Buying Property – A Key Lesson

A key point many investors overlook is “EXPECTED ANNUAL RETURN” or E.A.R.

The EAR bears a direct relationship with the cost of funds and is usually a little below the cost of funds because investors will accept having EAR below the cost of funds as they expect to be compensated by capital appreciation.

In Malaysia, the cost of funds has been stable around 6-7% pa so the EAR is generally around 5%- in many cases, people buy properties even when EAR is just 2-3% or even below but that is speculative.

Consider this equation (which governs all real estate decisions):

VALUE PSF   =                 TOTAL ANNUAL RENTAL

                                       ————————————–

                                               EAR      X      LOT SIZE

So if your total annual rental is RM9,600 (Rm800 pmX12 months), and your EAR is 5% and your lot size is 60 sf, then your VALUE PSF should be around RM3,200 psf.

What happens when your total annual rental increases to RM12,000 ie your rental goes up to RM1,000 per month from RM800 per month? This has the IMMEDIATE effect of pushing up property value to RM4,000 psf!

What happens when your monthly rental increases to RM1,500 per month? This means that your total annual rental is now RM18,000 so your property value psf goes up further to RM6,000 psf!

Now you are getting the picture! For small lots in a popular mall, its very easy to rent out a lot for RM1,000 per month and its equally easy for it to jump to RM2,000 per month-if it jumps to RM2,000 per month, your property value psf goes up to RM8,000 psf! (And it is so easy for a small lot in a good mall to command a monthly rental of RM2,000.)

It is not the size of the lot that is critical but the AMOUNT OF BUSINESS someone can do from a particular lot! So malls with daily footfalls (or visitors) of say 30,000 people as compared to shophouse which may have only 250 people walking by daily are far better places to trade in than shophouses.

So when you want to invest in property, lots in malls are definitely the best investment-far better than shophouses, industrial property, detached houses, terrace houses or condominiums. This is because of escalating rentals- owners of lots in popular malls can keep increasing rentals annually and the occupier will pay it especially if he is doing well in that location!

Also don’t forget that the owner will get a MONTHLY SURPLUS EVERY MONTH because his cost of servicing his loan to purchase his lot is fixed and as his rental increases, his monthly surplus increases! This is IN ADDITION to the CAPITAL GAIN he is enjoying.

So when you want to invest make sure you observe these 5 VERY IMPORTANT TIPS:

1. Ensure you are getting the expected EAR relative to the price you are paying-but even if you are not. As long as it is near there and the other following factors are present, then grab it!
2. Ensure the mall in which you are buying your lot is SUPER PRIME in location- NEVER COMPROMISE because a less prime location is a very HIGH RISK!
3. Ensure that you pick the BEST lots- look for where the entrances and foot traffic flow will go. Look for where your lot will be highly visible. The more people passing your lot, the better! The more people who see your lot, the better!
4. Ensure the Developer & Contractor are reputable and most importantly, the MANAGING AGENT/PROPERT MANAGER must have international standing. Avoid developments where the developer tries to be the property manager himself in order to earn more money because he will not have the necessary expertise or experience and the mall will face great difficulties.
5. Check which are the banks willing to finance purchasers because banks are very cautious- they will have done their homework and will not want to finance developers who are not likely to succeed- a bank by the very nature of the loan, is committed for at least 10-15 years and cannot afford to have problem properties in their portfolio. The more banks wanting to finance end purchasers, the more secure you will be.

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Tagged as: E.A.R, psf, rental