Say you buy a 2 million, double storey commercial property, also valued at 2 mil fair market value at the time of purchase.
You take 80% LTV (Loan to Value), means your loan is 1.6 million.
Let’s say your loan stretched over 20 years, at 4.50% interest rate.
That makes your monthly repayments circa 10k.
You rent out 6.5k/month for the Ground Floor of the commercial property, and another 3.5k/month for the Upper Floor of the same unit, totalling 10k/month or 120k/year
Most people think, my gross rental yield is only:
👉 120k / 2 mil = 6.0%
And net rental yield* is zero because your monthly mortgage repayment break-even with your monthly rental received.
…in which they dismissed as a ‘so-so only’ investment.
(*since this is a commercial property, tenants bear most, if not all of the property related expenses like repairs, maintenance and it is signed on triple net lease. Residential property landlords don’t enjoy such ‘perks’ )
But hold on a second…
Wealthy + advanced property investors think differently which average property investors don’t.
It boils down to these 2 things.
#1: You Get Capital gain
You said ”Thank you, CF, Captain Obvious!”
Bear with me for a while.
Let’s compute this fast:
Commercial property usually has steady value appreciation. 5% annual is the norm.
5% of 2 mil = 100k
#2: You Get Equity gain
Most people forget or not aware about equity gain
Equity = ownership of an asset.
As your tenant pays your loan monthly installment, your equity stake in the commercial property increases proportionally. The equity gain becomes obvious after a period of time.
Example, you take 80% loan, banks own 80% of the commercial property under your name.
Now, as you par down the loan (repayments made by your tenants), your equity increases, bank’s decreases, capisce?
Let me illustrate.
Your loan start with 1.6 mil outstanding, but by the end of 1st year, your loan outstanding principal amount drops to 1.549 mil (red circle below).
Your equity (ownership of the commercial property) increases by 51k.
👉👉👉 (#1 capital gain) + (#2 equity gain) = 151k
These are the values you have yet to unlock.
But remember, your initial capital (sans the admistrative fees) is only 400k.
As a comparison, with 400k, you put in banks, how much you get?
4% OTC fixed deposit rate (assuming you are private banking customer)…that turns out to be 16k/year.
But with the commercial property, you get 151k/year, with the same 400k capital.
👉 that’s 37.8% ROI in the first year.
In the second year, your outstanding principal portion of the loan drops from 1.549 to 1.496 mil (green circle below).
Your equity increases by another 53k.
And your commercial property, from 2.1 mil, increases value by 5%, or 105k, to 2.2 mil
So, capital gain + equity gain in the 2nd year:
👉 105k + 53k = 158k
Total accumulated ROI yet to be unlocked in the first 2 years:
👉👉 151k + 158k = 309k
…in just 2 short years, only using only an initial capital of 400k.
Mind you, we have not factor in the hike in rental, which started off at break-even level with mortgage repayments,
…but it will soon be cash flow positive from 2nd year onwards…to infinity and beyond.
You may refute the above and said – ‘But these are all unrealized gains!’
Yes, you are exactly RIGHT.
Because I told my high level property investor client the VERY SAME thing!
Then he humbly told me:
“CF, I am no smarter than you. But it’s a matter of mindset and perspective. I condition my mind differently. Most people see they gain 100k in value and they’re too excited to sell it. They sell too early. I don’t sell unless I need the money. And that’s what made me successful all these years.”
That is also the reason why high end residential property (like 1 mil and above) is so hard to sell in the market.
Most people who desire it can’t afford it or qualify for the loan.
But the people who CAN afford it are either shifting their game into high grade commercial property instead OR…
…they wait until the high end residential property prices are severely depressed due to the market condition or special circumstances (desperate sellers like couple heading for divorce wanting to sell their house) before they even consider buying them.
Just like a crouching tiger waiting to pounce on its prey
And when they do, you can be certain that these high level property investors reap another form of return – Upfront Below-Market-Value return.
The other irrefutable facts
Commercial property is for business purposes.
The rental and price increase in tandem with the profitability of the corresponding business activities.
In other words, rental rate and value appreciation work on a symbiotic relationship.
When rental increases, it means the commercial property is in high demand. As result, it is perceived as high quality therefore driving the valuation UP.
Similarly, when commercial property is perceived as high quality, it could command a premium rental from the highest bidder.
Like chicken and egg analogy, but in a positive way.
Case in point…
You try to persuade this long-queue-money-changer located in the LG level at Midvalley Megamall to move to another location…
He will kill to be in that spot even if you are the landlord hiking his rent 10% annually.
There are always no shortage of businesses which can afford the rental, but the caveat is, it MUST fulfill the criterion of the LPAV Quadrants.
No if’s and no but’s.
Commercial property can be very unforgiving if you don’t have the LPAV Quadrants dialed in.
But it can also be ridiculously rewarding when done right.
On the other hand, Residential Property rental rate can fluctuate based on supply and demand.
B2C in residential properties versus B2B for commercial properties.
It’s an open secret – price can be artificially driven up by some property investment clubs or speculators with no fundamentals to back it up. Despite this, residential property landlords could still be suffering from negative rental cash flow.
That’s why if you need to up your game, the first thing is not about more fancy strategies or tactics in property investing.
It’s not even about buying MORE apartments or condos into your property portfolio.
It’s about thinking differently and having an ‘evolved’ mindset.
This is exactly what a wealthy investors will think, act and react.
You see when Bill Gates is known to have 90+ billion net worth, he does not keep that wealth in his house (unlike some country’s ex Prime Minister).
Heck, Gates doesn’t even keep that in his in bank accounts.
Believe it, most of it comprises of his equity stake in Microsoft.
In fact, this is how the US top 400 wealthiest made their money:
- Wages and salaries: 4.4 percent
- Interest: 4.2 percent
- Dividends: 10.9 percent
- Sale of Capital Assets: 65.2 percent
- Partnership and S Corp Net Income: 16.2 percent
What do those numbers mean?
Salaries account for a small percentage of a wealthy person’s earnings.
So do interest and stock dividends.
A business–or some of its equity stake makes up more than half of a wealthy person’s net worth.
Another evidence from Business Insider
- The top 20% of the population owns 50% of all income generated through labor
- The middle 20% gets a slice of about 25% of labor income
- The bottom 60% only have access to about 25% of all income generated through labor
- The top 20% of the population enjoys 80% of business and capital income
- The bottom 80% of the population has to fight over 20% of income generated through business and capital
- The top 20% of the population boasts about 95% of capital gains income
- So, 80% of the population has negligible access to capital gains.
Last but not least, if you always hear people say, the rich gets rich by investing in real estate…
Then today, you will discover that’s absolutely a myth.
Watch the video below
Because property investing is a long term endeavor only for well-heeled investors with strong holding power (more so for commercial property investment), you should NOT get into this for the sole purpose of cashing out your returns in short term.
Only consider this if you are looking for asset to park your funds or ‘up your game’ by restructuring your existing, already profitable residential property portfolio.
This article is sponsored by Paramount Property, an award-winning developer with more than 35 years of proven track record in the property development industry in Malaysia.
Paramount Property most recent commercial property project is at Shah Alam, known as Sekitar26 Enterprise, where its head office is also moving to this commercial hub in 2019. It's a rare opportunity to have your commercial property be located in the same area as the property developer itself.
Commercial property investment yielding result from the case study above could possibly be achieved via one of the commercial property project by Paramount Property.