Here’s food for thought before investing in rental property

Grant Cardone, one of the most successful real estate investors with thousands of units in his portfolio wrote a book with the title- If You’re Not First; You’re Last. As brash as it sounds, this is the kind of attitude a real estate investor needs.

There are no middle grounds in real estate. You either gain big or lose it all. A good real estate investor knows when to invest, where to invest and when to quit a market.

Perhaps you are earning enough to afford an apartment that can earn you rental income and subsequent financial freedom. Buying property for the sole purpose of earning rental income requires serious in-depth analysis of several factors. In this article we break it all down:

Rental Income vs Capital Gains

Simple things first. How do you achieve financial freedom when you buy a rental property? You simply put it back into the market, rent it out to a tenant and earn rent money. It may seem sensible to invest in a rental property that will earn you the highest amount of monthly rent but there’s more to rental properties. Factors that affect your returns and occupancy rate comes first. How attractive is your property’s location? If you go for six months without a tenant, you are making losses.

A good occupancy rates means consistent cash flow. Then there is the question of maintenance fee. A high-end property will cost more to maintain than a low-end property. All these factors are determined by the type of property you choose; a topic we will discuss further below. Financial freedom should also come from capital gains.

John Latham, the Executive Director at Unity Homes notes that capital gains are a big consideration in any investment. In real estate, capital gains are normally tied to the land value. “Capital gains build in the background as you continually earn monthly rental income,” says Latham. In Tatu city for instance, an acre of land cost Sh25 million four years ago and that figure has increased to Sh60 million in 2022.

In a ripple effect manner, the increase in land value has impacted property resale prices and monthly rental income. A unit that was going for Sh4 million, four years ago would probably sell at Sh5.5 million now while those earning rental income are enjoying a couple of thousands more too.

Though the capital gains only become tangible when one resells a property, they cushion an investment against inflation and other circumstantial situations. If for instance, you used the property as security to access credit and you were unable to repay on time, you would still make a profit if you were forced into a distress sale.

However, if the property’s value remained the same years later, you would make no profits if you were to resell. Capital gains also enable you to quit a market by reselling at a profit, if you ever want to invest in something else.

When investing in a rental property, look into the location’s land value patterns and pick those that have potential for growth. Latham notes that some locations have already peaked and are likely to be static while those that are still developing will increase in value over time. Note that a location’s growth can be unpredictable sometimes, though frequent reports by real estate researchers will always track patterns.

Kitengela, for instance seems to have peaked prematurely while Ruiru, which at one point was considered to be on the same level as Kitengela continued to gain value. Suburbs and satellites towns which are still developing tend to have the most room for growth. With the rise of tech, suburbs have also become more attractive to renters as they can tackle accessibility challenges though delivery and ride sharing apps.

Picking a market

To further simplify your choice of rental property, evaluate your options based on the three market segments; the low-income, middle-income and luxury markets. The middle-income market may be divided into middle-upper and middle lower. If you invest in a property located in Syokimau, Westlands, South B or Ridgeways, then your target tenants are middle-income earners and your rental income could be a figure above Sh30,000 per month for a one-bedroom unit depending on the location’s distance from the CBD and amenities surrounding the neighbourhood.

To establish whether your property would be attractive to tenants within your target market, create a profile of your potential tenant. Tatu City, for instance is in a middle-income market and Latham notes that the potential tenants are drawn from different age groups.

Their income brackets are about Sh100,000 or more as this enables them to spend 25% to 35% of their income on rent. They probably have two or three school-going children and will therefore be attracted to good schools within the neighbourhood and well-sized homes. They may rent one- or two-bedroom apartments depending on family size.

Tenant Profile

Latham further explains that middle-income tenants value good finishing. They may not be in the luxury bracket, but they still want a taste of fine things in life. Tranquillity is also a big selling point for them as well as amenities for their children such as playgrounds. They also want a sense of community, hence will probably go for gated communities and anything close to that.

When it comes to pricing properties in this market, it all boils down to the amenities. The more convenience you offer, the more you may charge in rent. “Everybody wants a little bit of luxury in life,” he says adding that the middle-income earners always want slightly better things that boarder affordable and luxurious. With so many rental properties in the market, tenants go for rentals with added value.

