Pitfalls In Property Investment

Prevention is better than cure

We have seen in the earlier all the advantages as well as the optimistic side of property investment. In this chapter we shall adopt a more realistic approach. Optimists see a cup as half full, pessimists sees a cup as half empty. The opportunist drinks the water happily while the optimist and the pessimist are still arguing furiously over who is right. Similarly in life, one not only needs to be optimistic and realistic but also learn to capture opportunities decisively when they appear. In property investment, optimists take the first step to get into the property market. They then have to be realistic and start investing using their own money, and then managing and maintaining their properties. So, capture every investing opportunity when they arise and you will be on your way to investment success.

Mistakes in properties investment can be very costly and the pain can last for a long time. The good news is that most of the property investment mistakes can be prevented. Some of the common mistakes in property investment to be avoided are as follows:

1. Being over-committed

It is advisable to purchase properties one by one, slowly and steadily. You have to consider your own savings and the stability of your income, and rental income loss when your tenant moves out. Can you still pay the bank installments yourself? It is advisable to have at least three months of the installment payment savings in hand. Over-leverage or over-borrowing may cause difficulties if you are out of a job or when you are forced to take on unexpected financial commitments.

Always ensure that you can manage your finances no matter what happens. Investment is all about personal money, risks and reward management. Do not overstretch or over-leverage in property investment. Different people can tolerate different amounts of stress in investment. One of the ways to know if you are over-leveraged is to watch your sleep. If you can sleep well it means you are not over-committed. If you cannot sleep well and start worrying, it means you may have over-leveraged yourself in your property investment.

2. Buying an unproductive property

An unproductive property is a property without rental income, for example, vacant land. Buying an unproductive property is for those who have the holding power. For a new investor who has limited savings, it is advisable to begin investment in property with a view to receiving rental income. The rental income from the property can help you to pay down or reduce your loan repayment. If your property’s rental income is more than the repayment and maintenance costs, you have a positive cash flow property. For example, an apartment’s rental income is RM500 per month. Installment payment to the bank is RM300 per month. Average maintenance is RM100 per month. Therefore, the cash flow from this apartment is RM100 per month. A positive cash flow from property investment gives you more room to grow.

A property that does not generate any income but carries huge expenses in maintenance and high installment payment to the bank, quit rent, assessment fee, maintenance and repairs can be described as an “alligator”. If a person is ignorant, it may swallow him alive financially. For example, one acre of vacant land costs RM200,ooo. Since the land has no rental income, the purchaser has to pay the monthly installment of say, RM1,000 to bank. If the appreciation or capital gain of the land is slower than the monthly installment you will still lose money owning such a property. If you are unable to pay the bank loan for more than six months, the land may be auctioned off by bank for less than RM150,000.

3. Speculation rather than investment

Investment in property is normally geared for the longer term with rental income and hope for capital gain. Speculation is short term and geared for a quick profit. An investment property promises safety of the principal and an adequate cash flow return.

Let’s say, two places A and B are 200 miles apart. If you drive at the 100 mph speed limit, you can reach that distance in two hours, if you drive at 200mph, you can get there in one hour. Over time, the slower driver’s chance of survival is higher. It is the same in property investment, if you begin to invest in an income property with potential capital gain, your chances of becoming rich and wealthy is higher compared to speculating a non-income producing property for quick profit.

As for speculation, it depends on the market condition. Like driving at 200mph, if the road and weather condition is good, you may reach your destination faster. Property speculation is called flipping and is for very experienced investors.

4. Consumption rather than investment

Consumption is buying things that do not generate income such as buying a car or going for a holiday. Investment is buying an asset. An asset puts money in your pocket. Buying a property which generates rental income is an investment.

Property investment is a means of forced savings. Each month the owner of a property must reduce the principal sum and interest of the loan, thereby increasing the equity. When you invest in property, you are indirectly forcing yourself to increase your net worth and become rich. If not, your extra savings may be spent on other consumption goods.

5. Monthly negative cash flow

If you purchase a property with cash, the monthly rental income is the monthly cash flow of the property. If you purchase a property with a loan, the monthly cash flow is the monthly rental minus the monthly loan repayment to the bank. If your monthly rental is more than monthly loan repayment, you have a positive monthly cash flow income of the property. If your monthly rental is less than monthly loan repayment, you have a negative monthly cash flow.

You can structure a positive monthly cash flow property by stretching the tenure of the loan to maximum, thus reducing the monthly loan repayment. A positive monthly cash flow property feeds you. A negative monthly cash flow property eats you up financially.

6. Expecting quick returns

Normally, young investors expect quick capital gains on their property investment. One wrong investment in property can change a person’s financial health for a long time. The fact is that property investment is for the longer term. One needs to be careful, have a lot of patience and wisdom along the journey to become wealthy in property. The earlier a person realizes this fact, the faster he will become rich and wealthy.

7. Demand and supply

The price of a property is determined by demand and supply. When there is more demand than supply of property in the market, property prices will go up. When there is more supply than demand, the prices of property will go down. The chances of having capital gains is higher if the perceived demand for properties in the future is higher than the supply, and vice-versa.

8. Price and value

If the monthly rental income of your property remains the same but the market value or price of the properties has increased, that means the real value of your property has decreased. For example, a double-storey terrace house can fetch a monthly rental of RM1,000. The price has increased from RM300,000 to RM500,000 due to more demand than supply in that location. The yield or return on investment (ROI) is calculated as,

ROI = RM1,000 x 12 x 100%, which is 2.4% of RM500,000

The initial ROI was,

RM1,000 x 12 x 100%, which is 4% of RM300,000.

Therefore, the ROI has decreased from 4% to 2.4% or its real investment value has decreased from 4% to 2.4%. When the ROI of a property is less than the fixed deposit (FD) rate, the property maybe considered as over-priced.

9. Property cycles

Property cycles follow economic cycles. When the gross domestic product (GDP) growth is high, property prices remain high. When the economy is in recession (defined as two consecutive quarters of contraction or negative GDP growth), property prices may fall due to higher unemployment rate, increase in non-performing loans (NPL) and property forced-selling or auctions. All these factors will push down property prices. A period of high GDP growth may increase the supply of the property; and the oversupply can also push down property prices.

10. Capital gain and capital loss

Capital gain is when properties increase in price. Capital loss is when properties decrease in price. For example, a double-storey terrace house costs RM500,000 and can fetch a monthly rental income of RM1,000. After three years, due to contraction of the economy or negative GDP growth and oversupply of property in the market, the property may decrease in value to RM400,000. The capital loss is RM100,000.

11. Leverage and deleverage

Property leverage is buying property with borrowing, from the example above, if the purchase price is RM300,000 and you buy it with your savings of RM30,ooo with the balance RM270,ooo financed by a bank loan, then the sum of RM270,OOO is the leverage used to purchase the property.

Leverage is similar to a loaded gun. It can help you make money during good times but it can also hurt you financially during bad times. Using optimum leverage is better than over-leverage or under-leverage in property investment. Many young investors do not have experience with the ups and downs of property investment. Many of them have accumulated more than 10 properties over short period of time. Excessive leveraging can lead to deleveraging during economic crises. Deleveraging is a desperate action taken to reduce loans by selling your own property or being forced to sell by lending banks.

The 11 ways on how to prevent making mistakes in property investment will help you avoid making costly mistakes in property investment. Many unhappy and unwanted events in life can be prevented if you have better awareness and practice self-discipline. Prevention is always better than cure.