Residential property consists of private houses for people to live in such as apartment, condominium, terrace, semi detached and bungalow. The preferred characteristics of residential property would be location in a safe and secure place which is quiet and peaceful, surrounded by a friendly neighborhood, in an area at close proximity to facilities such as supermarkets, shops, schools and amenities.
Everyone needs a house to stay whether in good times or bad. The medium and lower ranges of residential properties are relatively resistant to the changes in the economy. The higher end residential properties costing say, above RM l million would be high-end condominiums and bungalows. Rental may swing with the changes in demand and supply in the market.
The amount that you can borrow from the bank is higher for residential properties compared to commercial properties. Generally, the feng shui factor is more important for residential properties rather than for commercial properties. Residential property gives you more tenant issues such as repair and maintenance such as plumbing and electrical works. Tenant management is also more intensive for residential properties, the common one being late payment of rental and even default.
Commercial property is a property that is used for business purposes. Commercial properties are shop offices, industrial buildings and retail lots. Commercial property is more sensitive to economic cycles. During the higher points of the economic cycle, commercial rental yield is usually good and during the lower point of the economic cycle the rental rate goes down in tandem.
The loan amount available is lower for commercial properties. It is usually less than 80% of the purchase price or market value, whichever is lower. The cost of financing is also higher compared to residential properties. The feng shui factor for commercial properties is not the same as for residential properties. Houses located at road junctions are not good for residential use, but for commercial use it is considered a plus point as it gives prospective customers better visibility. Commercial property maintenance and tenant management is easier in compared with residential properties.
Finding The Right Residential Property
You can make a lot of money investing in residential proper-ties. As it name implies, this type of property is for people to stay or live in. Residential property is one of the basic needs as everybody needs a roof over his head. You can make money from rental income and eventual capital gains from residential property because of its constant demand.
For young working adults who have some savings, you may begin the property investing journey by investing in midrange high-rise residential properties such as apartment or condominium for rental income. High-rise residential property has relatively higher rental income than landed residential properties. Invest in high-rise residential properties about 10-20 years old with occupancy rate more than 90%, and you can be assured of sustainable rental income. If you are young, you may stretch your loan tenure to the maximum to reduce the monthly repayment to the bank. When the rental is more than monthly repayment, you have a positive cash flow property.
When the investment can take care or sustain itself, you can focus on the next property investment. You may repeat the investment method above by accumulating as many units as possible. The equity of the property increases as your tenant helps you to pay your monthly repayment. When your loan is fully paid by your tenant, the property will belong to you. Whatever you owe today will be what you own after your loan is fully settled, by your tenant. Accumulate as many units as possible. When you are young, you can make money from high-rise residential properties easily.
You can also make money from landed residential property such as terrace houses, semi-detached houses and bungalows. Generally, landed residential properties have a relatively higher potential capital gain than high-rise residential property but rental yield would be relatively lower. The potential capital gain may be due to the location where the property sits on. The timing of entry or purchase may also affect the potential capital gain of a landed residential property.
You can make money from landed residential property during a buyers’ market where there are more sellers than buyers. You can negotiate and purchase at below-market prices. When you buy a below-market price property it means you make money when you buy.
During a buyers’ market, you may also consider investing in properties that are under construction. The reason is that property prices move in cyclical manner. Landed residential properties takes about 2 years to complete and high-rise residential properties takes 3 years to complete. Under-construction properties take 2 to 3 years to build. If you buy under-construction properties during a buyer’s market, upon completion the property market may change to seller’s market due to cyclical nature property market. For landed residential properties, the price is more sensitive to changes in the property market. Buy under-construction landed residential property during a buyers’ market for potential capital gain.
Landed residential properties in a good location appreciates faster than high-rise residential properties. Generally, high- rise residential properties such as apartment and condominium give us relatively higher rental income compared to landed residential properties such as terrace, semi-detached and bungalow houses.
You may create a sustainable portfolio of residential properties of high-rise and landed residential properties by using the positive cash flow from high-rise residential properties to support landed residential properties. Over a period of time, the capital gains from landed residential properties will increase your property portfolio’s net worth.
As an example, let us look at Mr. Lim’s residential property portfolio as follow; the example below is based on interest rate of 4.5% and 40 years term loan. (Figure 9.1)
High-rise residential properties give us positive monthly cash flow of RM451 for A and RM526 for B. Landed residential property has negative monthly cash flow of -RM148 for C and -RM298 for D respectively. Mr Lim’s total monthly cash flow today is RM531. After 20 years, the total monthly cash flow should increase to RM881.
