Friday, September 12, 2008

Real Estate Moment

Thanks to Maishinski and Jim Dandy for real estate advice in advice in recent comments on housing investments for those in the Diaspora – touching on management, financing, project issues – and lead to cost/property price issues. What is the residential cost per square foot in Naiorbi? They are frequently cited for commercial properties, but not for residential properties where houses are marketed by the location (most important), presence of compound, servants’ quarter, pool and finaly - number of bedrooms (whcih can be deceptive – I saw a 3 bedroom house that was previously a one bedroom, and the third bedroom had originaly been a walk-in closet)

More on Real Estate

first Dr Laila Macharia advises on housing finance myths and how to overcome them - These are;
- That one needs to be married to own a home.
- That a single person looking to purchase a home has to struggle for years
- That a family must save for a really long time to set aside money for their dream home.

and second Pesa Tu (hi; welcome back) gives away secrets of a successful housing developer as he reviews the dangers of the Nairobi apartment craze and the dangerous path the housing market is going down - these are

- Buy land in Lavington, Westlands or Kileleshwa
- Get the building plans approved
- Line up financing for the construction
- Put the artistic renderings of your XYZ apartments in the papers
- Sell 80% of the apartments before construction
- Bank your profits

Real estate can be a lucrative but risky investment jungle and if the by-passes and super highways as envisioned by Kenyans are ever built, there's no reason why one can't live in Machakos, Thika, Naivasha and be a quick sub-hour commute from the office to home.

29 comments:

Maishinski said...

Hey thanks Banks for putting up a separate thread on this interesting subject.

Knowledge shared = knowledge gained... So dear Kenyans, here's my opinion:

THE CASE AGAINST MORTGAGES:
This might come as a shocker to many but taking a mortgage to buy a home is one of the WORST investment decisions a YOUNG PERSON (under 45) can make:

1. A home is not a "wealth creating asset" - it is a "Security Asset" that makes you feel psychologically and emotionally safe while silently LOCKING UP your valuable capital.

2. You pay between 30%-100% markup to the developer.

3. Your total mortgage repayments are at least THREE times the loan amount. A loan of 2M over 20 years = at least 6M. You become a SLAVE - working for the bank.

4. Your mortgage commitments lock you in to your employer and you fear taking risks (e.g. taking a better paying job with a risky employer).

5. Initial years are mainly spent paying interest hence your home Equity "released" after say 5 YEARS will be negligible.

6. Government penalizes you heavily: Hefty Stamp duty; limited tax relief on mortgage interest (tax relief not applicable to diaspora)..etc

7. Transction and legal costs in the range of 10% of property value if taking a mortgage. 10% of 5m=0.5M all paid UPFRONT!!!

8. Your stress levels shoot up whenever you get into financial difficulty after taking a mortgage (fear of losing the house). This can affect your confidence and assertiveness at work - starting a vicious cycle that could lead to your retrenchment.

9. By locking your capital in the mortgage, you miss out on investment opportunities at the PRIME of your life - when you can afford to take risks and recover from failure. You end up having nothing except the house (which really belongs to the Bank).

10. You have little/no additional funds to invest in improving yourself leading to a stunted career. Your net-worth gets frozen.

11. Property values DO NOT always appreciate. If something bad happens (God forbid) and you lose your job after 5 years, the bank will quickly foreclose to recover their loan - you lose the only serious "asset" you though you had.

12. and if, in addition to point 11above, the value of real estate in that neighborhood DEPRECIATED (e.g. someone built a getto right next to your house) the bank will get a court judgement and pursue everything else that you have (you lose everything).

So now I ask you, why would anyone who wants to increase their financial wealth even think of buying a home???

POSSIBLE ALTERNATIVE:
When you are young, you are better off investing in WEALTH CREATING Assets e.g.:

1. Your Brain & Unique/Special Skills: Consider getting an Msc/MBA - can be much cheaper if you study distance/online; or a diploma program leading to honours degree if not already a graduate.

Have general knowledge in your field - but learn to do at least one thing EXTREMELY WELL and brand yourself accordingly. i.e. have a focus/differentiation strategy for the "company/product" called YOU.

Specialization boosts your career prospects both locally and internationally , increases your net income and job options (reducing stress and increasing health).

Sadly Kenyan education system at all levels is DESIGNED to churn academic generalists who lack sufficient depth to create their own niches - leading to high numbers of unemployed graduates, lack of innovation, substandard "research", poor application of knowledge.. etc.

2. A part- time business (turn your favourite hobby into a money making venture).

3. Look for ways of generating passive income (make your money work for you). E.g. by getting advertising revenue from your blog, selling advert space on your car to large corporations or getting royalties from intellectual property (e.g. music, ideas, formulas, softwae algorithms etc). Look for oportunities - be creative!

