Estimating your future net worth

Recently, I’ve been thinking a lot about my net worth in next 10 or 20 years. But sorry, I’m not going to share my net worth with you. What I’m going to share here is the way you can estimate your net worth. Most of my net worth is kept as investment in properties. For simplicity in estimating my net worth, I’ll ignore other (much) smaller investments such as fixed deposit, EPF and investment linked insurance.

I’m NOT going to build a complex financial model here to impress you. What I’m going to share here is a simplified method to estimate your future net worth; especially if you are property investor like me. Before you can start estimating your future net worth, you need to understand a basic principle call time value of money. Value of your money (or net worth) will grow if you invest in right instrument. The rate your money grows is appreciation or returns. On the other hand, value of your money will depreciate in future due to inflation.

There are 2 rules of thumb that you can use in estimating your net worth if most of your money is kept in properties like me.

1.       Property value will DOUBLE every ten years  (assume  appreciation of 8% / annum)

2.       Value to money will be HALF in 20 years  (assume inflation of 3.5% / annum)

To understand underlying principle for rule #1 above, you need to understand how long does it take for your property to double its value? – Based on my experience and research, most of the times; property value will double in 7 years to 12 years. I did a simple excel simulation to validate this. From table below, you can see property value double in 16 years if the appreciation rate is 5% / annum. If the appreciate rate is 12% / annum, property value will double in 7 years. For simplicity and fairness, I like this rule of thumb à property value should double every 10 years – provided you bought properties at correct location, location, location. I personally feel this rule of thumb is a fair rule of thumb although we can see many properties double in value in less than 5 years due property boom in last few years. For property value to double in 10 years, you need to find properties with appreciate rate of about 8% / annum which is always possible as long as you invest in right property type and right location.



To validate rule #2, I simulate how value of money depreciate with inflation. From table below, you can see value of money will be half in 35 years in the inflation rate is 2.0%. On the other extreme, value of money will be half in just 14 years if the inflation rate is 5.0%. Base on releases from Bank Negara (BNM), inflation rate in Malaysia is hovering between 2% to 3%. However, this figure is always debatable, especially if you are living in Klang Valley. For simplicity let assume inflation rate of 3.5%, your value of money will be half in 20 years. 

With these rules of thumb, you can easily estimate your future net worth.

Case 1: If total value of your property is RM 1mil currently (and assuming your rental can cover bank installment for balance of 20 years mortgage)

Property value in 20 years = RM 4mil, Value in today’s currency = RM 4mil x 50% = RM 2.0 mil

Case 2: If total value of your property is RM 2.5mil currently (and assuming your rental can cover bank installment for balance of 20 years mortgage)

Property value in 20 years = RM 10mil, Value in today’s currency = RM 10mil x 50% = RM 5.0 mil

Case 3: If you purchase a shoplot in PJ for RM2.5 mil with down payment of 30%, your down payment is RM750k. With rental yield of 6%, your rental should be able to cover your monthly installment for 20 years. So your RM750k will become RM10 mil in 20 years (today value of RM 5mil). This is the beauty of property investment – you will grow rich slowly but surely.

Are developers really making too much?

Food for thought
By DATUK ALAN TONG

http://biz.thestar.com.my/news/story.asp?file=/2012/8/11/business/11821521&sec=business

LATELY, there have been many ongoing discussions on the topic of high property prices. It made me ponder on the various causes that might have contributed to the situation, including the question of whether developers are making too much.

As I took a sip of tea, many thoughts came to mind which I found interesting and worth sharing before we dwell further into the real factors of rising property prices.

Based on annual reports (see chart) of three major property developers in Malaysia, namely SP Setia, UEM Land Holdings and Mah Sing Group, they are generating an average of 18% profit margin from their projects, and at the same time incurring a staff cost of about 7% of their total revenue.

These companies are major developers in mass residential properties which have high sales turnover, and therefore a good reflection of the average developers' profit margin in the residential market.

These findings may contrast with people's perception of the profitability of the property development industry.

Though it may sound like a fantasy, assuming I could convince these three property developers to give back their entire profit to their customers, it would mean an average of 18% discount on property prices for the year in question.

This would seem like a fantastic bonanza for the buyers of the properties in question. But would a 18% discount really make these properties affordable? I would imagine that people will still find these properties expensive.

Let's take an example of a terrace house that costs RM700,000 in Petaling Jaya. It would be priced at RM574,000 after the 18% discount.

If a home buyer is able to secure a 90% loan with a maximum repayment period of 30 years, the monthly loan instalment for RM700,000 and RM574,000 would be RM3,081 and RM2,526 respectively (based on a BLR-2.4% loan package with current BLR at 6.6% per annum).

