Determining How Much to Pay for the Rental Property

Here's what I do to determine how much I would pay for a rental property. And of course, needless to day, I would want to come to a price that is below market price (see my previous Blog on the importance of buying below market price).

• Firstly, I would want to figure out roughly what the market price is: and for this I want to know, what the transacted prices are and also what the owners are currently asking for.
• To find out what the transacted prices are, I would check with a few valuers, but be aware that these prices may be 6 months to 1 year old, as there is a lag in the data they compile. For the asking prices, it's quite easy to find out through checking with a few real estate agents, and also the owners directly. But note that these prices tend to be higher than what's actually transacted eventually as they tend to price it higher their asking price. Plus, owners would normally price in the commission that they pay to the agent, which can be 2-3% of purchase price depending on their arrangement.
• Secondly, I would like to find out what the properties in the area are renting out for. For instance, what would a basic 3R 2B unit be renting out for? What's the difference in pricing for these units on different floors? Are there any particular blocks that are more in demand? (because they are nearer to the shops / public transport like LRT). What about the rental for smaller units? And the less desired units? (could be because it's further away from the basic amenities). You can find out this sort of information out by asking a few agents who farm in the area. Just record down the information you collect in a note book for review later. But, I normally would discount the prices they give by say, 5-10% as agents tend to inflate the prices a little.
• The next thing, now that you have the estimated market price of the property and also what it can rent out for, you can work out what your yield is.
• The yield is calculated as the annual rental income divided by the price. So, let's say that gross rental income for a 3R 3B unit is RM600 per month, and the asking price is RM100k, the gross yield is 7.2% p.a. (assuming that you are able to rent it out, for all 12 months in a year – i.e. no vacancies).
• You should also calculate the net yield – which is the gross yield less the costs related to running the property like, maintenance, quit rent, etc. So, if your costs is RM50 per month, then your net rental income would be, RM550 (or RM6, 600 per year) which gives a net yield of 6.6% instead.
• The next question is: whether you are happy to purchase the property given the yields? In this example, buying a RM100k property for a gross yield of 7.2% per annum? Or 6.6% net yield. Note: that there are some costs which can be controlled (which can improve your net yield) like how much you spend to maintain the property like repainting, and others.
• At this stage I would take stock of how much I can finance my property for also, and hence how much my monthly installment would be. As indicated earlier, your rental income must always more than cover your installment for the deal to be worthwhile.
• Once, I am satisfied with my estimate of the rental income i.e. it can be verified, and more than cover my installments, I work out how much I would pay for that property. I do this by working backwards to arrive at a price which I am comfortable with. So, let's say I want a minimum 8% gross yield, I would need to purchase the property at RM90k (RM7, 200 divided by 0.08). And, if I want a gross yield of 7.5%, then the price would be roughly RM95k. So, effectively I establish a price range for the property I am looking to buy.
• Remember this is the price range I am willing to pay, but not necessary what the market is pricing it at. So, if the market price for the property is RM100k, and I am only willing to pay RM95k, effectively I would need to acquire it at below market price. This is where the numbers game and being able to identify the motivated sellers come in. Hence, this is where the work comes in: looking at least 100 deals, before I end up buying one or two units at below market price. (read my earlier Blog in this topic)
• Of course, the other way to improve your yield is by increasing the rental income; but there are limitations to this, as you don't set the rental, the market does. I would normally err on the conservative side when it comes to estimating rental income, and place more emphasis on being able to buy them at below market price from motivated sellers. You make money in property when you buy, so the lower the price that you pay, the more chances you have of making money, in terms of the yield you get (and also from capital appreciation in the long-run).

**

Next: we will discuss the importance of your Return on Cash in finding the right rental property.

--
Chris Gan
http://breadnbutterproperty.blogspot.com/

Other "Motivated Sellers"

The wonderful thing about Blogs is that you can always add to it, unlike a book, where its difficult to edit once you have published.

Just thought of a few more categories of motivated sellers:
1) People moving out of town: they are usually keen to selll quickly as they don't want to leave the house empty for too long. Thieves and rodents can be a problem. Plus if they are moving far away, for e.g to KK, coming back to tend to a house in KL may be a hassle.

