Updated: Jan 15, 2020
Last week I posted a video answer to the question, "Is it ok to live your entire life without buying a house?" This post is a follow up.
For many, many people, owning a home is part of the Malaysian dream. It signifies a "coming of age," that a person or household has "made it."
I vividly remember in 1993 when my parents sold the family semi-detached home in Taman Seputeh. They were looking to move to a bungalow but wanted it to be the "perfect" home. An offer for their current home came first so they decided to sell it and rent a bigger home while looking for the house they wanted.
My paternal grandmother was very disturbed that we lived in a rented home. Never mind that my father was hugely successful in his career at the time. It did not count that his earned income was substantial. The fact that he was renting was disturbing for my grandmother. She was relieved when my parents finally built their own dream home and moved into it 5 years later.
Such is the importance of owning in Malaysia. This begs a fundamental question:
What's the Big Deal With Owning a Home?
Forget what grandmothers think for a moment. What's the difference if you own or rent a home? Here are the main arguments for owning:
You build equity over time
You enjoy better security
You are not subject to rental increases
You can renovate and design the home to your heart's content
Now, let's analyse these arguments for moment.
You build equity over time. The logic is that your wealth increases as your house price appreciates. For example, if you buy a house for RM700,000 and, after 10 years it appreciates to RM1,500,000, you have increased your wealth by RM800,000.
When you rent, you do not enjoy this capital appreciation. No brainer right? There's a catch.
You see, your appreciation on your home is paper appreciation. That means this appreciation is zilch until you sell the house or you refinance it. Both options lead to other problems.
If you sell your house, you need to buy another house. If you refinance your house, your monthly repayments increase. We will revisit this in more detail shortly.
You enjoy better security. The common notion is that when you own your house, it is yours. It does not belong to a landlord who can ask you to move out when your tenancy expires or even earlier if your tenancy agreement allows it. You are not at the mercy of a landlord.
If anything were to happen to you, your mortgage insurance would cover your mortgage and your family would have a roof over their heads. A definite advantage.
However, you really only enjoy complete security if you do not have any borrowings against the house. If you do have borrowings, you have a bigger-than-a-landlord entity called "the bank" to deal with.
The same reasons that would cause you to default on rent payments would also cause you to default on your mortgage payments and the latter has more organised resources to deal with defaults.
Upon deeper analysis, both owning a home and renting a home offer specific security advantages but not enough to conclusively say that one presents a better advantage than the other.
You are not subject to rental increases. A tenant could be subject to periodic rental increments or a sudden drastic increment. This could cause a significant drop in his disposable income. A house owner on the other hand will never have this problem.
On the outset this seems like a big advantage. Look deeper though and you'll realise that this advantage is a mirage. Tenants have bargaining power too. Especially tenants who are good paymasters.
Landlords do not want to lose good tenants and are cautious about increasing the rent. In the event that the tenant cannot afford the increase in rent, she can always find a new house that matches her ability to pay. In fact, if a tenant's expenses were to increase, she can always downsize by moving to a cheaper house.
A good portion of the apartments I had for my vacation rentals business were rented. One of my landlords tried to increase rent after a year and I negotiated with him not to increase it. When our tenancy came to an end, I was already exiting the business and told him I would not be continuing. Within 3 days of my notice, he offered to reduce the rent.
As a landlord, I have also offered discounts to keep good tenants.
A house owner with a mortgage may find that his mortgage increases as interest rates go up. This may be small increases but it will not be as easy to get out of such increments.
You can renovate and design the home to your heart's content. Yes, a home owner certainly has much more freedom to do anything she wants (within the confines of the law) to her home. She can renovate and expand, exactly to her liking.
Tenants have less flexibility. In most tenancy agreements, the tenant will require permission from the landlord for any alterations, including boring holes in the walls to put up pictures or artwork.
However, a tenant can always move to a newer, better renovated property as soon as she finds that the property she currently lives in is becoming worn. She can do this with relatively less capital expenditure.
Again, there are advantages to both owning and renting in this context.
You've probably noticed by now that there doesn't seem to be a pronounced advantage between either buying or renting. But I can hear you thinking...
