# Should You Still Invest In Real Estate Property?

March 1, 2012 4 Comments

I don’t invest in real estate property simply because:

**Property Is an illiquid Asset**

It can take months to turn it into cash by selling it. To put up a sale, you have to spend time market your house, negotiate with the buyers, deal with the agent who will help you find new buyers, and find good lawyer who charge reasonably for legal transfer work. There are simply too much work. I would rather spend time researching for stocks investment.

If you do invest in one, what if you need money urgently for contingency use? Such as to pay for health care bills should you or your family members suffer a sudden serious illness? Then you will probably do a fire sale by selling your house at a discount.

**So Should You Still Invest In Real Estate Property?**

The only reason I will consider invest in real estate property is because it gives the power of leverage. Here’s how it works:

Let’s make the assumption below:

1. You only need to put down a 20% deposit of the the purchase price.

2. 2% fixed interest rate per year of the loan.

3. Exclude agent’s commission and lawyer’s fees.

4. The price of the property has gone up after 5 years.

5. There is no rental collected.

Price Of The Property = $200,000

Initial deposit (Your investment) = $40,000

Let’s assume the price of the property goes up to $300,000 after 5 years, and you sell the property for a decent profit.

Total Loan → $200,000 – $40,000 = $160,000

Interest of the Loan (5 years) → $160,000 x 2% x 5 = $16,000

Total Cost → $200,000 + $16,000 = $216,000

Profit → $300,000 – $216,000 = $84,000

Total Return of your $40,000 investment → $84,000/$40,000 * 100 = 210%

Average Annual Return → 210 divide by 5 years = 42%

Well that’s not too bad. But remember this is based on a 2% interest rate and we excluded the agent’s commission and lawyer’s fees. The rate of return is reduced when the rate and fees are increased.

However, remember:

1. There is no guarantee the price of the property will go up.

2. Interest rate fluctuates all the time.

3. There is no guarantee you can find tenant.

In my opinion, if you really want to invest in real estate property, consider below:

- Do this for second property investment.
- The property must be located in a very good strategic location.
- The condition of the property must be in good order.
- Buy when there is a significant price drop (recession is the best time to buy). Do make sure that you have a 100% secure job, so can still pay the loan if you cannot find any tenant!
- Take up the maximum loan period (30 years) and put as minimum deposit as possible. So use remaining cash and invest in stocks. Remember the power of compounding return!
- The loan package interest rate MUST be as low as possible (Do a comparison with all the banks).
- Rent out the property, use the rental income to pay for the monthly installment. Make sure the rental is high enough to cover the monthly installment & utility expenses. I would prefer a 50% buffer, because there will be times where tenant will move out and you need time to find a new tenant.

**How To Estimate Monthly Installment?**

Let’s use the example discussed above:

Price Of The Property = $200,000

Initial deposit (Your investment) = $40,000

Total Loan → $200,000 – $40,000 = $160,000

Interest of the Loan (30 years) → $160,000 x 2% x 30 = $96,000

Total Liability → $160,000 + $96,000 = $256,000

Monthly Installment → $256,000 divide by 30 years divide by 12 months = $711.11

The target rental rate should be at least **$1066**.

Remember, a real estate is a liability when it does not generate income.

Alvin, interest on loan (5 years) —> $160k x 2% x 5 yrs = $16k. You’ve applied straight-line computation, without interest on principle + interest from year 2 onwards. Is this for simplicity of explanation or are there other reasons for such computation?

Hi Jin, the interest on principle i used is based on $160k loan, excluded the $40k. And it assumes that the house is sold 5 years later with annual 2% fixed interest rate. Based on 2%, the interest to be paid will be $3200 per year.

The last portion where interest is calculated for 30 years. Is there an error on the computation? It’s only multiplied by 5 years.

Yes it is a spelling mistakes, thanks for pointing out ! =)