High-rise residential properties give us relatively lower capital gains after 20 years, that is, only RM10,000 for A and RM20,000 for B. (Figure 9.2)
Landed residential property C and D have relatively higher capital gain after 20 years, that is, RM100,000 for C and RM100,000 for D. Total capital appreciation of all the properties of Mr Lim after 20 years is RM230,000.
Equity gain is from the loan paid by tenants. After 20 years total equity gain for Mr Lim’s portfolio is RM475,000. (Figure 9.3)
Mr Lim financial position 40 years later is show in Figure 9.4 below.
After 40 years, Mr Lim total net worth would have increased to RM 1.73 million and total monthly cash flow to Rm 5350. (Figure 9.5)
Factors affecting potential capital gains are:-
- Security and comfort
- Quite and peaceful
- Good neighbourhood
- Near greens (mountain) and water (pond) for cooling effect
- Good view such as city or mountain/hill view
- Near school, public transport, shops and banks
- Good feng shui
Finding The Right Commercial Property
Commercial properties gives not only rental income but also potential capital gains. The entry level for commercial property is relatively higher as the bank loan for commercial property is normally less than 80%. You can make money from commercial properties by buying them at below market prices. You can then enjoy rental income and potential capital gains.
When you buy a commercial property below market price that means you make money when you buy. For example, when the market price for a shop office is RM800,000 and seller willing to sell to you at RM600,000 after some negotiation. You have made about RM200,000. You can then easily sell if off at the market price of RM800,000. When a purchaser buys from you for say, RM780,000, after all the transaction costs, you will still make a profit of about RM150,000.
The real value of a commercial property is based on its useful value and rental income. The yield of commercial properties is preferably at least twice the fixed deposit rate. The yield is (monthly rental x 12) / (purchase price) x 100%.
Rental is RM5,000 per month Purchase price is RM800,000
Rental yield would be,
(RM5,000 x 12 divided by RM800,000) x 100%
If the current fixed deposit rate is 3%, this commercial property can be considered as good value for money. Cash flow is derived from rental income. Rental income depends on the occupancy rate of the property. Buy only properties in an area with occupancy rate at least 90%, meaning that at least nine out of ten units of similar property in the area is occupied. A property has positive cash flow when the monthly rental income is more than the monthly repayment to the bank.
If you want to rent out your commercial property quickly, first you may consider giving a relatively lower rental for the first year, and the following year at the market rate. The monthly instalment can be reduced by putting up a higher down payment and stretching your repayment period longer. The survival of a commercial property investment depends mainly on the monthly positive cash flow from the property. Therefore, by all means ensure every investment property comes with positive cash flow.
For commercial properties, besides stretching your loan to its maximum tenure, you may have to increase your down payment in order to get positive cash flow from your property.
Mr Lee’s commercial property portfolio as follows; the example below is based on interest rates of 4.5% and a 25-year term loan (Figure 10.1)
Today, shop office A has positive monthly cash flow of RM2,454 and Shop office B has RM2,447. (Figure 10.2)
Total monthly cash flow today is RM4,901.
Shop office A, capital gain after 12.5 years is RM250,000 and RM350,000 for Shop-office B. Total capital appreciation after 12.5 years is RM600,000. (Figure 10.3)
After 25 years, the property net worth will increase to RM3,300,000 and monthly cash flow will increase to RM16,000 (Figure 10.5)
After 25 years when the property loans have been fully repaid by the tenants, the properties will give you capital gain and perpetual cash flow.
There are four ways of making money from commercial properties.
- Initial capital gain
When you buy a commercial property below market price, you have to make initial capital gain.
- Equity gain
As your tenant pays your bank’s monthly repayment, your property equity increases proportionally. The equity gain becomes obvious after a period of time.
- Capital gain
Commercial property is for business purposes. The rental and price increase in tandem with the profitability of business activities.
- Cosmetic repair
Beside the fixing electrical wires and plumbing to ensure a proper flow of electricity and water, you may increase the value or price of your commercial property by doing cosmetic repairs such as painting works and a little bit of landscaping.
How to select an Investment Grade Commercial Property?
Commercial property such as shop office with individual title, are normally priced in the range from RM1 million to 3 million or strata office with lower entry point, normally in the range from RM200,000 to RM500,000.
There is no perfect commercial property but you can select an investment-grade property. The yield should be more than twice the fixed deposit (FD) rate and there should be at least 30 residential houses to support one shop office. The purpose of selecting an investment-grade commercial property is not only for the rental income or cash flow but also for capital gain. There are many factors that may affect the potential capital gain of a commercial property.
The location of a commercial property is the main determining factor of its potential capital gain. A good location for a commercial property should be in a high growth area such as in a high population area with high migration from rural to urban area due to the pull factors of factories, office tower, supermarket, hospital and shopping mall. A good location of a commercial property should also be in the direction of growth of a town or city. Towns or cities expand outwards about a kilometer a year. The capital gain is derived from the usage of the property due to population growth.