4. Buy Stocks in 1 or 3 fundamentally strong companies with excellent future prospects and whose business you understand well and believe in - picked accoding to your risk appetite.

TURBO-CHARGE:
Consider use leverage (loans) to maximize potential returns - but be smart about it - losses are also magnified when you leverage.

Finally, use the power of COMPOUNDING... reinvest your gains wisely to further maximize returns.

As you grow older (40+), you can start channeling some of your profits to security assets like bonds and family home (which means you might be able to buy your dream home in cash!)

Together, we can make 2030 happen by 2020... Spread the knowledge!

:-)

x-loan said...

This is a very cool loan blog.Keep it up my friends!

http://x-loan.blogspot.com
http://refinancial.blogspot.com

Mushenzi said...

Great piece Maishinski. Thanks

Anonymous said...

Great article, and follow-up comments maishinski, thanks to all for raising the bar in the blogsphere. One of the reasons I like this blog!!!

propaganda said...

Investing is fine. And we all get how long mortgages are crap. But so is paying rent in your late 30s.

I'm ready to buy, develop and defend my own piece of earth as an alternative to a house in the city. But everything seems overpriced or located in ridiculous places like the road from Thika to Garissa or out in Kitengela.

Maishinski said...
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Maishinski said...
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Maishinski said...

Thanks for the heads up guys.

Rental property is a Wealth Creating Asset. If you can get an area where tenants are likely to pay a significant chunk of your mortgage for you (as rent) then it would make sense to take a motgage.

Example would be a beach front villa (like Diani?) which you can rent to tourists.

Like Propaganda says, the problem is such properties are so darn expensive it no longer makes business sense to buy!

Mashatall said...

Maishinski,
Read your post and felt that compelled to respond to a few of your points.
1.The equity you build in a home is reflected in two ways, the repayments you make monthly and the market value of your property(capitalgrowth). So a home bought today at 5M might be worth 8M in five years time, and although you might have only paid 1.5M to purchase it, you can actually put it back on the market and walk away with over 5M. Now thats a tidy profit!
2.When you pay rent you never get any money back and there is no tax relief, at least with a mortgage you do get tax relief upto 150,000 on interest paid every year.
3. If you invest in the so called wealth creating strategies you cite, by the time you cash out your money to purchase your home in cash, the house will be more expensive that if you had bought it years earlier. Try buying a house in South C that was just going for 4M five years back now, it will probably cost you about 8M.
4. never purchase big ticket items like a house for cash, you only end up locking a lot of equity which you could have deployed in other investments that would enable you pay the mortgage easily.
5.Using leverage when investing ensures you have free float to invest in other assets, and if they can generate income and give you good cash flow even better.
My advise to anyone serious about buying a property is, take up a mortgage and maintain an emergency saving of like six months in case you lose your job, time enough to think of an exit strategy for your property. Also do not be fooled into paying rent for the rest of your life, that money will never come back to you and you will only be making someone else wealthier!

Anonymous said...

Hey banks,

Are you following the mini meltdown at the wall street? Lehman brothers just filled for bankruptcy after Barclays walked away from the deal and analyst are saying we have not seen anything yet. Greenspan says things are not looking good.I wonder if there will be fallout in Kenya banking and stock market in the future.

bankelele said...

Maishinski: very interesting perspective, but I feel I must I disagree with you on that, and that it’s better to own than to rent a house in perpetuity.

Propaganda: I too am on the look out for real estate to buy, but it’s a crap shoot I say with the high mortgages – maybe Equity can sort out Housing Finance and make it more affordable for the middle class?.....maybe….

Mashatall: I agree that real estate is a buy opportunity. Hover Nairobi is becoming a crap-shot with the haphazard approval of building plans, expensive mortgage, increasing traffic jams, and risk that an investment may not be around for 20 years. I’d be comfortable going into commercial real estate, but residential is unbearably risky despite the profits

Maishinski said...

@ Mashatall,

You have raised some good points. But are they valid?

My guess is that you're looking at it from a property speculator's viewpoint (i.e. someone engaged in property flipping - a very risky activity that is under the wealth generating category).

This is different from a typical homebuyer’s perspective (someone who wants to stop paying rent - i.e. intends to live in the house).

Still, your argument is based on several fallacies (irrespective of perspective), which I shall expound below. My points are backed by numeric examples based on typical real-life scenarios:

MYTH #1: GUARANTEED CAPITAL INCREASE
Remember:
1. More than 80% goes towards INTEREST during the initial year of mortgage.

2. There's no guarantee your house will increase in value.
3. Interest payments normally knock off any increase in value.

Now here's something many people don't understand...

