with real estate, considered a non-liquid investment. If the investor wants out quickly and is willing to sell at a loss, as he probably will his stock, he should be able to locate an immediate buyer.
If you are like most investors, however, you have been programmed to believe that making a sizable profit on the sale of your real estate investment is not only desirable, it’s expected. You will make a profit, but the more you expect to make, the longer it may take to locate a buyer.
Real estate investment is more liquid than many investors realise. Depending upon how badly and quickly you want to sell, you can always find a buyer “at a price”.
As an alternative to finding a “quick” buyer, you can also refinance the property. This alternative will give you immediate, tax-free cash, if this is what you suddenly need.
In any event, do not shy away from investing in real estate because you cannot get your money back out as easily as you can in your savings account.
WHAT ABOUT HOMEBUYERS?
Although inflation is a friend to real estate investors, however, inflation is an enemy to all homebuyers. There is always a big difference between a homebuyer and a real estate investor. Homebuyers don't earn income from their homes. Homebuyers buy houses for their own stay. Whenever inflation strikes, cost of living becomes higher and higher, including the price of a new house, monthly instalment of housing loan, maintenance cost of houses, utilities and other household expenses.
Unlike real estate investors who benefit from higher rental income and property prices due to the presence of inflation, homebuyers have to rely on their existing sources of income to cover the increasing household expenses.
Never think that you are already a real estate investor even if you have bought a home for yourself.
YOU DON'T HAVE TO START OUT BIG
Always remember also, you do not have to start out big in real estate investment. If you use the right techniques, you will be able to build an estate in real estate. You are using the principle that inflation is now working for you instead of against you. You are merely working on the principle that after many years you can expect your invested capital to increase in value, and it does not matter how small you start – that principle remains the same.
That same basic principle of growing your investment in real estate is the principle that will help you reach your investment goals.
ABOUT THE AUTHORS:
This article is contributed by KCLau and Dr. Ong Kian Leong, both the co-founders of the first ever online property investment course for Malaysians, called Property Method (www.PropertyMethod.com).
Dr. Ong Kian Leong (commonly addressed as Dr. OngKL), is the creator of GoFinanceTM, a tool that allows investors to accurately evaluate if an investment is worth investing as well as worth financing for maximum return. Claimed by himself as a student in the life-long learning journey, he is also the master trainer of Property Method and the blogger behind www.REIJB.com (Real Estate Investment Blog).
KCLau is a financial educator who has published 6 books and co-created more than a dozen online financial courses. His popular personal finance blog is one of the most visited websites in the financial blogosphere. He also hosts regular and free financial training online featuring various financial experts. You can get free training by visiting www.KCLau.com.