"Property investment is for rich entrepreneurs."
"She owns multiple properties. She's definitely enjoying good passive income from them."
This is a common perception amongst many employees. It's also the wrong perception.
Passive income is alluring to many people because it suggests the possibility of getting money without having to work for it. Property investment is commonly thought of as one way to achieve this. The truth however is very different.
The best way to get into trouble investing in properties is to think that it's going to give passive income and that you'll be able to quit your job soon after.
In this post, I will explain how you should look at property investment and how you, as an employee, can grow rich with properties.
Let's start with getting rid of the passive income myth.
Property Investment Will Give Me Financial Freedom
This is the catch phrase bandied about by many a guru in the property market. But let's get real for a moment.
How many property investors do you know who are financially free solely from their investments in property? I'm guessing one to none.
You see, the word "financial freedom" is very vague. What is financial freedom? Owning 10 properties? Having RM3 million in spare cash? If you think about it, financial freedom can mean different things to different people.
The underlying principle would probably be the same - having the financial means to do what you want. This is a dangerous proposition if you don't know what you want and believe me, after speaking to many people about their goals, I've realised that very, very few people actually know what they want.
Assuming you know what you want, will owning multiple properties give you this ability to "do what you want?"
For example, after your 20th property, would you be able to quit your job, move to paradise and live the good life? Well... there's a higher likelihood that you'll be working harder than ever to pay the mortgages on those 20 properties.
Here's a little secret...
The majority of people with multiple properties are not financially free.
This is because all the properties they own are not giving them a substantial passive income. Think about this for a second; if an investment property gives you an income of RM500 and you're an employee earning RM15,000 a month, how many properties would you need to buy before the income from the properties matches that from your job?
That's right. 30 properties.
What if only 5 of these properties give you positive cash flow? You could be stuck working for the rest of your life to pay the mortgages.
As I will demonstrate shortly, for the average man, cash flow from property investment does not lead to financial freedom. The big money is made on capital appreciation which happens over the long term.
Financial freedom comes from planning what you will do with your money and living within your means.
Therefore property investment should be looked at as the act of forced savings for high returns in the future. With this mindset, you as an employee, can and will grow rich with properties.
Property Investment is Forced Saving?
There is a cost to owning property, and more often than not you will be paying out of your pocket to keep your investment properties.
Now, just because the rent you collect is higher than your monthly mortgage payment, does not mean you have positive cashflow. For example, if you collect RM3,000 in rent and your monthly repayment to your bank is RM2,500, you will not have a surplus of RM500.
There are other costs to keeping your property which include:
Building service fees
Add all this in and you may be forking out an additional RM1,400 every month which makes your cash flow negative. If you want a detailed mechanism for calculating your cash flow, you can use the property investment calculator that comes with my book, The Ultimate Guide to Buying Property (download it here).
With all these costs to consider, you will find yourself negatively geared most of the time. This is the case with the vast majority of investment properties that are financed with high loan-to-value ratios. You will need to have and grow your earned income for this.
In the residential market, you can increase your rental income through creative initiatives like student accommodation, housing for multiple occupants or short-term accommodation. In these cases, it is possible to make positive cash flow but this is certainly not passive income and the income may not be substantial.
You must be wondering, what's the point of buying investment property if you're going to have negative cash flow. I mean, if you are forking out RM1,400 to keep a property, it isn't really an investment is it?
Actually it is. Let me give you an example. Have you ever bought an investment-linked insurance policy? It's where you pay a sum of say RM2,000 per month or RM24,000 annually, with part of this money going towards insuring you and another part towards investment.
You're forced to pay this amount for a long-term period and at the end of this period you get back your investment money with interest.
Think of property investment in exactly the same way. For example, you're forced to set aside RM1,400 every month towards your property, but after a period of 10-years you can sell the property for substantial gains.
In the example of this property where you are forking out RM1,400 per month, your return if you sold the property after 10 years could be the equivalent of 8% to 13% per annum. Very few investments would be able to give you this quantum of returns without a substantial increase in risk.
If you look at property investment as forced savings, you will:
Be motivated to keep increasing your earned income to build a large portfolio,
Look at property investment as a long-term game
Become immune to the ups and downs of the property cycle
This greatly reduces the risk associated with property investment.
This leads us to another big secret...