FACT: TIME VALUE OF MONEY:
Did you know that 100K right now can have the same purchasing power as 1M in 20 years?
Given the choice of investing 100K now or waiting for 1M in 20 years, what would you choose? Sometimes, the perceived increase in property value is due to inflation - in the end you get more "bills" with the same purchasing power. Net result, ZERO!

MYTH #2: RENT IS A WASTE OF MONEY
Actually, renting releases your equity - enabling you to invest now so you won't have to pay rent tomorrow.

Again - time value of money. The rent you are paying now is the CHEAPEST you will ever pay for that particular property. In ten years it will cost you much more to maintain the same standard of living.

MYTH #3: REGARDING MORTGAGE TAX RELIEF
1. Not applicable to Diaspora
2. Bullcrap benefit as it's too little to be of practical value.

Take for example a mortgage for a flat worth 3.85M (loan=3.5M): Monthly repayment 46,087.64; term 20yrs; interest 15%pa; deposit 10%(eaten up by upfront bank fees).

INTEREST IN FIRST 7st YEARS IS GREATER THAN 40,000.00 (check with any amortization calculator)!

On the 8th YEAR you still owe the bank 3,149,429.14 and you have paid interest worth 3,566,878.15! Now any smart dude would have his jaws on the floor right now!

POSSIBLE ALTERNATE SCENARIO
If you had kept your 350,000 in a fixed deposit account for 8 years; 4.5% interest per annum compounding, and topped up with a standing order of 45,000.00 (the amount you would have used for mortgage), you would have 5,689,703.48!

5.6M! ...and that’s just by leaving your money to rot in the bank (i.e. amongst the lowest returns possible - but safer than shares or starting a business).

Now, if you made additional wise investments (with a small amount of risk money) the likelihood that you can buy your house in cash AFTER EIGHT YEARS ONLY increases significantly.

MYTH #4: WRONG TO BUY REAL ESTATE FOR CASH
Actually that's the best decision you can ever make - provided the valuation is fair. Remember time value of money? all other things being equal, the price of the house will be the CHEAPEST ever at that point in time. This insulates you to some extent against deflated property markets.

MYTH #5: USING A MORTGAGE TO BUY A HOME IS INVESTING
This is a big lie - perpetrated by property developers and mortgage banks. Read my earlier post.

MYTH #6: A SIX-MONTH STASH WILL PROTECT YOU
Six month salary in emergency savings is good - but once the bank gets wind of your potential inability to pay your mortgage the FIRST thing they will consider is to FREEZE all your liquid assets (including your precious 6 month stash).

Now, picture this, you don’t have a job and your EMERGENCY stash is frozen. Kids crying at home - no food... Wifey is in hospital... What to do?

CONCLUSION
Paying rent can be the smartest thing you do - provided you LIVE WITHIN YOUR MEANS. Just be humble and keep rent below 25% of your NET income as a rule. Then you'll be the one with the last laugh.

DISCLAIMER: All my Internet posts are my own personal opinion; in addition, they should not be misconstrued as advice. Few people have the discipline or analytical skills required for long-term investment. Consult widely and make your own decisions according to your risk appetite.

Maishinski said...
This comment has been removed by the author.
Maishinski said...

Speaking of Intellectual property:

;-)

NOTICE TO ALL:
I reserve all rights - including copyright to all my online articles (past and present) under all applicable laws. Anyone who wants to re-publish verbatim can contact me.

Reasonable Quotes (not exceeding 10% of a post) are ok provided credit and source URL is given.

propaganda said...

@ Maish: Rent of the Sh3.85m flat today is Sh20,000 to 23,000. Assuming no increases over the eight years, that's Sh2 million burned. With increases, renting for 8 years will eat up even more.

Add Sh1.2 million in mortgage relief (150,000 by 8) and I will have paid at least Sh3.2 million of the Sh3,566,878.15 you have calculated from money I would have spent anyway on rent and taxes.

If in Year 8 i have only spent Sh200,000 in disposable income, I'd say owing 3,149,429.14 (which has less value due to inflation and is less that I can sell the apartment for) works for me.

Maishinski said...

Hmm... Interesting viewpoint.

Ok, consider this.

If you take the mortgage, and live in the house, you pay approx 30k monthly interest after tax relief for 8 years.

Remember you have to maintain your property to retain/enhance its value. But lets ignore maintenance costs to keep things simple.

Now 30k over 8years = 2.88Million down the drain. What better proof do you need that Renting is cheaper?

Next point:
Suppose you live within your means and 23,000 rent is 25% of your NET income.

This means you have a net salary of 92,000. If you take a mortgage based on our example, your cash in hand will be 46,000 per month.

Suppose you are then invited to sign up for an Ma/Msc/MBA loan of 800,000 repayable over 2 years at 13.5% interest. Well Guess what - you wont be able to afford it (requires 40k per month).

