By now, I’m sure you can name a number of benefits for investing in properties. This includes mainly collection of rent and to achieve huge capital appreciation.
However, as you read, it seems that present reality is far from our expectations. Some collect lower rents and witness a fall in market prices for their properties. Hence, it behooves us to ask ourselves, ‘Is investing in properties a great way to build wealth?’
To do this, I believe it is time for us to revisit the benefits for investing in a piece of real estate. This write-up is not intended to reintroduce the main advantages of property investment but is written to further elaborate on the context of the key benefits to investing in real estate.
Before I begin, here is a quick note.
This article is written specifically to first or second-time local property buyers in Malaysia who plan to acquire a high-rise residential property for investment. So if you happen to be a seasoned investor with a portfolio worth millions today, it may not be as helpful or relevant to you.
As such, let’s revisit the 5 key benefits for investing in real estates in Malaysia:
#1: Rental Income
To keep it simple, let’s say, the purpose is to receive rental income passively. So in this context, we shall exclude room rental strategies and income from AirBnB and only refer to rental income from letting out the property unit as a whole. In addition to rental yields, I find that rental income comes in handy in two places:
a. It pays off the interest portion of our mortgages. Hence, rental income would eliminate or reduce our cost of funding our property investments.
b. Rental income is a type of income that is leverageable. It means that bankers recognise rent as a legitimate source of income and hence, would take this into consideration if we want to obtain more loans in the future. The loans could be additional mortgages to finance more investment properties in the future.
For instance, let’s say, you are collecting RM 1,000 a month in rental income. As such, assuming that a bank has a credit policy to allow one’s Debt-Service Ratio (DSR) to be 60% of his monthly income, the bank would allow you to commit as much as RM 600 per month in additional debt commitment, which is estimated to worth around RM 120,000 in additional mortgage. Hence,
RM 1,000 in rent a month = RM 120,000 in additional mortgage eligibility.
RM 2,000 in rent a month = RM 240,000 in additional mortgage eligibility.
RM 3,000 in rent a month = RM 360,000 in additional mortgage eligibility.
#2: Tax Advantages
‘But, we have to pay taxes for our rental income, right?’
The answer is yes. We have to declare rental income in our tax files and pay the relevant tax amount for our rental income. The tax amount is computed, netted off the following deductible expenses:
a. Interest paid on a loan facility taken to finance the property (mortgage).
b. Fire insurance premium.
c. Quit rent and assessment.
d. Repairs and maintenance of the property.
e. Cost of replacing old tenants with new tenants.
f. Rental collection costs.
and so on and so forth.
So, if you are a young property investor who finance 90% of the property with a mortgage, it is likely that you will record a small rental loss from the investment property and thus, will not be paying income tax from your rental income.
#3: Instant Boost to Net Worth
First, let me set the context here:
I’m not referring to discounts and rebates from property developers and as well as special deals via property bulk purchases. The onus is on buyers to first learn about valuing a property and identify genuine property bargains from the other deals which are not. So, please take note.
In this write-up, I’m referring to the following scenario:
Let’s say, you intend to invest in a ready-built apartment unit situated at Bandar A, a mature township in the Klang Valley. You did your research and had figured out that the Median Price of apartments at Bandar A is RM 500 per square foot (psf).
The specific apartment that you are looking at is a 800 sq. ft. unit where it has a market valuation of RM 400,000 (RM 500 psf) presently. However, you talked to its vendor and managed to convince him to sell it to you for RM 360,000, which is RM 450 psf (a genuine discount from its market valuation).
As such, here is what you do:
a. You place RM 36,000, which is a 10% down payment for the property.
b. You pay RM 14,000 in transaction costs to buy the property. They include SPA legal fees, loan agreement fees, their stamp duties, and valuation report.
c. Excluding its MRTA, you borrow RM 324,000 in mortgage to buy this property and hence, require you to pay RM 1,247 in monthly installments. This assumes that you incur 3% in interest rate and the loan tenure is for 35 years.
With that, the changes to your personal net worth is as follows:
a. Before purchasing the property, you have RM 50,000 in cash and thus, having an original net worth of RM 50,000.
b. After this transaction, you now have a property that is valued at RM 400,000. But, you will also have a liability of RM 324,000 (excluding MRTA) and thus, you will have a total of RM 76,000 in property equity (or net worth).
Thus, you can increase your net worth by 52% from RM 50,000 to RM 76,000 in less than a year by investing in one of such real estates and they could be found in the subsale market, instead of the primary market.
#4: Future Capital Appreciation / Inflation Hedge
Once again, referring to note #3, I’m only referring to properties that are priced below or on par with the median price of similar properties in a good township. Hence, if the median price of apartments at Bandar A is RM 500 psf, I believe, it makes sense to expect capital appreciation for the long run for your property, if you purchased it at a price of RM 500 psf or below.
So, continuing from note #3, let’s make an assumption that your property could appreciate at a rate equivalent to the 10-year average inflation rate in Malaysia, which is 2% per annum (2011-2020), from the market valuation of RM 400,000. At year 10, your property’s value could appreciate to RM 487,598 (RM 609 psf).
In the meantime, you would reduce your outstanding mortgage to RM 262,945. Thus, your property equity (net worth) at Year 10 would be RM 224,653.
Before purchasing the property, you have RM 50,000 in cash.
10 years later, you have a property equity amounting RM 224,653, which works out to be a CAGR of 16.21% in that period of time. This is despite your property appreciating just 2% per annum over 10 years.
However, if you have bought a property at Bandar A at RM 1,000 psf, you would most probably experience a fall in the price of your property even after you had held onto it for 10 years as the median price at Bandar A has not appreciated to RM 1,000 psf at that point in time.
#5: Erosion of the Value of Debt
To real estate investors, debt is a form of capital and it can be interest-free.
Referring to note #3, you pay RM 1,247 per month in mortgage installments. Of which, in the first 10 years, 60% of your installments (around RM 749) would be interest costs payable to the bank. The remaining 40% shall be used to pay your loan principal.
Hence, if you can secure a tenant who pays RM 1,000 a month in rent, basically, you own your property interest-free as your tenant pays for its interest costs.
Meanwhile, the principal sum of your mortgage would erode in value over time due to inflation. Hence, it allows you to pay your loan with cheaper RM.
In short, I’ll maintain my views that investing in properties is still a practical way to build wealth sustainably in the long run. To do this, I believe property buyers should first have realistic expectations and be grounded with the fundamentals of property investing. Thus, once again, here are the 5 key benefits of investing in real estate in Malaysia:
a. Collection of Rental Income
b. Tax Advantages
c. Instant Boost to Net Worth
d. Future Capital Appreciation / Inflation Hedge.
e. Erosion of the Value of Debt