In our previous article “How to increase the return of an investment property to more than 20%?” we have shown you how we increase the return of an apartment to more than 20% from a bad starting point. Most investors have such experience where they found their investments were not as good as they expected in the beginning.
However, the most important thing for a successful investor is that he/she will never stop looking for ways to improve his/her investments. In this article we will use a real case to discuss how an investor can improve the return on his/her property from one of the investment tools exclusively given to real estate investment – refinancing. (You can read “Why you want to take up a loan for your real estate investment?” to understand how a property worth borrowing/leveraging can have higher return on investment.)
A real case
There was a reader of reijb.com asking for our advice on how to turn one of her rental apartments in Penang, which was supposed to be a not-worth-borrowing property, to become a worth-borrowing one, in order to optimise the power of leverage on the investment.
With our property investment evaluation spreadsheet (which you can download it free by subscribing to our newsletter), she found her property in a bad situation if she loaned 90% (see table below summarised by the reader).
We assumed the reader has invested RM69,415.56 (down payment) in the property and her existing loan amount was RM40,000. Her existing return (cash-on-cash yield) is 4.23%.
The cash-on-cash yield becomes negative if she loans 90% of the property purchase price (RM104,400) with an interest rate of 4.6% and tenure of 25 years. This means that it will be a negative cash flow of RM 22.61 every month with the loan.
Even if we re-evaluated with an interest rate of 3.75% (which is offered by most banks now), though the cash flow becomes positive (RM21.92/month), the property is still not worth borrowing. From the chart below, we can see the return decreases when the loan amount increases showing a typical not-worth-borrowing model.
Suggestions to improve investment return
To turn her property into a property that worth borrowing, we have two suggestions for her:
1. First she needs to refinance the property in order to get a lower interest rate for her outstanding loan, say 3.75%, compared to her current outstanding loan at 6.1%
2. Second thing is to increase the rent to at least RM660.
Table below shows the improved cash flow projection for the property with these two suggestions.
With the two measures, though the monthly cash flow will reduce to RM81.92 if she loans 90% of RM104,400, her return will increase to 6.36% because she can take back RM53,960 from the loan (RM93,960 less RM40,000 outstanding loan).
In other words, after taking back RM53,960, she effectively had just invested RM15,451 in this property. She can use the RM53,960 to invest in new properties or other places.
However, we suggested her to refinance just enough to repay the outstanding loan RM40,000. As we can see from the second column in the above table, she will still get an increased return of 6.21% with an increased monthly cash flow of RM359.37 if she refinance RM40,000 only.
A real problem
After hearing our suggestions, the reader fed back a real problem to us – she has been trying to increase the rental to as low as RM 30 per month but each time she plans to do that, she was advised against doing that because the reason was that she might just loose her current tenant who pays the rental promptly.
The tenant has requested her to install iron grille on the windows but she refused his request. Moreover, the reader believes RM 600 is the highest rental in that apartment building. Other apartment units are renting out at RM 450 to RM 550.
More suggestions
With her feed back, we suggested more to her, but basically is to “communicate” well with either the tenant or her banker.
• For tenant, we suggested her to install the grille so that the tenant will find it more reasonable to accept an increase in rent. Maybe she can add more “gifts” to this rental increase like giving the tenant a DVD player or rice cooker which won’t cost much. The most important thing is to communicate with her tenant with confident and the tenant may find her having all the reasons for the increase.
• If increasing the rent is really impossible, there is another solution but it may be a bit troublesome. She has to communicate and negotiate with bank to refinance for an interest rate 3.7% or below with 30 years tenure (see below table for the improved return without the increase of rent).
However, if her age doesn’t allow her to apply for loan tenure of 30 years, then she may have to consider a “third party loan”, which uses a joint borrower from her close relative whose age is eligible for 30 years tenure. Though not every bank will do “third party loan”, as far as we know, Standard Chartered and CIMB banks do provide this kind of loan.
As we can see from this case, improving the return of an investment real estate sometime may not be easy and straightforward. But the fact is real estate investment does provide ways to control and improve your return on investment. Sometime the result of improvement may not be a big amount in money. What we appreciate most is the chance for us to explore and learn more to enhance our investment skill.
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We write regularly about real estate investment. Some of our featured articles include:
“How to find good real estate/property agents?”
“What must you know before buying auctioned properties?”
“Where to find cheap properties?”
“Why apartment can be the best real estate investment?”
“How important is location to an investment real estate?”
(Also, don’t forget to subscribe to our newsletter to receive a property investment evaluation tool. You can use this tool to estimate monthly cash flow, monthly installment and return on investment for your property. This tool will also show you if a property investment is worth borrowing/leveraging.)
Your comment and feedback on our posts are very much welcome. Please visit our blog posts to view other readers’ comments and write your feedback.
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{ 5 comments… read them below or add one }
“Other People’s Time (OPT)”, a team of people like agent, contractors, lawyers and bankers as you mentioned in previous post, does this team welcome any property investor? or simply say welcome others to join? If yes, I am interest to join.
‘If you don’t know jewelry, know the jeweller.’ – Warren Buffet.
Hi Raymond,
Thanks for your interest in joining us.
In fact you are not the first one asking to join us.
We are an investment holding company formed by several private investors.
If you are interested to join in our furture deals, what we can think of is we will form a new private limited company for more private investors. Once we have found and studied through any good deals, we will then inform our investors with a business plan to see if they are interested to invest in the deals.
However, in order to protect the interest of other investors, we require each investor to prove their financial strength and credit record before we can put them in our investor list. The information is private and confidential and will be summarised and submitted to financial institutions for financing purpose of each deal.
You don’t have to be rich to join us, but you do have to be stable.
You may send us your particulars and proof of financial strength with credit record so that we can keep you posted of future investment opportunities.
Cheers
Hi OngKL,
Some questions here:
1. Say 4 investors setup a company to invest in properties. What happen if 1 of the investor gone bankrupt? How can we protect other investors?
2. It seems your team is focusing in JB, do you guys plan to expand to Klang Valley?
Hi Ho,
1. If one of the investors has gone bankrupt, his shares will be liquidated to pay off his creditor(s). However, other shareholders have the first right of refusal to his shares, i.e. they have the first right to buy back his shares. If he is a major shareholder, the company (board of directors/shareholders) definitely has to go through a lot of hassle to resolve it and may face a possibility to liquidate the whole company if the buy back of all or part of his shares by other shareholders is unsuccessful.
In such a case, we don’t think there is a “fool-proof” method to protect other investors’ interests. That’s why selecting partners is the most important thing in incorporation of a company.
2. We do hope to expand to Klang Valley this year but we have yet to come out any concrete plan. Main reason is we are still looking for the right team members from the area.
Cheers
I came across 2 units of flat worth RM57k(2 rooms) n Rm70K(3 rooms) with existing tenants occupants in butterworth (penang). Monthly rental (2 rooms flat) is RM300, maintenance fee RM40. The other (3 rooms) monthly rental is RM320, no maintenance fee. Both flats are located at prime area. Are both units worth while to invest? My choice is 1 of the unit, i don know which unit should i invest? Is it advisable to buy with cash? or should i borrow from bank?