2) Behind on loan instalments
If they are behind on their payments and the bank is chasing them, they will be more open to sell at below market price. Some just want to "breakeven" and get rid of the property. So, if you make them a decent offer, they will probably take it; so aim low.

3) Foreclosure / 'Lelong' coming
The owner would like to avoid this and would be open to negotiations. But just be careful as sometimes they may want to sign the offer to purchase, so that they can buy some time with the bank. Delay tactics. I personally have not bought any property facing foreclosures.

**
Chris

Retire Well by Investing in Rental Properties

Retire rich, retire young? Well, that is the dream for a lot of people but hey, if you can’t, you should at least retire well. What does that entail? To me, it is having a passive income stream which you don’t have to worry about in your twilight years. A bit like my mum having a pension from the government that comes in on time every time. She was a school teacher.

If you don’t work for the government and thus have no pension, how else can you do this? I will show you how you can do this by: 1) investing in little green houses (rental properties) and utilizing some of your EPF money (Employees Provident Fund).

Let’s start with your EPF fund
Most people work hard all their lives, building up their nest egg for retirement, but seldom spend time planning for what to do with the money when they eventually retire. I mean, they know they will have a lump sum of money in their bank account when they turn 55 years old, but how many know what to do with it? Most likely two things will happen: firstly, they will put the money in fixed deposit which earns a paltry return that is not enough to pay for their upkeep, or 2) they (or someone else) will spend the money for them. Fact: those who withdraw EPF at age 55 will have exhausted 70% of their savings after 10 yrs . These are scary thoughts: at retirement you will either live poorly or be broke, before you kick the bucket.

So what can you do this solve this dilemma? It was also reported that Malaysian’s will need to have at least RM1.4mil to 2.8mil in the bank to live comfortably in their retirement . How they figured this out was that with RM1.4mil, earning a fixed deposit rate of say 3% p.a. will give you at least RM3, 500 per month in income, to live on. Well, how easy is it to save up RM1.4mil in your life time?

Investing in little green houses to retire well
Rental properties may not look like an exciting vehicle but it can work quite well. It can help secure your retirement income, with some help from your EPF funds.

Here is how it works: let’s say you invest in a medium cost flat which cost you RM100, 000. And you get bank to finance it up to 80% (i.e. RM80, 000 loan), for 25 year tenor, at 4.3% p.a. (current base lending minus 2.2%).

Your monthly installment is RM422.0 or roughly RM5k per year. This amount goes towards paying off the bank’s interest, and also reducing your principal outstanding. Initially, a large portion goes towards servicing interests, and this gradually reduces as we go along. If you are 35 years old now, you should finish paying off your loan when you are 60 (when you own the unit outright).

Next, let’s assume that you can rent this unit out at RM600 per month. And maintenance charges, quit rent, Indah water, etc sets you back RM80 per month. That leaves you RM520 per month; after paying installment to the bank, you are left with RM100 per month. Hmm, that’s not a lot of money left over in this day and age, is it? But, something is better than nothing, right?

But, what if you had 10 of such units? that would mean an extra RM1, 000 in your pocket at end of the month (yes, I know, assuming we can rent them all out, and it’s not empty, burnt down, etc right?). But, that’s not what we are talking about here, though. Assuming worst case scenario, your rent only covers the installment; you would still be building up massive equity in the units. In any case, you won’t need the extra income until you retire.

EPF + Little green houses = retire well
This is where your EPF money comes in. By investing in your rental properties now, you are effectively leveraging on your EPF, and in a sense, have determined how you will be investing the lump sum that you’ll receive at retirement.

Here’s what I mean. Let’s assume that you are:
- Now 35 years old.
- Have RM100,000 in your EPF account now, and earn RM5,000 per month (from salary),
- EPF pays 5%p.a. dividends (which is the long term average over 10 years),
- Your salary increases 3% p.a. and you make normal contributions (12% employers, 11% employees).

At age 55, when you retire, you should have RM950, 000 in your EPF (assuming no withdrawals along the way for unit trusts, medical etc). And of course, you are gainfully employed till you retire.