From the above example, while the discount may seem substantial at absolute price, it is not significant in terms of monthly loan instalment for home buyers.

The debt commitment level for the latter is still considered high and out of reach for most people especially those who have just started their career.

Now, let's take a hypothetical scenario that the property developers decide to make their staff work for free that year.

It would mean another 7% discount to customers after deducting staff cost. Even with this total discount of 25%, property prices in many areas would still be considered unaffordable to many.

Anyhow, back to reality, it is impossible for any commercial enterprise to work for free or give up its profit if it was to run a sustainable business, as well as to satisfy its shareholders' expectations.

For the property development industry which has a product life cycle of four to six years (starting from land acquisition to handover of keys to customers), it is a challenge to further compress the profit margin after taking into account the risk and inflationary factors involved in such a long product life cycle.

Let us look at other industries as a comparison and review their profit margins.

For the banking industry, the three largest local banks that were selected are Maybank, CIMB and Public Bank. Likewise, the three major players from the mobile telecommunication services were Axiata, Maxis and Digi.

The results showed that the average profit margin for the banking industry is 35%, while the mobile telecommunication industry is enjoying an average profit margin of 26%. So, back to my question “are developers in Malaysia really making too much?”

Compared with the average profit margin of the banking and telecommunication industries, the profit margins of property development companies are significantly lower and definitely not on par in terms of the actual profit before tax figures.

Putting aside the profit margin for property development which is already relatively low compared with the other two industries, what are the other factors that are causing high property prices?

Many other underlying factors could be looked into in relation to the escalating property prices, instead of merely contemplating the issue as a market trend or as a result of developers' profits.

The Government, property developers, home buyers, as well as NGOs (non-government organisations) will need to work together to identify the root causes of inadequate supply of affordable homes in Malaysia.

Let's ponder this issue over the next few weeks and I welcome any suggestions and feedback to shed some light on it as I dwell further into this crucial topic in my next article.

FIABCI Asia-Pacific chairman Datuk Alan Tong has over 50 years of experience in property development. He is also the group chairman of Bukit Kiara Properties. For feedback, please email feedback@fiabci-asiapacific.com

Is Your Home an Investment?

Many treat his or her home as an investment while others not. If my memory serves me right, Robert Kiyosaki not only didn’t treat his home as an investment; in fact treat his home as a liability. For him, investments suppose to generate income for owner but owning a home incurs expenses to the owner.

From my perspective, whether a home is not an investment is really up to you.

Are you likely to move out in the future?

If your answer is NO, your home is definitely not an investment because it don’t generate income for you nor your can reap profit from selling it in the future when price increased.

If your answer is YES, you may reap profit from selling your home at higher price in future. But where are you going to live? Prices tend to rise across the entire market. So if you sell your current home and getting another new home, you are merely rich for a while before dumping profit from your old home to new home. In this case you can’t really enjoy profit from your first home. Hence, we shouldn’t treat your home as an investment. UNLESS you willing to go significantly downscale for your next home, move to a less desirable neighborhood or move out further away from city centre; those are the only way you can enjoy fruits of your home price appreciation.

Do you really make profit from your home when you move out?

Without most of us realizing, it cost more to buy, renovate and maintain a home than you think. Biggest home ownership costs are renovation and bank interest. Hence, it is important not to buy a home that is too big for your need or overly renovate and furnishing it. The profit that you make selling your home may just sufficient to cover your interest, renovation and furnishing cost. In fact, I personally have a friend that stretch his budget to buy a home in upscale neighborhood, over spent to renovate and furnish his home under the name of convenient, investment and “enjoy life”. In our previous gathering, he lamented cash flow problem he encountered in serving bank loan (for car and home) as well as credit card debt for his renovation and furnishing. He is obviously regretted; this is a good lesson not to over spend in home ownership. 

Besides straining your cash flow, you almost certainly lost some investment opportunity (i.e. opportunity cost) along the way while you were spending your money buying the home.

No matter what, I would like to stress that buying a home is still better than renting home. For me, it’s even better if you can spend less on current home and invest in few investment properties (i.e. rental properties) that able to generate positive cash flow to fund your dream home; of course not immediately, but say 10 years down the road. I personally prefer to treat my current home as a saving instrument rather than investment instrument. 10 years down the road, I’ll sell my current home (and probably 1 or 2 investment properties) to fulfill down payment of my dream home in upscale neighborhood. Monthly installment of my dream home will then by funded by positive cash flow from remaining investment properties.

