Financial choices in your 20's: Part 2

Invest or have fun first? That is the question

Continued from part 1

Many youth in their 20’s land their first decent paying job out of college and will do one or all of four things i.e. buy a car, move out of home and/or travel (includes shopping spree) and have fun!

I personally wouldn’t mind doing all the above.

However, saving and investing at a young age has always been one of my dreams. Most young people will not understand the golden opportunities from investing unless they talk to people who have experience in investing and have good knowledge about it.

For example if one invests in a piece of property in during their 20's just imagine how much the value of that property would have increased by the time he or she is in their 30’s! 

A writer at Kenyan Daily post wrote an article of 10 great rules that will help someone remain poor. They include;

1.     Never Wake up early.

2.     Never plan to spend your money.

3.     Don’t think of saving until you have very large amount of money.

4.     Don’t engage in activities usually reserved for the uneducated.

5.     Don’t think of starting your own business until an angel comes from heaven and gives you capital.

6.  Complain about everything except your own attitude: Blame the system, the government and the bank that refuses to lend you money. They are all bad and don’t want you to get rich.

7.    Spend more money than you earn. To achieve this, buy consumer products in credit and keep borrowing from friends and employer.

8.    Compete in dressing; Make sure you wear the latest clothes among all the workers in your office. Whenever your neighbour buys a new phone, get one that is more expensive.

9.     Get yourself a nice second- hand car that costs more than three times your gross monthly pay.

10.   Give your children everything they ask for since you are such a loving parent: They should not struggle for anything because you do not want them to suffer. That way, they will grow up lazy and hence poor enough to ensure they cannot help you in your old age.

Young people are full of energy, potential and excellent ideas. Let us not waste time and start saving and investing now. However, as a young investor, don’t rush to start investing without a plan. It is a good idea to have a mentor who will guide you on this.  Always have a goal, what you want to achieve, then put down a strategy and specific activities to help you achieve it. Definitely challenges will be there but when you have the desire to invest for a brighter future, you will make it.

Orison Swett Marden states that “there is no investment you can make which will pay you as well as the effort to scatter sunshine and good cheer through your establishment”.

We wind up this great post by highlighting five advantages of investing in your 20’s.

Mitigating against leverage risks

Guest post by Samuel G. Njenga

The higher the leverage, the higher the risk but as we saw last time the higher the profit margin.

We all agree that in Kenya, a developer’s world only makes a lot of sense when the concept of OPM (Other Peoples’ Money) is utilized to the maximum. So then along the same line of thinking, developers in Kenya are clever enough to utilize the less risky of the OPM; off-plan sales.

The idea is of course to sell concepts on paper and expect that potential buyers will show up, pay deposits for yet to be built units. As the construction goes on, the buyer injects more cash and preferably by the time the construction is over, the buyer has fully paid for the unit. This is clever coz it essentially means the developer utilizes the cash from the would-be buyers and makes some coins. However, this arrangement works best when there is a show house and buyers can see how the end product will look like. In some cases even without the show house buyers could still trust the developer especially if they have a name…importance of a name?

The other very important idea that developers consider is to ensure that a loan is structured with several draw downs. Interest is normally charged on the amount drawn as opposed to the total loan amount. After the first few draw downs. A clever investor is able to gauge on the response from clients on the units. One can reasonably tell whether there is interest on the units once the ground breaking is done. Most buyers will be comfortable once they see progress on the site. And by the way, one might be very happy to see so many would be clients visiting the site and commenting on the good work done, but a seasoned investor knows that a lot of demand may not translate to effective demand.

Effective demand is quantity of a good or service that consumers are actually buying at the current market price.

Of course we also have latent demand when a customer/consumer is unable to satisfy their demand, mostly due to lack of money.

What if you already have the loan and the sales are not forthcoming? One option would be to re-negotiate the re-payment terms with the bank so that they extend the period where u service the loan interest without paying the principle and whenever a sale is done, the bank receives their cash. Kenyan banks are kinda flexible and are also alive to the market conditions.

Developers are also keen to change the prices as the construction continues. In other words, the buyer who buys off plan will always get a very good offer and the one who comes in when the unit is ready, then pays much more. Sometimes the increase would be as much as 10-15% so it is always wiser to buy off plan or at least when the ground is broken.

Next, let’s look at the importance of location when investing in real estate.

Leveraging in real estate

Guest post by Samuel G. Njenga

Leverage (debt) magnifies outcomes. What does this mean?

To illustrate how leverage works in a real estate investment, we'll take the following investment parameters (The figures are hypothetical but not so far from reality, just to put the points across):

•Construct 5 units for sale each at construction cost of 5M (inclusive of land)

•Financing at 14% interest (service interest during construction) and repay loan on sale of units

• Sale price of 7M per unit for total sales of 35M

Let's look now at the ROI (Return on Cash Invested) with different options:

25M utilized by the developer from his/her pocket for all the construction costs:

Profit of 10M on 25M invested = 40% (return on cash invested)

50% (12.5M) cash from developer and 50% (12.5m) construction loan:

•cash out will include interest on loan (say 1M) and full loan repayment (principal) 12.5M for a total cash out of 13.5M

•Return = 35M – cash out (13.5m) – developers cash (12.5m) = 9m

•9m/cash invested (12.5m) = 72% return

  

30% (7.5M) cash from developer and 70% (17.5M) construction loan

•cash out will include interest on loan (say 2M) and full loan repayment (principal) 17.5M for a total cash out of 19.5M

•Return = 35M – cash out (19.5m) – developers cash (7.5m) = 8m

•8m/cash invested (7.5m) = 106% return

  

As you can see, even though your risk increases with leverage, especially if the sales are not made fast enough it might be a wise choice when you can increase your ROI by as much as the margins above. A seasoned investor will actually use OPM (Other People’s Money) as much as possible. Now this is good debt.

Assuming you got the 25M and as opposed to just utilizing the same for the 5 units…and do without a loan, suppose you put the entire amount as 30% (read last option above). This means, you can now get a loan of around 60M. In other words, you can now construct 17 units.

Sell the 17 units @ 7M for total sales of 119M. If you manage to sell the units within 1 year, then you’ll have paid an interest of around 7M (coz you’ll not draw the cash all at a go).

Cash out is now 7M (interest) + loan repayment (principal (60M))

Returns = 119M-67M = 52M/25M (cash invested) = 208% return……this one will drive someone crazy……or let’s say if I made this, then I’d be off to Benidorm for a month... and switch off my phone

The above figures paint a good picture about debt if well utilized. Take note that the above example(s) are purely driven by sales in good time. This is quite an assumption and a seasoned developer will tell you that without sales, then you are doomed. Notice how crazy it can turn out if you got a 60M loan and sales are not forthcoming…..you will cry in the toilet… But trust investors to take huge risks….after all what would be the worst case for this type of investments??? .....

Next post we shall think along this line.