7/19/2017

Think Investments. Think Finance.

By: Wajahat Aslam Raja, CEO - Marsons Holdings


Think. Intellectualize. Ponder. Think of money as a unit of measurement. Think of income producing assets as tools. Think of your intellect as the workshop and carve out your future. If you have decided to live on God's green earth for as long as naturally possible, then live. In fact, don't just live. Breath in, sip it, see, feel, smell and touch God's limitless bounty in the form of His creation on this earth.

Income producing real estate, collateral, mortgages, markups, return on investments, blah blah. Fancy words used by the banker throughout the ages to confuse you and me. To keep his little world of money secluded and perhaps secretive. Not very effective I can assure you. Think.

You need to make money but you have heard the saying that you need money to make money. Yes, that's true, but who said that money has to be yours? You don't have 100% of the capital? No problem, there are banks. You don't even have the capital to offer as down payment? Well you must have friends or family.

What do banks look for? A return on their investments. But more importantly, a safe return on their investments however small they may be. Defaulters are probably a banker's worst nightmare. So how does this fear reflect on their personality? Well for one, they have a tendency to increase interest rates wherever there is a high percentage of risk involved. But what else? Well, since banks are mostly interested in making money on money without doing anything with it except lending it out. They excuse themselves from any risks as much as possible by insuring the mortgaged commodities or assets. In doing so, they also excuse themselves from any rewards that may follow. One such reward is the appreciation of assets that have been mortgaged. Consider this. A bank mortgages a house worth One Million Dollars for a 6% interest rate spread over 20 years. Now by definition, you would pay almost twice as much as the initial value over the course of 20 years which sounds awful but consider this. The probability of the value of the house not appreciating every year by at least more than 6% is next to nothing. This is of course taking into account that the real estate prices will always go up, which they will, always. This is substantiated by the fact that real estate is always in demand, there is not going to be more of it, populations are increasing etc. But don't think that you will take the entire 20 years to pay it back. Think more like 3 or 6 or whenever you can calculate that the selling price of your mortgaged asset has far exceeded the total paid plus outstanding capital on the mortgagee and sell it off. Rinse and repeat. You probably don't want to pay the entire installment yourself. Then don't. Mortgage a rentable property and channel that rent towards financing that mortgage. Now in theory this would probably fail. But practically, it does not. The theory would firstly take into account inflation and then it would consider the rate of appreciation of the property and then by subtracting them would give you the true appreciation of the property. Whereas in reality, inflation doesn't actually affect you personally or your property, even if you make the same amount of money you did last year. This is however true for only short periods of time. The issue with theoretically testing this hypothesis is that in theory you cannot ignore inflation whereas in reality, you can.

Let me explain. You decide to buy a property worth 7 million with a 25% down payment of 1.75 Million which leaves 5.25 Million for the bank to finance. Let's say that the bank agrees to finance the outstanding capital for a KIBOR+4% p.a mark up. For you to  break even on your investment. You would require the property to appreciate by KIBOR+4% p.a right?. This is not true. Since the property is actually valued at 7 Million and the bank has financed 5.25 of that, the breakeven calculation only applies to the financed amount because the down payment is your personal investment and all proportional appreciations are yours to keep. That brings the required rate of appreciation to (KIBOR+4)*0.75. you have saved a quarter of all future earnings already. Now we will assume that the property is rentable, albeit not for a very high rent. Lets say at 3.4% per anum, which would mean that from the KIBOR+4, 3.4% is coming in the form of rent which leaves you with an outstanding payment of KIBOR+0.6% bringing the required rate of appreciation to (KIBOR+0.6)*0.75. Now you have saved one third of your installments. Lets dig deeper. One year has passed. You have made your payments on time and the bank has received a large portion of the mark up and a small portion of the principal amount. This payment of the principal reduces the mark up paid to the bank the following year when the bank recalculates the mark up considering your mortgage is on a variable rate. The more you pay back early, the less interest you pay back over the tenure of your mortgage. But since the idea is to pay off the mortgage as soon as you are able to sell the asset for a favorable profit, you pay much less than is generally expected.

This process is doable but it requires some key articles to be successful. It considers your ability to not only have the down payment available and pay the installments on time, it also considers your ability to locate prime real estate with a high appreciation potential, a high possibility of making balloon payments to lower the principal and also to have other means of financing to pay off the mortgage at the time of sale. These other sources could be friends or family or colleagues who would lend capital interest free for a few weeks.

Like all businesses, this one also carries risk. What it does not carry however is the requirement of a lot of time or effort or expertise or management of any kind on your part making it a very lucrative way to build assets on the side if you play your cards right. As I write this, I assume that you are much smarter than me and also that you can create even better options by most effectively employing the resources available to you.

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