Earned Income is More Important Than Passive Income
The fastest way for you to increase your income if you're an employee is to become damn good at what you do and master the skills required to get you promoted fast. Too many employees are caught up in the dream for entrepreneurship and passive income.
If you want to be an entrepreneur because you're motivated by passive income, you'll be in for a very rude awakening. Entrepreneurship is very, very difficult. Chances of success are minimal. You may find that you have to work harder for less money, especially in the early years.
If you want to be an entrepreneur so you can be free to do what you want, think again. Doing what you want is a luxury most entrepreneurs don't have. As an entrepreneur, you may very often find that nobody wants your product or service. You will have to improve, adapt, refine or start over. You have to find a niche that meets demand. In short, you can't do what you want.
I'm not saying you should ditch your idea of being an entrepreneur if you're passionate about it. However, if you're motivated by an easy way to become rich, entrepreneurship is the wrong way to do it. In fact, you stand a higher chance of increasing your income every year as an employee.
If you focus on building your earned income, then invest what you can into properties and gradually build your portfolio as your income increases, you will have a substantial nest egg before you retire.
How Do You Build a Substantial Nest Egg
Property investment is a long-term game. When you buy, you should be looking at an 8-year horizon at least before you divest. In times of a property boom, you may be able to make quick gains but if your plan is quick gains, your risk goes up. This is because it is difficult to predict when a boom or bust is going to happen.
If you buy at the peak of a boom, you may have to wait significantly longer for appreciation because a bust is on its way. People who bought Malaysian properties in 2014 for example, may still be waiting to see a significant appreciation on their properties in 2019. This is because we entered a bust sometime in 2014.
If the property cycle is anything to go by, 2019 would be a good time to be buying.
But property cycles aside, if you invest for the long-term and look at property investment as forced savings for high returns in the future, then booms and busts in a cycle have less implications for you.
The key to building a substantial nest egg with property investment is to understand capital appreciation.
First, you will make more money on the appreciation of your property if you are leveraged. You will also be able to buy more properties with leverage.
Second, capital appreciation does not equal more money for you. You cannot buy goods and services with capital appreciation. It is not the same as cash. You can only enjoy the fruits of appreciation when you sell the property.
Therefore, it makes sense to leverage and to plan the sale of your properties well in advance.
Leverage can be your worst enemy if you are stretching the limits of your ability to repay. You must understand your cashflow with every purchase you make. I've tried to make this easy for you with the property investment calculator (download it here).
Now let's look at how you can build a large property portfolio.
Buy a property that you can afford. This means, you should know your cash flow. As in most cases, this may be negative but that's fine. You should look at this as forced savings. However, you must be able to afford this cost. If you cannot comfortably afford it, then you should buy a cheaper property or don't buy at all.
Look at your investment property as a business. That means you should have a system to prepare the property and rent it out fast. You cannot throw a hodgepodge collection of furniture together into a property and assume it is ready to be tenanted. You have to make your property beautiful. Tenants should be dying to live in it. You will then find it easy to rent out the property.
Grow your income. Focus on building your earned income. Aim for that promotion. Pursue that new job opening with better prospects. Develop your self. Become the employee that every company wants.
Your rental income also contributes to your ability to take a mortgage. Your rental income from your first investment property will be recognised by banks as additional income. You will need to be able to show a minimum of 6 months of rental income. Most banks would factor 70% of this into your overall income.
For example, if your net salary is RM15,000 per month and you have a rental income of RM2,500 per month for 6 months at least. Banks will calculate your income as RM15,000 + RM1,750 (70% of RM2,500). This means to the bank you are now earning RM16,750 and you will be able to borrow again for your 2nd investment property.
Gradually, as you increase your earned income and rental income, you will be able to keep buying more properties and build that nest egg. The key is to always watch your cash flow. You must know exactly how much you have to fork out every month on each new property and ensure you can afford it.
Invest for the long term. Don't invest in property for short term gain. You may stretch your self too much and find it difficult to dispose your property in the short run. Property investment is about holding power. You should be able to hold your property until you can sell it for a significant profit. You should never be in a situation where you are forced to sell. Forced sales are usually not profitable.
For more information on how to get a bank loan and how to profitably rent and sell your property fast, read The Ultimate Guide to Buying Property.