Top 5 Ways To Begin Investing In Real Estate

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Real estate investing can be quite easy if you start simply.

Do you have a big dream and small savings? Looking to invest in real estate? I have identified five ways in which you can invest in real estate with your small savings and achieve your big dream. Real estate is the best source of passive income around. If done well, could support you for the rest of your life as you glob-trot or do whatever tickles your fancy.

From my experience, and what I have learned over the years, here are three 3 ways you can invest in real estate without a lot of money.

Before you do invest, make sure you read some of the lethal mistakes you should avoid.

1. Join a Joint Real Estate Buying Venture

This could be just you and a couple of friends coming together to purchase real estate for the purpose of earning an income from it. There is an African proverb that says that “If you want to go fast, go alone. If you want to go far, go together”.

Important Data You Will Need! Find out how many members you will need and how much contribution each member will make. Before that, ensure that all your goals and interests align before engaging in any purchase formulated into an investment plan.

2. Leveraging Real Estate

Leveraging is basically borrowing money to increase the potential return on investment. The potential for large gains is tied to leverage and low-cost financing.

When I talk about leverage, I mean this – Consider a real estate property on Kiambu Road valued at KES 12.5M (three-bedroom apartment), with a requirement of 20% down payment i.e KES 2.5 M. The buyer could use this relatively small percentage of 20%  (i.e. KES 2.5M) of his own money to gain control over the asset. He can do so by making a purchase with a majority of the money being provided by a lending institution.

Why does this make sense?

Let’s compare the gains, to the gains from an un-leveraged purchase as we seek to highlight the value of leverage. Please note this works best for properties you seek to rent out and earn additional cash inflows from.

Scenarios & Assumptions:

Δ Assume that this property value appreciates at 6% (year-on-year growth rate, 2014 estimates), and the borrower’s net worth would grow to KES 13.25 M in just 12 months.

Δ Also assume the same borrower bought a house of KES 2.5M, with the same appreciation rate of 6%. His new net worth would increase only by KES 150,000 over the course of 12 months as opposed to KES 750,000M on a leveraged purchase of much more expensive property. The KES 600,000 difference demonstrates the potential net worth increase provided through the employment of leverage.

Note: Some serious investors start out using leverage mainly to purchase rental properties. As such use cash flows from these properties to pay down the debt. The investors may opt to sell the property after four to seven years from when they purchase it to realize equity gains.

The financial structure is as follows:

Scenario 1: 100% Cash Purchase

House Value: KES 12,500,000, Sale Value: KES 16,727,820, Annual Rental Income: KES 900,000 (7.2% yield- usually ranges between 5-10% on real estate)

Revenue & Expenses,

Kes ‘000

Purchase Year 1 Year 2 Year 3 Year 4 Year 5
Rental Income 900 900 900 900 900
Interest Payments
Debt Principal Payment
Purchase or Sale of Property (12,500) 16,728
Net Cash Flow (12,500) 900 900 900 900 17,628

Returns Multiplier: 1.7 x , Internal Rate of Return: 12.5%

This is an okay scenario and a 12.5% internal rate of return is not something to sneeze on or disregard.  It is typical for real estate deals to yield such returns if you give 100% cash to buy an asset and then sell it at a moderately higher price in 5 years or so.

Be sure to factor in and readjust inflation as well.

Scenario 2: 20% Cash Payment

Cash Payment: KES 2,500,000 (20%) , Debt Payment: KES 10,000,000 (80%),  Debt Interest Rate: 15% (my own estimated average), Debt Principal Repayment: KES 874,743 (per year)

Revenue & Expenses Purchase Year 1 Year 2 Year 3 Year 4 Year 5
Rental Income 900,000 900,000 900,000 900,000 900,000
Interest Payments (736,726) (736,726) (736,726) (736,726) (736,726)
Debt Principal Payment (138,017) (138,017) (138,017) (138,017) (138,017)
Purchase or Sale of Property (2,500,000) 5,884,020
Net Cash Flow (2,500,000) 25,257 25,257 25,257 25,257 5,909,277

Returns Multiplier: 2.4 x, Internal Rate of Return (IRR): 19.4%

A decrease in the initial investment makes a very big difference in leveraged investments. The yearly cash outflows in terms of interest and debt principal payments reduce our cash ligature but we reduce our cash inflows by KES 874,743. Also, keep in mind that KES 12,500,000 is much bigger than KES 874,743. On the sale of the property, we still sell the property at 16,727,820 but must pay our outstanding debt of 10,843,800 at year 5.

