Kenny

I recently came across two investors who made money in property investing in the property boom during the last three years (i.e. from mid-2009 to end 2012), albeit in very different ways. I have taken the liberty to simplify and change some numbers as well as ignore all expenses so that we can compare apples with apples. Also, I used residential properties for this article as it?s very much a familiar arena to most readers.

Calculating your investment returns

There are many different ways to calculate a property investment returns but the Internal Rate of Return (I.R.R) is by far one of the most accurate methods of calculating the cumulative property investment returns over a specific holding period.

Inexperienced property investors and home owners who only look at capital gains as a measure of investment success are always surprised by the difference between the earnings that they expected to realise from a property investment and the actual investment return.

Capital Gains or Growth do not equal investment returns due to many variables like financing, nature of loan amortization and many other costs involved in the entire property transaction process.

How IRR Works

Because a dollar in hand today is preferable to one a year or five years from now, Internal Rate of Return reveals in mathematical terms what a real estate investor?s initial cash investment from Day 1 will yield based on today?s dollars, not tomorrow?s dollars.

Here are the details of the example we will be using: Both properties are located within a 5 minute walk to MRT station and are near the city.

Note: A financial calculator or Excel is needed for I.R.R calculations (a basic tool for all true blue investors).

Investor A:

Purchased a newly launched 916 square feet condo in a mature estate.

Purchase Price (2009): S$930,000

Down-Payment: S$180,000 (20%)

Loan Amount: S$744,000

Upon completion and T.O.P in 2012, he received offers for S$1.2 million.

Equity = S$1,200,000 ? S$744,000 = S$456,000

Gross Profits = S$1,200,000 ? S$930,000 = S$270,000

I.R.R = 36% per year

Investor B:

Purchased an old 16 year-old 936 square feet apartment in a growth location.

Purchase Price (2009): S$520,000

Down-Payment: S$104,000 (20%)

Loan Amount: S$416,000

Rental Income (3 years): S$2,400 per month

He received offers for S$800,000 in late 2012.

Equity = S$800,000 ? S$416,000 = S$384,000

Gross Profits = S$800,000 ? S$520,000 = S$280,000

I.R.R = 78% per year

Here are some questions to ponder:

1. Who is the smarter or luckier investor in this case?
2. If you were presented with both investment options, which would you go for and why?

My analysis of the two investments

Investor B had similar gross dollar profits with Investor A (S$280 thousand as compared with S$270 thousand) but his actual return on cash invested is two times greater than investor A!
Investor B has a lower down-payment (S$104K for B compare to S$180K for A), but B?s actual return on cash invested is two times greater than A.
The returns are higher for B, in terms of cash invested now (down-payment), rental yield now, probably higher returns in future than A?s since B?s property is also located in the growth corridors of Singapore, while A?s property is already in a matured estate.
Similarly, there are higher chances of rental increments due to a growth location and possibly a bigger and more stable tenant base for B, and lower vacancy rates.
Investors A?s property is a new property bought directly from a developer, while B?s property is an older re-sale property from an individual seller. One of the arguments I stand firm on is that the higher profits that A should have gotten, have already been discounted into the developer?s profit margins and expensive marketing costs.
Investor A?s Day 1 initial cash has zero returns for 3 years until property completion. Investor A is waiting for his returns to materialise 3 years later, while Investor B?s cash is already working hard for him through a strong rental cash flow from DAY 1.

My recommendations of which investment to choose

Choose investment B, if your strategy is to hold for rental as well as property value gain. This property will probably give you a good rental over the years as it appreciates in value. I would highly recommend this low-risk strategy to the average investor with limited cash resources and who seeks safety.

Choose investment A if your strategy is to buy and sell. Reinvest the money again in a similar way but good profits will only come during a booming economy. And of course, if you sell high, you buy high too. This strategy is speculative and only suitable for an investor with ?fun? money.

My concluding thoughts

Why plant a seedling if you can plant a tree today? Investor B is already making money from Day 1. Yes! You can have your cake and eat it too.
If I were given 10 such opportunities, I would invest 10 times in the B type of investment scenario. Better rental yield, better capital appreciation, better long term potential, less risk, less dependence on the economy ( good or bad, I still get rental income regardless of property value)
For A, maybe unless you want to use it for your own use or as a gift for loved ones.
Investor A has an easier no-brainer task ? SELL, pocket the profit and look for more deals like this. He thinks making money in property can be as easy as this and will most likely try to replicate the same strategy again. But tomorrow is not today? crazy economies like today don?t always happen.
Buying an older re-sale property (Investor B) can have much higher actual returns than simply buying an off-the-plan property (Investor A).
B?s property does require a lot more leg work and sweat before the sweetness? but that?s the whole point of it ? ?FUN?! Its ?fun? that makes it all worthwhile for a true blue investor who loves and knows investing!

Simply taking Rental Yield alone as a benchmark for analysing investment properties is like taking a bow and arrow to a real gun fight! Understanding and knowing how to calculate Internal Rate of Return (I.R.R) in any of your investments is a crucial skill of an investor. Measuring your property investment?s actual returns through I.R.R will help you become a more savvy and educated investor in today?s more volatile times.

By guest contributor Gerald Tay, CEO of CREI Academy Group, who exposes widely-held property investment myths that have proven highly ineffective in creating wealth, and prevent a comfortable retirement for the ordinary investor.