I want to examine what makes property investment such an attractive vehicle that the wealthy use. Also, what are the factors that will affect your property investment returns?
Let’s look at the first image, it shows Property Investor: Ali. The initial capital is 20k, which is based on a 10% downpayment. The property value is 200k. The investment unit has been rented out for 30 years. The variables are interest rate, rental yield, appreciation rate, rental growth, and loan tenure. Taking a 4.5% interest rate, the rental yield of 5%, the appreciation rate on the property value as 3%, and rental growth of 3%. I am taking the return on rental income as 8% which is the same as the return rate in the 2nd image. This is assuming that the market is able to return an 8% if they are investing the money in the same thing.
From the 1st image, Ali’s net income is negative for the first 8 years, it turns positive from year 9 onwards. That’s why the cumulative income from a bigger loss starts to pare down and turn positive in year 16. The last column in 1st image shows the Accumulated Return on Rental Income which starts to compound from year 16 till year 31 to become $170,283.43. The total net worth will become $485,452 adding $170.283 which becomes a total of $655,735. In the 2nd image, Raju starts with the same capital, compounds at 8%, all returns are reinvested which will grow to $402,506.28.
Both systems do not require additional external funds to be added and all the funds are reinvested. What makes the difference between Raju and Ali which was $253k?
Property is a leverage game, you are taking leverage of 90% in this scenario. You are building up principal through other people’s money or people are paying through the means of rental. There will be a turning point when more of your money is utilized to build up the principal and the interest expense will start to reduce. With more free cash flow from the unit, you can invest the money into the stock market or invest in another property. The longer your loan tenure, the lesser you need to pay each month in terms of the mortgage.
The larger the property value, the appreciation quantum will be amplified as well. For example, an 10% appreciation on 200k property is 20k, appreciation on 2000k property is 200k. Referring back to 1st image, by around the 5th year, if you sell the property at around 220k-225k, your ROI on capital is 100%, assuming we don’t consider rental income in the picture. For example, 20k capital gain / 20k initial capital = 100%.
If we assume a rental income of 10k per year, a total of 5 years will provide around 50k of rental income. This builds up property equity. You will get capital gain and property equity if you sell at the 5 years. The estimated return will be around 20k + 50k = approximately 70k.
I want to conduct a study that is closer to us, the private property price in Singapore that we are looking at is around S$ 2m. The downpayment is 25% which is 500k. At 40 years old, the loan tenure is a maximum of 25 years. After 25 years, if the owner sells the house, there will be a capital gain of 2.5m assuming that there is a yearly 3% appreciation. That’s when the owner can cash out and downgrade to a cheaper resale HDB.
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