From the loan amortization schedule, your original RM100k owing should be around RM22, 000 (at end of yr 21) which coincides with age 55 when you retire. At this stage what you can do, is to use your EPF lump sum to pay off your loans as you don’t really want to service your loans after you stop working. So, if you had 10 units you would need to fork out RM220, 000 (and you’ll still have RM730k left).

But, more importantly from the cash flow perspective: you will now have RM520 per month /unit as you no longer are paying for the loan. That would mean RM5, 200 per month of passive income from your 10 units which are now fully paid up. That would certainly a better return on your EPF money, right? RM220, 000 to generate RM5, 200 per month!

Of course in this example, we are assuming that
- there’s no increase in property value,
- you do not refinance the property,
- interest rates and rental rates remain unchanged,
- and the “excess” (diff between rental and installment) is not used to reduce the amount outstanding.

What I have shown here is a simple plan to retire well: by investing in rental properties, and setting aside some EPF money when you retire to secure your retirement income. All you have to do is to find 10 rental properties, with rental income that can at least cover their installment, and watch your equity build up. And, at retirement pay off those properties with your lump sum money from EPF and take over the rental income stream of RM5, 200 per month. What if this is not enough for you to retire on? Your retirement income is only limited by the number of little green houses that you have, so go out and find a few more!

*Read the rest of this Blog to find out how.

Chris

100k and below rental properties - Personal Money, March 2010

Here's a recent article that appeared in Personal Money published by the Edge, March 2010 issue.

Some of the areas that have properties below 100k: Desa Tun Razak, in Cheras, Rampai Court in Setapak and Taman Sri Muda in Shah Alam.

I personally prefer the low rises (5 storeys walk up) vs. the high rise. Less maintenance problems; if the lift breaks down, you will have a lot of walking to do if you are on the 10th floor! Not a problem if its a walk up. Be careful with Rampai court, although its priced attractively, watch out for the white ants! the area is very prone to this problem.

Happy hunting. Email me if you want to read the full article in pdf.

Chris

Who are the Motivated Sellers?

I only want to buy from motivated sellers. Period.

Who are they? They are the people who really want to sell their properties; not those who say "well, maybe if I can get the right price" or " actually, sell also can, but it's okay if I don't." No. These are not the people I am looking for. That is why, you need to go through the numbers (as I mentioned in my earlier post) - so that you can find the motivated sellers. They are usually the ones who tend to sell below market price.

So, what are some of the types of people that I have bought from, that were motivated to sell? I use the word motivated but sometimes, the people were actually desperate to sell their property, for whatever reasons. If you are looking to be acquire a few rental properties in the area, it is also important to remember to be fair in dealing with these sellers. Although they may be desperate to sell, you don't want to have a bad reputation, as someone who "takes advantage" of their predicament or bad fortune. It's always better to have a win-win deal.

Motivated sellers:
1. People who are going through a divorce. Both parties don't want to keep the house, and neither one wants to pay for the instalment. They are usually quite happy to sell it quickly and get out of this mess. So, you are doing them a favor. 

2. They have just bought a new house. With another mortgage payment for new house coming up, they usually just want to sell their old place, and move. Sellers like these are usually quite happy to take a lower price, as long as it closes quickly as they don't want to incur interests on their loan while still paying for this one.

3. Gambling problem. It is the usual story where they may be pursued by Ah Longs and need to settle their debt like yesterday. Sometimes, the house may have been left empty for a while as they fled to hide, so may be in "as is" condition. You can find some good bargains, but make sure the seller's title and documents are in order before you buy.

4. Terminal illnesses. It is sad but sometimes the seller needs money for medical expenses, like for cancer treatments. The house is most likely to be fully paid up. They would want a quick sale, for obvious reasons, and normally would take a discount to the market price. In this situation, you are also helping them but be fair when it comes to pricing.

5. They don't know the market price. yes, it happens but not very often. In a mature area, the owner may have lived there since day one, when he bought it at RM30k, for example. He doesn't comprehend that prices have moved up a lot, and is happy to sell for double the original price? But the market price could be RM90k? Happens when the owner sells the property himself (without an agent's help).