The Returns Multiplier and the IRR increased because of reducing the purchase price. There is a disproportionate effect on the entire transaction as money today is worth more than money tomorrow.

Important Data You Will Need! When it comes to identifying a property that would leverage well, you will need to conceptualize how much rent you will need to collect relative to the property rent i.e. the gross rent multiplier. Find out the rate at which the bank is willing to provide you with the mortgage and the mortgage interest relief you will expect to receive to compute accordingly. Additionally, consider all costs involved in purchase which are not included in my scenarios before estimating your return.

A word of advice: Following the rules of major investors, always seek a higher IRR than 20%.  This means more rental income growth, a better selling price, better terms of debt or a combination of all those.

Warning!

Just as with most investments, leveraging also comes with a degree of risk. Hence it should be used prudently. As much it can work in your favor, leverage can also work against you so be warned.

Given the previous example of a KES 12.5M property purchase, if the value of the property does not appreciate then leverage will work against you. As the property value depreciates with time so does the equity value. You need to be very very careful as this may be a very likely scenario as many Kenyan properties are over prices and buyers only realize at the point of resale.

Under a leveraged scenario, a decline in value will wipe out any gains expected to be made at the end of the investment period. This leaves you dealing with losses rather than profit. This goes as well for rental income.

Also under the full payment scenario, if the same borrower chooses to buy the lesser costing property of KES 2.5M and the property does not appreciate in value, the buyer would lose KES 150,000 in the first year. This depends on the rate at which the value is decreasing. 

Some tips on how to screen real estate properties for Leveraging:

• Steady Income:  Seek rental property that has the potential to garner a steady but increasing rental income with an appropriate gross rental multiplier.

• Market Maturity: Seek to purchase a property that is in a mature market with proper infrastructure for ease of renting and also reselling.

• Low Capital Expenditure Requirements: Seek a rental property that has minimal repairs and structural problems with will not cost you much to fix.

3. Land Options Trading

Said to be a revolutionary product that essentially allows an investor to pay a fee (at a fraction of the sale value)  to the seller, compelling the seller to hold a parcel of land that they wish to buy at a locked price for a fixed duration of time. If at the time of expiry of the contract the seller has not fulfilled their option to buy, they can transfer their rights to a third party at an even higher price before expiry. There are numerous advantages to these kinds of agreements, which are essentially strictly defined terms and properties such as low-risk exposure and higher returns and much much more as land is such a lucrative business in Kenya.

4. Real Estate Investment Groups

Essentially are like small mutual funds for rental properties which offer you a chance to own rental property, but do not want the hassle of being a landlord then they make a great solution to this problem. They buy or build real estate properties such as apartment blocks and then allow investors to buy them through the company as such joining the group/club. In Kenya, a single investor can own a fraction, of one, or multiple units (self-contained living space), but the company operating the investment group collectively manages all the units. The management takes care of maintenance, advertising vacant units, and interviewing tenants. In exchange for this management, the company takes a percentage of the monthly rent.

5. Real Estate Investment Trust (REIT)

These are publicly-traded instruments on the Nairobi Stock Exchange as initially listed by Stanlib last year. They are essentially created when a corporation (or trust) uses investors’ money to purchase and operate income properties. Before investing in this fairly easy option, make sure you do your research on the performance of these instruments.

Bottom Line

We have looked at many options that you may use to venture into investing in real estate in Kenya. However, just like with every other investment, real estate investing also comes with its own fair share of risk. Therefore, make sure that you make careful choices weighing all the costs and benefits of your actions before diving in.

Happy Investing!

Meanwhile, You can click on the following links to read more about real estate investing.


Disclosure: This information is provided to you as a resource for informational purposes only. It is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal. This information is not intended to, and should not, form a primary basis for any investment decision that you may make. Always consult your own legal, tax or investment advisor before making any investment/tax/estate/financial planning considerations or decisions.

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Irene Makanga
Irene has an MBA in Finance and is an avid businesswoman, passionate about financial literacy.

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