Property investment is a lucrative business even when market sentiments are not exactly encouraging. Many investors will tell you that they still make money and this is the best time to find the ‘hidden gems’ of properties, especially those below market price by understanding the market trend.
For those with a deep pocket, investing in property might be easy for them initially, but the challenge later on will be on how efficient they can strike a balance between monitoring their investment profitability at the same time invest in more properties.
Here are some rules that have helped property investors achieve their property investment objectives and may help you in your property investing journey as well.
Rule of 72
Dubbed as the eighth wonders of the world by renowned math genius Albert Einstein, who formulated the famous formula E=MC2, the rule of 72 is really worth understanding, especially in doing property investment as real estate is a business where you practically “double-up” your money invested.
The rule of 72 indicates how fast the money you invested can grow by 100%. It shows you the number of years to double up the original money invested into your property. For instance, if you have invested RM50,000 into a property promising an 8% return annually, you would double-up the money in just 9 years.
Say you get lucky and purchase a similar property at RM50,000 but with a 15% return annually, you would have doubled-up the money invested in less than 5 years.
The rule of 72 works because of inflation. Can you still remember how much a pack of nasi lemak costs 20 years ago and compare it to now? Moreover, your home mortgage should decrease over time, but at the same time, your rent increases.
Take the same example and you will know the amount of money according to your age. For instance, if you invested in a property with RM50,000 with an 8% return at age 31, the value will increase to RM800,000 by the time you reach 67 years old.
The rule of 72 essentially summarises one of the most powerful forces in the history of human’s economy – the power of compound interest.
If you know how to apply the rule of 72 in your property investment journey based on the annual rate of return, you can then plan your retirement almost more accurately; therefore the notion that people can retire before the retirement age of 60 by investing in the right property is one that is practical and possible to achieve.
Rule of 78
Did you know that making payments before they are due does not necessarily reduce the total interest owed to the lender? This is a misconception that sometimes makes investors confused.
The Rule of 78 is also known as the sum of digit. This rule will guide you to understand how the annual interest is calculated, as well as help in differentiating how much of your monthly instalment is actually going into paying the capital and interest respectively.
This rule is applicable based on an assumption that investors are looking to take a fixed interest rate with a fixed period loan.
Apply this rule when it comes to investing in property. Take the balance of your mortgage loan and multiply the balance of your annual interest rate. Then divide by 365. From the total amount multiply number of days per month. Quite a tricky calculation this is!
These days, a number of mortgage consultants are offering services where they can help you save on interest by splitting your repayments and paying them at different times.
Rule of 1%
This is the fastest method an experienced property investor will use before deciding to invest in a property.
Basically the rule of 1% states that any property you invest should be able to be rented out at 1% of the purchase price of the property.
So for a RM600,000 home, the rental at 1% will be RM6,000. Some investors will increase this percentage from 1% to 1.5% and even 2% for greater cash flow.
The rule actually helps investors do a quick estimation if the monthly rent recovered will be sufficient enough to cover or exceed the monthly mortgage payment.
Let’s say you put 20% down payment for a property worth RM600,000, you would have a mortgage of RM480,000; so according to the rule, the monthly rental cannot be less than 4,800.
Rule of 50%
Besides the rule of 1%, investors will also consider the rule of 50%. This rule basically states that 50% of your rental income will be used or allocated for the expenses incurred on your property.
For instance, let’s assume you have a property renting at RM1200. Thus, you should plan to pay RM600 (0.5 x RM1,200 =RM600) on your expenses not including the mortgage. Essentially, this indicates that you have RM600 left to pay mortgage before getting the profit.
The Cap Rate
Capitalisation rate or Cap Rate is a good method to calculate the rate of return if you buy or invest in a property because it measures the property’s value relative to your cash flow.
This is done by having the total amount of net income divided by the cost of the property or asset.
For instance, let’s say you buy a home at RM300,000 and your expenses such as property taxes, repairs, maintenance and insurance averages out to RM500 per month. If your rental is fetching you RM1,500 per month, then your net operating income is RM1,000 per month or RM12,000 per year.
So using the formula provided, you will get a return of 4%. But is 4% a good rate of return? It depends on many other factors such as location, security, opportunities for growth and so on.
There are many more rules that experienced investors will use other than those stated above. Share your thoughts and feedbacks by sending me an email at firstname.lastname@example.org
About the Author
Chan Ai Cheng is the General Manager of S.K Brothers Realty (M) Sdn. Bhd.