6. He/She is an investor. I have bought a few units from people who are like me, investing for rental income. They may have lived in the area, and subsequently rented it out to others. After a few years of collecting rent, they may have moved on to investing in commercial properties, for example. They are quite happy to see another investors take over, and these transactions usually are quite smooth, and the pricing, a win-win.

In all these cases, the only way to find motivated sellers is to go through the numbers. You will find them. And another important point is, always ask. If the price is stated as X, it does not mean that it has to be that. You can always offer a lower price; and sometimes, they may be motivated to sell to you. You'll never know what their circumstances could be. It always pay to Ask.

**
Chris    

How to find rental properties below market price

I once read that financial guru, Robert T. Kiyosaki of the "Rich Dad, Poor Dad" fame, and his wife owned more than a thousand of those "little green houses" (rental properties in Monopoly game). Yes, 1000 rental properties! That really blew me away so to speak as that's quite an achievement. Today, they collect cash flows from those houses every month, and all of them are fully paid up. Imagine what your bank account would look like? So, I said to myself: even if I collected 100 of these little rental properties in my life time I would be ecstatic. Even if each only gave me RM500.00 per month, that is an extra RM50, 000 per month! Now that's passive income!

With that, I started my journey in collecting "little green houses"; and set a goal in my first year to accumulate 10 units. It was pretty ambitious as I had not set aside much extra cash for this purpose. But, I knew there would be ways I could "bootstrap" my cash flow from my salary to buy the properties. (More on this later).

The key to the whole program of buying rental properties successfully is to be able to buy below market price. As Warren Buffett the great investor says: Price is what you pay, value is what you get". You are trying to find out what the value is, and pay a price lower than the value. In property investing it is similar to other types of investing: it doesn't take much effort to buy at market price. But then, it's more difficult to make money. This is more so in property, where as stated in the DeRoos' 8 Golden Rules: you make money when you buy! So whenever possible, buy below market price.

I am going to split the process down to two parts: firstly, what it takes to find those below market price rental properties, and secondly: how do you know if these owners are motivated to sell (what I call motivated sellers).

Well, once you have identified your area to buy these rental properties, the next step is to get to know it well. That means, getting a map of the area and make a large photocopy of it, so that you can mark down the areas that you wish to buy, and those to avoid. You can even put it up on your wall so that you look at it every day.

To know the area really well, you will need to do some work. You need to go on a walkabout around the area and look out for properties to buy. Sometimes, agents will hang the "For Sale" sign outside the property. If you just want to buy at the price that everyone else is buying at, then just look in the newspaper's classified ad section. Normally the advertised price would be higher than what the buyer is looking for; so, if you've paid that, it would be above market price. So, in short, to get bargains, you need to do legwork!

How do you find out what is the market price for the properties in the area? Remember there may be different unit sizes and also located on different floors. The 3R 2B would cost more than a 2R 1B, and sometimes even for the same kind of property, e.g. a 2R 1B, there may be slight difference in size due to the layout, hence the value. So you need to know all these things before you make an offer. (In short, know everything there is to know about the property).

Also units on different floors command different prices especially if it is a 5 storey walk-up flat. Generally, the lower floors command a slight premium; you don't have to walk up the flight of stairs. So, units on ground floor and 1^st floor are desirable. But if you are buying for rentals, don't worry too much about the lower floors. People who rent don't mind walking up a few flights of stairs if they can pay slightly cheaper rent. Same goes for renovation; people who rent are transients so they won't be too concerned about whether the unit has marble or tiled flooring. I generally don't pay for the premium of lower floors or extra renovations.

Well, the best way to find out what the market price is to Ask. That means, ask the agents that "farm" in the area, ask the owners, and ask the people who rent in the area about what the price is. Some will give you some ridiculously high prices but some will be more realistic. Make sure you check on what are the transacted prices too and this is where you need help from the valuers. They will be able to tell you prices transacted usually lagging by about 6 months or so. That would do, as you are trying to get an estimate what the value of the property is. If you are fortunate enough to know someone who also buys in the area like me with my friend, then you can quickly get an idea of pricing.

