My name is Geoffrey. I am considering venturing into the low-end rental properties market. I plan to take a Sacco loan of Sh12 million using my payslip at 12 percent per annum. The loan shall be on reducing balance with monthly repayments of Sh200,000. My plan is to buy a two-storey building with 14 bedsitters in the Ruiru area where I will get a total monthly rent of around Sh84,000.
Is this a good investment? What return on investment should I ideally look at and what hidden/obvious costs associated with rental properties should I expect? How do I handle this loan to pay it off as fast as possible?
Dominic Karanja, a financial planning and investments consultant.
Ruiru is a fast-growing town with high demand for low-cost rental houses, especially those targeting young professionals and students.
Though venturing into the rental property market can be a rewarding investment, it's essential to thoroughly evaluate all aspects before embarking on such a long-term investment.
You need to carefully weigh the potential returns against the associated costs and risks before making the investment decision.
When you compare the monthly loan repayment of Sh200,000 against the monthly rental income of Sh84,000 you will have a significant shortfall of Sh116,000 monthly which means that, for the duration of the loan, the rental income alone will not cover the loan instalments which can strain your finances unless you have alternative income sources.
Without additional payments, a Sh200,000 monthly loan instalment, for a Sh12 million loan at 12 percent per annum on a reducing balance, will take approximately 7 years and 9 months to repay.
As you project the expected rental income you should also consider the tax on rental income whose rate is 7.5 percent currently, on the gross rent received.
You should also consider that you may need to renovate parts of the property before renting it out which will push your costs upwards significantly.
There will also be regular maintenance of the building and individual units, and you will need to budget for a certain percentage of the rental income to cater for maintenance.
You should also factor costs associated with screening tenants, handling tenant disputes, and potentially hiring a property manager.
If you are going to engage a property management firm to manage the property, expect 5-10 percent of your monthly rent income to be spent on that service.
Periods when units are unoccupied result in lost rental income and I would urge you to be conservative and work with an average occupancy rate of 80 percent when projecting your rental income.
Before you commit to buying the property, you should do proper due diligence, including a professional inspection, to identify any potential issue.
You also need to consider valuation fees, conveyancing fees, and other legal costs associated with property purchase. You need to make sure that the national government rent of the land is leasehold and county government rates, and any other applicable taxes payments are up to date.
To know whether your investment makes business sense you need to calculate Return on Investment (ROI). To calculate ROI, you need to consider your annual rental income and your total investment costs.
The ROI for rental property investments is often measured annually as Net Annual Income ÷ Total Investment Cost × 100. If you buy the Sh12 million building generating Sh84,000 per month, the annual gross income is Sh1,008,000. The ROI (Gross) will be 8.4 percent (1,008,000 /12,000,000 ×100=8.4 percent).
After deducting maintenance costs, taxes, and other expenses, your Net ROI could drop to around 4-6 percent, which is quite low for such a high-risk investment.
A good ROI for rental properties is generally 10 percent or higher (net) annually. In this investment you should be guided by the "1 percent rule" that is used by property investors.
The "1 percent rule," is used to determine if the monthly rent earned from investment in property will be more that property's monthly mortgage payment.
The goal of the rule is to ensure that the rent income will be equal or greater than the mortgage payment, so that the investor at least breaks even on the property.
Your monthly rental income should be at least 1 percent of the property’s total cost (that is Sh120,000 per month for a Sh12 million property). At rent income of Sh84,000 per month, you fall short of this benchmark.
While your initial ROI might be low due to high loan repayments, the investment could become profitable over time as you repay the loan and increase rental income, however under the current economic situation, it may not be possible to increase the rent drastically in the near future.
If you decide to continue with the investment you will need to carefully consider the costs and have a solid plan for managing the property and loan repayments.
Consider consulting professionals like a financial advisor for personalized financial advice and other aspects of that investment and, or other investments that you should consider instead.
If you have any money problems, send us an email at [email protected] and leave your number for contact. Money questions will be answered on this column.