You can have a helicopter view the location of the commercial property from Google hybrid map (www.wikimapia.org) The best location for a commercial property is in front of a trunk road or highway. This type of location for commercial properties captures about 80% of the mobile customers and about 20% of its residential customers. The location of this commercial property must be on the left side of the road or highway for residents returning home from work. People have more time to do their chores such as banking, marketing and buying food for their family on the way home.
Another good location for commercial property would be in a residential area. The survival of the business in a residential area depends on the number of residential houses support, preferably at least 30 houses to one shop. This category of commercial property attracts about 80% local customers and about 20% mobile customer.
In this type of minor commercial areas, the demographics of the residential population is important. Demographic statistics would be things like average income level, age and gender. The income level of the residents determines what kind of business would be suitable for that area. The type business will determine the rental income and the value or price of the commercial property.
The signboard of a shop office acts as an important marketing tool for the products or services of the business. A business offers a product or a services. Marketing and sales efforts bring in revenue. Visibility of a shop office is very important in order to attract customers to the shop. However, visibility alone does not guarantee the success of a business. There are many businesses located in very visible locations that have failed because they cannot be accessed due to logistics problems, such as road structure. Besides visibility and access, the other consideration would be parking. Do not invest in commercial properties that you can see but cannot be reached or accessed by vehicles or public transport.
As mentioned above, besides visibility, the accessibility to a commercial property is even more important. Accessibility is not only the ease of flow of traffic a leading to the commercial property, but also having ample parking space near to the commercial property.
Supply and demand
When 100 units of commercial shop offices, for example, are at its equilibrium, this supply should match with the demand for these commercial properties. The price will go up when the supply is less than demand. When the shop office supply is more than 100 units, it is considered as oversupply.
Orientation and design
The orientation and design of the shop office also have an impact on its rental and its capital gain. For intermediate lots facing either the eastern or the western direction, owners or tenants would have to pay more for air-conditioning due to the hot sun in Malaysia in the morning or evening. They may even have to put up more tinted glass windows. Therefore, commerical properties facing north or south are preferred. Similarly, for end lots or corner lots, we have to be also careful to ensure that they do not have the sun beating down on them directly from the east or west.
Commercial properties should be built on the same level as the road or highway. If it is higher than the road and a reinforce concrete (RC) wall is erected in front of it, that will affect its visibility and accessibility. On the other hand, if the commercial property is lower than the road, it may also have visibility problems.
If there is additional parking space behind the shop, this can also add value to the commercial property. Customers can park in front and at the back. Underground parking and parking bays built nearby also can add value to a commercial property.
Facilities a such as public transport such as Light Rail Transport (LRT) station, bus stop and taxi stand can also enhance the value of a commercial property.
Options for financing
With the loan-to-value (LTV) ratio of 70% for the third residential loan, some investors have re-looked at their investment strategies, such as switching from investing in residential properties to commercial properties. Commercial properties require a down payment of 80%, although the value of a commercial property is more often than not, much higher than that of a residential property. Plus, financing by banks is between 80% and 90%, depending on the individual banks.
Let me share with you a few ways of “raising funds”.
- Refinance your existing home
- Sell your liabilities, such as non-performing properties.
- EPF (Employees Provident Fund), if you purchase shop-apartments.
- Partnership: form a company with two or three other people, or form a real estate company.
- Recommendations: be a real estate agent and get the 3% commission when you find good properties
“For primary markets, if there are no residents to support, the project can be abandoned. For example, Bukit Beruntung. Some of the lots have been turned into deer farm or bird- house. So, in the worst-case scenario, if you have made a mistake, do something about it. Just rent it out. Also, do buy from reputable developers,” I always amuse my class with interesting pictures of how some commercial lots have been transformed for swiftlet farming and so on.
Put your money in a basket that you know best or know very well. This piece of advice comes from none other than Warren Buffett himself.
Let me shares with you a few important calculations, in order to gauge whether a commercial property is worth investing or not.
1. Calculating Rental Yield
The percentage should be more than two times the prevailing fixed deposit rates. For example, if the fixed deposit rate today is about 3% pa, your rental yield should be at least 6%.
– Available parking space at the area.
– Take note of the flow of people/traffic in the area.
– Availability of public transport – LRT, bus station, taxi, etc.
– Frontage should ideally be on the same level as the road.
– At a t-j unction is not necessarily bad for commercial properties, unlike residential properties.
– Ensure that your unit is not blocked by electrical boxes, telephone poles, hydrants or flyovers