Another good source of information on the market pricing for properties is in the classified ads, and on-line property portals like www.iproperty.com. They give you an indication of the asking price by owners and agents but these tend to be inflated, so beware. Still, they provide a good rough gauge if you like.

Here's the crux of finding good properties at below market price: it's a Numbers game. Most people look at one or two properties and then they give up; they could not get the price they were asking for, and it's too hard work to look at more. No, property is about Numbers. Dolf DeRoos has a 100: 10:3:1 rule which means that you need to "look at" 100 properties, out of which only 10 you would make an offer on, and try to arrange finance / sort out the details for 3, and may only end up buying 1. At first I thought they were hypothetical numbers, plucked out of thin air but guess what? It works. In own case, I certainly had those odds: usually it would take me looking at 20-30 properties before I came across one or two that were worthwhile to make an offer on. Now, what does looking at property means? It means you are able to evaluate it to the extent that you can say, why you want to buy it, or why you rather pass on it. It is that simple.

This approach is like a funnel: you have to put a lot of properties in at the top before one, comes out through the bottom. After looking at a few of these properties, you will soon recognise, what some of the reasons are that you would pass on it. Usually it's because of the high asking price, or the state of the unit (needing repairs), or the owner does not have the title in his name, and many others. But, once in a while, you will come across a gem: a motivated seller, looking to sell his rental below market price, and you make an offer on it. And when you close it - it is an incredible high. Once you find one, you know you will find many, many more. It is a wonderful feeling knowing it can be done. But, it requires persistence and belief that the numbers 100:10:3: 1 will work for you. Happy looking at properties


**
Chris
Next: Who are the motivated sellers?

I Love Dolf's 8 Key Rules of Property Investing

I just love the simplicity which Dolf explains things when it comes to investing in properties. I keep these 8 rules, on a piece of paper stuck up on my wall so that I always remember them. And, it has helped me greatly when I was aggressively buying my rentals last year. I helped me to focus and I hope it will help you too.

1. Put no or as little money down as possible.
This is important especially if you are on a blitz to acquire many properties. Try asking for a 2 or 3% earnest money instead. You will find you will have more money to buy other properties. How do you do this? just tell them that's what you always pay, and most times the agent/owner will agree.

2. You make money when you buy
So, make sure you pay attention to the price you pay. Always know what is the market price and strive to buy at below market price. How do you do this? I will cover this later on in the blog, and is probably one of the most important steps in creating positive cash flow from yr rentals.

3. Don't sell unless you have to
Well, don't sell ever would be too strong, hence I said unless you have to. Why kill it if it's the Golden Goose? Of course, if its dud and you are sure that it will not change, then you may want to sell it. If the property is appreciated, then you may want to consider refinancing it, every few years to get some cash out. (to buy more properties?)

4. Fall in love with the deal, not the property
Ah, this is a very important rule: Most times you won't be living in the place anyway, so why fall in love with it? What you need to know is this: someone wants to live in it, am willing to pay rental for it, and you want to get it at a bargain price, if possible. So, negotiate based on facts, not emotions.

5. Be countercyclical
I am a contrarian by nature. If people say the economy is bad, I tend to think otherwise. Why waste a crisis? there are plenty of opportunities to be found. In a bad market, there are still bargains to be found, so do not despair. It is probably easier to find a bargain in a bad market than when the price of properties are sky-rocketing!

6. There's a deal of the decade every week.
It's true. Never get hung up if you make an offer on a unit, and the deal falls through. There is another one just round the corner which may be even better. But, you do need to work the numbers, and "see" many, many properties before you find one that makes a good deal.

7. Never be the first to name the price
If you name the price, you lose. You could have got it cheaper, and in negotiating, naming the price is always a bad move. So, you have to encourage, or persuade or do whatever to make the other side to name the price. Then, we can negotiate from there. The asking price is never the final price, in any case.

8. Always buy from a motivated seller
This is a critical rule to stop you from wasting time. I never want to buy from someone who says " Well, I would like to sell but, if I don't get the right price, I won't" Then he is not motivated, and so I will move on. Later I will tell you about how to spot a motivated seller; and how that can help you buy below market price, all the time.

Have a good one.

Chris