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How Do People Make Money From Real Estate

Updated 19 Oct 2018 – By Loanstreet


There is a lot of talk on property investments and how it can bring financial freedom. While we understand that it involves a lot of hard work, research and maybe some luck, it is imperative to know that monetizing from real estate is not a sure fire thing. Today, we look at some basic ways on how people make money from real estate.

Flipping

What is it?

Flipping of real estate properties refers to the purchase and quick resale of a property to earn a profit.

How Does It Work?

The common rule to flipping is to “buy low and sell high”. Often, investors agree to purchase future developments from developers at a certain price. These properties are expected to appreciate in value as the construction occurs and as the property approaches completion. When the investor finds a buyer who’s willing to pay the right price for his property, he will sell the property for a profit.

Stuff To Look Out For

That is the gist of the process. However, there is in fact, much more to flipping than just that. The investor must be able to bear the entry costs (mortgage loans, legal fees, stamp duty etc.) and possible holding costs (quit rent, assessment tax etc.) to buying properties.  Additionally, if the investor sells his property in less than 5 years, his earnings will be taxed (RPGT).

As such, the investor must be insightful enough to choose a property, whose projected value would exceed the costs of buying and holding the property.

Note that completed properties can also be flipped for profit. This is often done by purchasing undervalued and/or rundown properties, renovating them to raise their value and then selling them for a profit.

Rental Yield

What is it?

Renting is the temporary loan of a property or good to a tenant in exchange for regular payments to the owner. 

How Does It Work?

In the real estate business, investors often purchase properties in key areas and rent them out in order to gain regular and passive income in the form of rental fees from tenants.

A common example is houses that are made into dorms for students in areas around universities and colleges. Once the lease is signed, rooms are rented out to students in return for monthly rental fees.

Stuff To Look Out For

Naturally, owners will have to bear several costs, especially if they’re buying new properties. For new properties, owners will have to pay entry costs in addition to holding costs. Holding costs include renovation costs, insurance costs and taxes. Since the owners aren’t selling the properties (within 5 years of the purchase), they aren’t required to pay RPGT. However, their rental income will be taxed via income tax, assessment tax and quit rent.

Rentals are meant for long-term gain. It is estimated that it takes approximately 5 to 7 years to reap a stable and “healthy” return from rentals. That said, renting is a good way to gain from holding properties that still haven’t gained much value (for sale).

Cash Out Refinancing

What is it?

Cash out refinancing or re-mortgaging refers to the restructuring of a loan to a new loan with new features (including new maturity dates, interest rates or monthly payments).  Before reading ahead, take some time to learn about what exactly does refinancing mean in the property market.

How Does It Work?

Investors make use of Cash Out Refinancing to earn a passive income through rentals and/or expand their property portfolio. The following example illustrates how this is done AFTER the 10 year limit on Cash Out Refinancing was implemented:

Investor A buys a property worth RM 500K using a mortgage loan worth RM 450K (90% LTV ratio) from Bank X. After 5 years, the outstanding loan amount is RM 407K. The loan is summarized below:

Initial Loan Amount = RM 450K

Outstanding Loan after 5 years = RM 407K

Tenure = 30 years

Interest Rates p.a. = 4.0%

Monthly Instalments = RM 2,148.37

At that point (5 years into the loan), the property appreciated in value to RM 750K. Investor A then chooses to refinance his loan through Bank Y (assume that the new loan has the same tenure and interest rate per annum).  Hence, Bank Y will now pay off Investor A’s outstanding loan in Bank X with the following conditions:

Outstanding Balance to cover = RM 407K

Tenure = 30 years

Interest Rates p.a. = 4.0%

Monthly Instalment = RM 3,222.55

Cash Out Amount = [90% x 750K] – RM 407K = RM 268K

Tenure = 10 Years

Monthly Instalment = RM 1,279.47

Total Refinance Amount = [90% x 750K] = RM 675K

Total Monthly Repayment = RM (3,222.55 + 1,279.47) = RM 4,502.02

This means that by simply “holding” the property, Investor A’s property portfolio has appreciated by RM 250K. And because he has paid off RM 43K off the initial RM 450K loan, he is entitled to “cash out” that amount in addition to a percentage of the appreciated value. Meaning his total cash out value is as follows:

Total Cash Out Value = (LTV ratio x appreciation value) + (Initial Loan Amount – Outstanding Loan after Z Years)

The investor would typically rent out his property in order to cover the monthly instalments and breakeven till he’s able to sell the property for a profit.

Meanwhile, the property will continue to appreciate in value. As such, if at any point he wishes to end his mortgage payments, he could sell the property to pay off the mortgage and still leave with a profit.

Additionally, if the investor does not have any immediate need for the cash collected, he may re-invest it by buying another property, which would add value to his property portfolio. Moreover, the loan can be refinanced for cash even after the loan has been paid off.

Stuff To Look Out For

Refinancing your property can lead to an increase of instalments and a longer tenure. Be sure to weigh the purpose of refinancing your current property and if you have a solid strategy to sustain your finances in the long run.

Note: Make use of our Home Loan Calculator to calculate the additional costs to purchasing a new property.

Conclusion

These are only three methods of monetizing your real estate property. Seasoned and more matured property investors play by a different ball game altogether. Investing in property can be very lucrative but take caution in making rash decisions based on uneducated whims. With wise financial planning, research, self-education, experience and maybe a little luck, you might find yourself on top of the curve for all that effort.

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