While property is certainly a stable and safe investment, being a successful investor is not as easy as just buying up properties. There are many factors to consider - before investing into a property, when you are investing in property and after you have purchased the property.
One of the most important considerations will be, “Is the property worth investing in?”
Being able to determine a property’s Return On Investment (ROI) – and understanding all the factors that affect it – is the most important skill a property investor must learn.
There are basically 2 types of returns when it comes to property: rental yield and capital gain (also known as capital appreciation). In this article, we will first look at Capital Appreciation as a measure of ROI.
Part 1 : Calculating ROI on Capital Appreciation
Capital gain is the one-time profit (or loss) incurred when you sell your property. Calculating capital gains is pretty straightforward:
ROI = Net Purchase Price, less Net Selling Price, divided by time (in number of years)
The Net Purchase Price includes all the costs involved in purchasing the property, PLUS all the holding costs incurred before the property was sold. The Net Selling Price is the transacted price less the costs involved in the sale.
For example, let’s say you bought a landed property for RM500,000 (including all legal fees and other costs involved in the purchase) and you sold it for RM650,000. You made a profit of RM150,000 or 30%, right? Well, actually no.
You need to also consider all the other costs, such as renovation or refurbishment (if any), transaction and legal fees, and real property gains tax (RPGT) if the property is sold within five years of its purchase. A more realistic calculation would be something like:
RM650,000 (sale price) – RM500,000 (purchase price) – RM7,000 (legal fees and stamp duties) – RM19,500 (3% agent’s commission) – RM25,000 (refurbishment, renovation, etc.) = RM98,500
If the property is sold in the 5th year, a 15% Real Property Gains Tax (RPGT) will be imposed. To read more on RPGT, go to http://realestatemalaysia.info/how-does-real-property-gains-tax-affect-your-property-investment/
RM98,500 – RM14,775 = RM83,725
That’s a 16.75% return within 5 years, for an average of 3.35% per annum - about the rate of bank FDs! Of course, with property, you get rental income in the time you’re holding the property, so factoring that in, you actually get significantly more returns than FDs.
The above calculation is based on the property being purchased entirely with your own cash. Not many people do that. Most people will take loans and that’s when things get more interesting.
Using the same example above, let’s say the purchase was funded by a 90% bank loan. The calculation would now be:
RM650,000 – RM450,000 (loan principal amount) – RM7,000 (transaction fees) – RM19,500 (agent’s commission) – RM25,000 (refurbishments, etc.) = RM148,500
RM148,500 - RM22,275 (15% RPGT) = RM126,225 (a capital appreciation of 25.25%)
But wait...the only cash you paid out was the 10% of the purchase price and some other transaction fees, which maybe works out to about RM70,000. Compared to your capital outlay, you’ve made quite a bundle by leveraging on a bank loan! Of course, you still have to factor in bank interest. Then again, you can use any rental income you get while holding the property to offset it.
(These are broad figures used to illustrate a point. Exact figures may be different from case to case. For a more detailed breakdown of charges involved in a property transaction, go to http://realestatemalaysia.info/important-things-first-time-property-buyer-in-malaysia-must-know/)
A word of caution though – you can’t just finance any property and make lots of money. You still need to consider other factors such as the property’s potential, the rental market and rental yield, and your own financial situation (can you sustain yourself financially in case of some unforeseen circumstances).
What is a good ROI for properties?
This is a question that only you can answer – what will satisfy you, for all to the effort, time and money you are going to put in?
It’s not easy to project what kind of returns you will be getting from a property as that depends on many variable factors. As a benchmark, most investors will compare with other low-risk investments such as bank FDs and EPF dividends. Your property investment should give you significantly better returns, otherwise it makes sense to just park your money in those other vehicles and relax, right?
How to choose properties with good ROI?
Many people make the mistake of buying a property on emotion, usually when the market is booming. But a bad purchase decision may cost you lower returns or even negative returns. So do your research carefully and establish your investment strategy before making a purchase.
Here are some of the major factors you need to consider:
Stage of the property cycle: Property values go through phases of rises and falls. It is important to know where the market is heading to ensure you purchase your property at the right price.
The location: The best locations are normally near amenities such as schools, public facilities, and shops. Areas experiencing population growth are especially desirable.
The neighbourhood: The quality of the neighbourhood will influence the types of tenants you have. This will affect your ability to dictate the rental and selling price and ultimately your ROI.
The property itself: Aim for a property that is always in demand. This may not be so easy to identify, so do your homework carefully to find out what properties are important to the people in the neighbourhood.
Above all, remember that property investments are not ‘liquid’ because you can’t withdraw your investment quickly. Properties are a long-term commitment so your investment strategy should be long term as well. Buying properties and hoping for short term gains is probably the first step to disaster, as you would not be in the right investment frame of mind.
These are some of the major points to consider when embarking on your journey as a property investor. As you gain experience, you will discover more of the ins and outs of the field and these will give you the ability to make sharper investment decisions.
In our next article, we will continue the topic on calculating ROI with the focus on rental yields. Stay tuned!