Surely, Building Equity Is a Serious Advantage for Home Owners Right?
Yes, building equity is a serious advantage but let's go deeper into my explanation above.
First, it must be understood that there are many ways to build equity. Home ownership is one of these many ways.
Second, it is important for you to realise opportunity cost. Every investment that you make has an opportunity cost. For example, if you put RM100,000 towards owning a home, the opportunity cost is putting the same RM100,000 into a fixed deposit with a 3.8% per annum return.
Now, if you bought a house that cost RM750,000 with a 90% mortgage from a bank, you would have to come up with RM75,000 for the downpayment. On top of that, you'd have the following costs:
Let's assume your renovations cost RM40,000. The rest of the fees would add up to RM37,670.
Therefore, in total you'd have to fork out RM152,670.
If your mortgage interest rate is 4.5% and tenure 35 years, your monthly instalments would be RM3,194.
Now let's say the property appreciated every year by 5%. In the 10th year, the property would be worth RM1,221,670. It would appear that you have a RM471,670 gain. But hang on...
After paying off the balance on your mortgage and deducting your maintenance cost over the years (taxes, MLTA, repairs, and annual improvements), your estimated net gain would be RM35,000. That is an annualised return of 2.06%.
Now let's say you decided to rent the same property, and the rent was RM2,500 per month. And let's say you spent RM10,000 sprucing up this apartment to your liking with soft furnishing and art work.
Your savings from not having to buy with a downpayment and closing costs would be RM142,670. Your monthly savings from the difference between renting and buying would be a further RM694 (RM3,194 - RM2,500). This would be RM8,328 per year
If you put the RM142,670 in a fixed deposit with a return of 3.8% and increased it by RM8,328 per year the compounding effect would give you a staggering net gain of RM167,319. Your equity would be nearly 5 times higher!
(If you like, you can test the returns from owning a home using my property investment calculator that comes together with the Ultimate Guide to Buying Property here.)
Alright, if it makes more financial sense to rent than to buy, then...
When and Why Should I Buy?
Interestingly, home ownership in Malaysia is higher than most developed countries as of 2016 at about 76%, indicating that many Malaysians prize owning a home. There is however a trend that is gaining popularity in some parts of the world - more and more people are not buying in to the home ownership dream.
That aside, you must make a distinction between buying-to-stay and buying-to-rent. This is because there is a cost to owning property. If a tenant is absorbing your mortgage interest and a good portion of your maintenance costs, you might find that the returns are much better.
Let's use the exact same example above, only this time you buy-to-rent and you rent this property to a tenant for RM2,500 per month. Your return, if you sold the property, in the 10th year would be RM285,000. That is an annualised return of 11.1%. This beats any bank FD. In fact very few investments can give a return rate of this quantum.
When you buy-to-own, your property is not exactly an investment because the returns can be very small. If you plan to live in the property for a very long time, say 20 to 30 years, and the average appreciation is good, then it becomes a good investment. In the short-term, with a mortgage, it may possibly be a liability. This means, you make a net loss on sale.
Therefore, if you're buying-to-rent with a mortgage, and the property will have good rental and capital appreciation, it is almost always a good investment. Buying-to-own does not necessarily yield good returns on sale.
There is however a non-financial consideration to owning your own home. The pride of owning your own house and gradually moulding it into the perfect home is difficult to quantify financially. For some people, this is the dream. Nothing wrong with it. Just don't look at buying-to-own as a financial investment. You're buying a lifestyle of your choosing.
Over time, when you've cleared your mortgage on the house, your cost of living will be significantly lower. If your house is unencumbered, you may lose your job and still not have to worry about the most basic human need - a roof over your head. Technically, you could become a Grab driver or flip burgers for your daily expenses but you'd never have to worry about the house.
Ultimately, if you are contemplating buying-to-own, it boils down to this - are you looking for financial gain or the joy of ownership? Do you want the freedom to move to anywhere in the world without being tethered to a property or do you want to build a nest anchored in the stability of relative permanence?
The choice is yours.
However, don't be fooled by mirages. Always remember that there is a cost to owning property. Ensure you know your cashflow and please, make sure you can afford it. My property investment calculator will help you with this.