With a 92K NET salary you would probably be a young aspiring manager / specialist with untapped potential. Not getting that Msc/MBA/MA can lock you out of a 150k (NET) salo.

That's the cost of missed Opportunity.

If you were paying rent, you could defer savings (balance in bank still earns interest) and invest in yourself (40k for Msc/MBA/MA etc) and still have 29,000 cash in hand for day to day + emergency.

In 2-3 years time your disposable income can double as you go up the career ladder - giving you the chance to save the 45k monthly and still have "risk money" for business, stock market and investment.

Just the fact that you owe no one anything will be a major boost your confidence in life and improve your overall health.

I call it "Perspective Z" - the often ignored perspective of future lost opportunities.

pesa tu said...

@bankelele: Thank you ,its great to be back
@everyone: Let me give another perspective.whether to invest or take a mortgage depends on your intellect, abilities,networks and how well u understand the world.

Suppossing you bought land somewhere within the Nairobi City limits for Ksh 3- 5 million thru a normal loan.
Then live in a hse whose rent is less than 25% of your net income.I can bet with a 90% probability that the land value will double in 3 years and yopu can sell all or part of it still service a loan and own a house free and clear(if u aren't choosy about the area).
A mortgage is good if u r assured of secure employtment 7 years and above.The danger is that the hse and your old car are your only assets when u retire.U have to sell thge hse if ur kids have to to go to an expensive postgrad course.This is the life of most of Kenya's formerly high flying managers.They have assets but cant generate cashflow.

pesa tu said...

If i bought a flat in South C for Ksh 4 to 4.5 million what are the odds that in 3 to 5 years it will be valued at Ksh 8 million?

Maishinski said...

Pesa tu,

Exactly! Nothing but a big gamble...

Anyway, regarding your perspective - Couldn't agree more.

We can learn from the old-timers mistakes - or we can snooker ourselves just like they did.

Cashflow vs Profits? Bamm! cashflow wins, hands down all the time. Ask your banker.

Mashatall said...

Maishinki/Pesatu,
I respect your views and do realize that we all have different ways of investing, one thing you always need in your portfolio is to recognize passive investments(real estate falls here), and active investing which is what Shinski is basically advocating. You have to balance your portfolio with both styles of investing, and BTW both styles have their inherent risks and speculative tendencies. But i still hold fast and say a mortgage is a better deal any day, than renting so that you can have access to cashflow.

Maishinski said...

Objective of investing is to Increase wealth. A dollar today is worth more than two dollars "tomorrow". Thats the very principle on which Mortgage Banks lend to you!

Ever wondered why banks don't buy and hold the property - then declare profits or sell when value appreciates? After all they have the funds - and can afford to wait 30 years for maximum profits...

Keep in mind that seasoned bankers are highly trained in Finance - surely they can spot a good deal?

Solution to the puzzle: They know the value of "a dollar today" compared to two dollars tomorrow...

A home mortgage has never been, and will never be, an investment. Period.

Why rush to throw your money down the drain? I just don't get it...

Remember: While it is good to learn from your own mistakes, it is even better to learn from other people's mistakes.

:-(

propaganda said...

So the Sh3.1 million I will owe the bank 8 years from now is actually worth less... say Sh1.5 million today? And that is after I have paid them Sh3.2 million I cannot invest anyway because it must go to rent and taxes? Man, this mortgage is looking better and better :-)

Anonymous said...

Actually Propaganda, its the other way round...

Seems you're set on a motgage though. Good luck!

Anonymous said...

Propaganda, remember, after 8 years you still owe the bank more than 3M.

The guy who paid rent owes nothing - and has cash in hand to buy a brand new house.

It's a no brainer really...

Anonymous said...
This comment has been removed by a blog administrator.
Anonymous said...

You're right. It is a no-brainer.

Both the guy who has paid rent and Propaganda spend the same amount in the eight years. But Propaganda can then buy the flat for Sh3m, while the renter would have to pay a higher market rate.

Real Estate Guru said...

I really appreciate this post, thank you for sharing. Some very interesting points to think about it.

MattGarciaSeminars

donald said...

I recently came across your blog and have been reading along. I thought I would leave my first comment. I don't know what to say except that I have enjoyed reading. Nice blog. I will keep visiting this blog very often.

Betty


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Anonymous said...

My take on this is that investment in real estate or other investments would amount to the same thing. The only difference would be if one is a risk taker (which promises high returns) or risk averse. It also greatly depends on the job that one holds. A person with a stable income guaranteed over a long period of time and with limited investment knowledge would rather stick with the mortgage instead of burning up money in pyramid schemes.

Overall investing in business has Huge returns but it is a very risky and technical process that requires experts to succeed.

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