“How much more would you pay for a park, a swimming pool, a gym, park benches or even trees?” poses Latham. Middle income earners are quite flexible as they have more disposable income, compared to low-income earners. Each extra amenity will earn an extra thousand or two in the form or rent and that translates to more income for you.

However, be careful not to invest in a market that has an oversupply of apartments or rental units. According to the Hass Consult report, 2021, Kilimani and Kileleshwa (which fall under middle-upper markets) had an oversupply of apartments. Oversupplied markets are competitive and difficult to price. The above report further notes that the rental market is driven by affordability and locations such as Langa’ta which offer affordable units experienced growth.

High occupancy rate

If you opt for a property in the low-income market, your rental income should be below Sh20,000 a month for a one bedroom and Sh10,000 to Sh15,000 for a studio. Tenants who go for low-income neighbourhoods are looking for accessibility, and low cost of living (through rent, transport and food prices). Your potential tenants are likely to be people schooling or working close to the neighbourhood.

Such neighbourhoods are attractive to young people who are just launching their careers and small (single or two-person) households. They may not demand luxuries such as a gym or a swimming pool, but they are not willing to compromise on security, utilities and infrastructure. They are also quite exposed, thanks to the internet and will want good finishes in their spaces.

One bedrooms and studios tend to be in high demand as they are suitable for such demographics. A three-bedroom unit in a low-income market will probably stay vacant for a while. While the monthly rental income may not be much in a low-income market, the yields are promising given that the occupancy rate will always be high. Such properties are affordable, thus attracting a long list of potential tenants. There maintenance cost is also low, hence there will be fewer deductions from your monthly income.

The capital gains are however possibly low as low-income neighbourhoods exist in locations with extreme sporadic development, hence lacking room for growth. In addition, developers in low-income neighbourhoods tend to ignore zoning laws thus affecting the location’s ability to increase in value. An investment in the low-income market is, however, cushioned by the high occupancy rate and the cost of buying such properties is usually low.

Feared market

Lastly, the luxury market offers the highest monthly returns. Surprisingly, this market is one of the most feared due to the small number of tenants who can afford such properties. Latham explains that the luxury market seemed lucrative about six years ago but over time the bubble bust leaving developers with unoccupied properties.

Over the years, property owners have had to drop their rent prices to attract tenants. True to this, the above cited report indicates that neighbourhoods like Riverside, Gigiri and Spring Valley spiralled downwards in the first half of 2021 in terms of rent prices. “One needs a massive salary to afford a house in the luxury market,” says Latham.

And when a property loses such a tenant, it could take months to replace them. Latham cautions that the luxury market is not primarily a tenant’s market, but rather works well for home buyers. Nonetheless, when it comes to preference, the market is all about premium finishes and exclusivity. Potential tenants, have high expectation and the maintenance cost is also quite high. If you’re planning on investing in the luxury market, inspect properties with a critical eye before buying. Aim for perfection in the finishes and amenities within the location.

Your tenant will want access to fine dining, luxury shopping, exclusive golf clubs and anything branded as premium. Simply put yourself in the shoes of a rich person-how demanding would you be if you were spending Sh150,000 on rent? To ensure you earn stable returns, look into markets that are still growing and avoid those that are stagnant. The above report, indicates that some luxury neighbourhoods such as Karen, Muthaiga and Nyari continue to experience substantial growth in rent prices.

Payment models

Finally, the payment model when purchasing a rental property is crucially important. The faster you pay up for the property the better, as your cash flow shifts from negative to positive. Off-plan payment models offer the best returns as you spend less on the property, compared to buying ready properties that were built on credit. If the developer borrowed to build the units, the cost will always be transferred to the buyer.

But unlike buying a home, whereby you’d be willing to make sacrifices if the unit is what you’ve always wanted, investments are all about getting your math right. Stick to investments within your means. Requesting your bank for a personal loan is not the worst idea though, cash buyers tend to have straightforward ROI while those who seek funding tend to incur hidden costs such as legal fees and cost of credit (which adjusts to inflation over the years).

[email protected]