What Robert Kiyosaki didn’t tell you

Money & You by Yap Ming Hui | August 4, 2012

http://biz.thestar.com.my/news/story.asp?file=/2012/8/4/business/11785165&sec=business

A FEW months ago, I was having breakfast with a friend when he told me about the seminar he was going to attend in May to hear Robert Kiyosaki speak.

In the past year, he had read all the author's books and had already taken out two maximum loans to buy properties to rent out. I was curious to know more. We barely finished drinking our coffee when he insisted he had to leave. He was going to the bank to apply for another loan to invest in more properties. There was little I could say or do to stop him from leaving.

As the day progressed, I could not shake off an uneasy feeling that something was not right. I worried that my friend might be setting himself up for financial ruin. As I edited the opening pages of my new book, I recalled my introduction to Kiyosaki's work and understanding of his principles.

More than 10 years ago, at about the same time when I made the decision to pursue a career as an independent financial advisor, Kiyosaki published his seminal work, Rich Dad, Poor Dad. In it, Kiyosaki challenged the preconceived notions the middle class had about their inability to achieve financial freedom.

In highlighting the need for financial literacy, the advantages of becoming a business owner and investor, and overcoming obstacles with a positive attitude, he underlined two fundamental concepts of financial freedom: a “can-do” attitude and fearless entrepreneurship. I have no doubt that Rich Dad, Poor Dad had a positive impact on millions of people all over the world. Indeed, reading it certainly inspired me to work towards becoming rich and doing this fast.

However, as time passed, I observed that many Malaysians who adopted Kiyosaki's approach became trapped in the “rat race” with no way out. This outcome was the exact opposite of what Kiyosaki envisaged in Rich Dad, Poor Dad. I wondered why this was so and decided to read Kiyosaki's books again.

It was clear that Kiyosaki's other books built on Rich Dad, Poor Dad and helped to crystallise some important theories about personal finance. For instance, you should not spend more money than you earn. It is important to invest in assets rather than liabilities to build a passive income from your investments. This is how to make your money work for you so that you become rich and wealthy.

Nevertheless, with the benefit of experience and knowledge as an independent financial advisor, it was not long before I became uncomfortable with what Kiyosaki was saying. In the book he co-authored with Donald Trump, Why We Want You to Be Rich: Two Men, One Message, he made statements which implied that the only way out of the “rat race” for the middle class was to become rich.

Also, all the suggestions Kiyosaki made were about “what to do”; he never gave concrete advice on “how to do it.” For example, you must take on “good debt” to become wealthy. This meant taking on more risk by acquiring loans to invest in properties. However, he didn't show you how to manage this risk or the investments you made.

I feel that the approach Kiyosaki advocated is muddled and has the potential to be both dangerous and misleading. The closest analogy I can give to illustrate my point is this: you're put in a Formula 1 race car and told not to be scared as there's nothing to stop you from driving at the same speed as other Formula 1 drivers. Only, you have never learned the special skills needed to control a race car.

The fact of the matter is that taking on more risks does not guarantee financial success. Fraught with uncertainties, it might get you rich quick, but it can also ruin you. For instance, I know a 45-year-old bank manager who, inspired by Kiyosaki's work, quit his well-paying job to start a business.

Two years later, his business is heading nowhere, he is on the verge of eviction, his wife has taken the children to live with her parents and the hire-purchase company repossessed his car.

Then, like my friend with whom I had breakfast, many have taken out maximum loans with a view to getting rental income and capital gain. However, they cannot find tenants or buyers and struggle to make the instalment payments to the bank.

To be fair, let me state that I am in favour of what Kiyosaki proposes; in fact, we share a common purpose: both of us want to help people to get out of the “rat race.” However, I feel that, on the whole, Rich Dad, Poor Dad and other books by Kiyosaki are no more than successful tools to motivate people to think about how to manage their personal finances. It is unwise for Malaysians to use Kiyosaki's work as the only guide to acquiring wealth. In other words, getting rich is not the only way to get out of the “rat race.”

I am confident enough to say this because I have discovered a more plausible and less risky solution to becoming wealthy. Instead of jumping straight into taking on more risks and acquiring debt, take a metaphorical step back and start by optimising your existing financial resources.

The aim of doing this is to help you work towards becoming financially free. The by-product of this exercise is that you will acquire knowledge and experience about how to manage financial risks and investments. When you have become financially free, your position is secure.

Only at this point is it wise to start applying Kiyosaki's concepts and ideas to increase your financial risks and acquire more wealth.

When you adopt this approach, rest assured you will enjoy peace of mind and have the ability to focus wholeheartedly on creating more wealth regardless of the outcome. This is because you will know that you are financially secure. By far, this is a more certain, safer and better approach to becoming wealthy.