Real Estate Investing (I)

When we were young, we would use mud or plasticine to model artificial houses and then destroy them a few seconds later to create other pieces of art; maybe, just maybe, we should have kept on sculpting the beautiful masterpieces and then years later we would have giant homes that we would call our own.

Hey there dear reader😊, welcome to today’s blog!

Owning a land or building in Kenya is considered a fruitful investment, especially when it’s executed well and the assets are able to generate stable income for the owner. However, the purchase of land and the construction of buildings often requires substantial capital which is not easily accessible to a majority of Kenyans. In fact, most Real Estate projects use finances from a group of individuals or from financial institution borrowings (aka mortgages). In today’s blog, we’ll try to understand what Real Estate Investing entails and how today, it is easier for you and I to be investors given the array of investment options. This is part one of this Real Estate topic, enjoy.

Real Estate

Real Estate involves the purchase of property, often land and buildings, for the purpose of income generation.

In our country, land purchase has become a common investment for individuals and institutions; many ‘land traders’ have assumed the role of buying land at significantly discounted prices, then selling them at a premium. As a result, the value of properties have escalated over the years and some have argued that a few unwarranted price increases are a bubble waiting to burst; a theory I support given the exaggerated ways land is valued by some property owners, “naskia reli itapita hapa kwa hivyo shamba yangu ni kitu 20 million 1/4 acre”. This overvaluation will soon catch up with owners especially when the properties result in no real value addition.

Regardless, we cannot deny that there’s value in owning land or a building. The benefits are attractive:

1. Regular income in form of rent/income from land use e.g. from large scale farming.
2. Appreciation of the land value especially in a flourishing economy; greater purchasing power and greater demand for goods & services.
3. The properties can be used as collateral when taking a loan.

Different Real Estate Classes

Real Estate can be grouped into the following categories: land, residential RE, industrial RE and commercial RE (office & retail). Residential RE, as the name suggests, is property used for residential purposes, industrial RE is property used to build factories, warehouses, distribution centres etc. and commercial RE is property used or rented out to run various businesses and operate showrooms, restaurants and malls.

There are many ways of earning income in real estate:

1.Owning rental properties (being a Landlord)

By far the most common way of earning income; buying or building properties which bring in cash flows in form of rent. For most landlords, the virtue of patience is vital when starting out this kind of project since it takes time before realizing any financial gain (after construction and at least when occupancy is optimal). Also, most of the time loans are taken to undertake these projects which means that before enjoying a majority of the rent as profit, the loan has to be paid using the rent. Before purchasing land or renting out property, due diligence needs to be done to ensure any issues that may arise are handled before hand.

2.Real Estate Investment Trust (REIT)

A REIT is a company that owns, operates and/or finances an income generating real estate, and is an alternative investment option to the direct purchase of real estate. Given that investing directly in land, apartments or retail buildings can be expensive, REITS enable its investors to be involved in the world of real estate without directly owning the tangible assets. They invest the money you’ve invested with them in real estate projects and then profits are distributed to you periodically.

A REIT can be bought and sold in an exchange just like stocks. The benefit of investing in a REIT is that, you get to have access to RE investments (indirectly), and there is no need for complicated “title transfers”. You also receive dividends (in this case rent) annually since companies that operate as REITs must pay 90% of their taxable profits to its investors.

3.Renovate & Sell (aka House Flipping)

Another way of investing in real estate is through becoming a ‘real estate trader’. This activity is very common in developed nations where experienced real estate persons buy undervalued properties and then sell them at a profit in less than 6 months. This is a venture that requires an eye able to identify properties that are currently trading below their potential/worth.

In addition to the buying and selling of undervalued properties, house flipping also involves buying a depreciated building, renovating it (adding value), then selling it at a premium. This is especially lucrative for old houses in prime locations (location!location!location:)

As is with all investments, there are some drawbacks in direct/indirect real estate investing:

1. Illiquidity – this applies to direct purchase of property; that you can’t dispose the properties easily to get the cash fast. When you want to convert the asset to cash or vice versa, it takes time especially to find a willing counterparty. Therefore, if want to dispose your property, you’ll have to come to terms with waiting before getting cash which can be disappointing. Also, there are a lot of brokerage fees and legal procedures which are involved in property transactions.
2. Maintenance costs – in order to make good returns, property must be in healthy shape. This means having expenses which can be expensive to landlords and property managers.
3. Significant capital – as mentioned earlier, real estate demands heavy initial capital investment. In addition to this challenge, it takes time before realizing financial gains by having tenants and full occupancy.

However, often when investors have made careful and calculated investments, real estate attracts handsome returns and it’s an investment that also ensures that people around us have a roof over their heads.

Thank you for reading today’s blog dear reader❤. As always, feel free to comment your thoughts and questions down below.

Next blog will be part two of this topic that discusses and applies what we’ve read today to the our country’s context. Stay tuned!