What About Investing in Property?

Objectives

There only two ways to get income from property: Capital appreciation gain or passive income stream via rental. Which is better? The answer is at an individual's level. Personally I would prefer a steady cash flow from the latter because at the same time the property being rented will also have appreciation gain over the years. Not everyone makes $$ or invest correctly from venturing into property, the same goes to every investment option available.

Consider a person who buys an apartment from loaning RM250,000 for 30 years loan has to pay approximately RM800/month to the bank. He/she decides to rent it out at RM650/month only. Most people will think that this is investing since you have an apartment that is rented to people BUT you do not technically own the apartment until you have settled all outstanding amount in the loan. In addition you are sapping RM150/month just to top up the payment, this becomes a liability instead.

He/she could sell for capital gain but with RPGT it is only wise to do it after the 5th year onwards. A prudent way is to generate rental income with a positive cash flow which is the main deciding factor before you say buy. A positive cash flow means rental received exceeds mortgage payments. If he/she managed to rent our RM1000/month, there will be a surplus of RM200/month. Within a year it could accumulate into RM2400 and if used to offset loan, could save 3-4 years in the 30 years loan.

Benefits

Tremendous leverage capability, in simple words means making money from money you did not have but which is borrowed. If you made the right choice, rental would help pay off installments and capital gain from value appreciation in the long run. This is the single most advantageous benefit over investing in the stock market.

Because you can leverage OPM (other people's money) a.k.a bank, the banker would be glad to take your property as collateral. This is also something that cannot be achieved in the world of stock market. If you borrow money for stock trading and lose it, you will need to dig more money out to pay it off.

Certainty of growing urban population in cities. With more people being brought into this world, cities will continue to grow creating demand. This has commonality with consumer stocks which are my favourites as many of you know.

Other lesser benefits:

Property will always have value. Well the same goes to stock if you choose a right company. I agree that a property might lose value but zero value, the question is; Will someone buy it from you? Unlike shares you can sell it easier.

Hedge against inflation. As long as the returns are better than FD you can say it is a good hedge. Same goes to stocks, 15% compounded growth rate is more or less an ideal percentage in property as well. Though people will say they earn more than 20%-30% in the case of buy before launch and sell later, I really think people are jumping into greed without knowing the consequences. See what happened in the US housing market. This is exactly why our government imposed RPGT back again and why Bank Negara is mulling over 80:20 LVR and disallow 100% or 95:5 financing. Kudos to them!

Real Property Gain Tax (RPGT)

Announced during 2010 Budget, RPGT will only be applicable to properties that are sold within five years of their purchase. This is an attempt to curb speculation activities in Malaysia. RPGT will only take effect if you make a profit from disposing your properties within five years of purchase. The tax is on the profit made after deducting allowable expenses such as legal fees and stamp duty paid.

RPGT Tax Structure

But if the property loses value, tax relief is provided for the allowable loss if disposal price is equal or less than acquisition price. There are also exceptions from being taxed which includes:

• Transfer of ownership from husband or wive & vice versa.
• Transfer of ownership from individual to company if you hold shares in the company.
• Transfer of property as collateral to loaner.
• Inheritance of the property.
• Disposal of assets as charity.
• Acquition of property by government under any law.

Citizens and permanent residents also enjoy an exemption of RM5,000 or 10% of the gains whichever is the greater, besides a one-time tax exemption on the gains arising from the disposal of one private residence. This one-time tax exemption is most useful to us and can only be used for one residential property but with a catch. Husband and wife can only be exempted only once jointly. This means that upon ROM, the wife will automatically lose her individual right for exemption if she had not exercised it yet. So for those not yet married but considering to go into property for the 1st time please so do before you go off a anxiously signing your cert as you will lose one right!

Having explained RPGT, tax rates and exemptions might change from year to year especially during budget announcements so keep an ear to it. The next budget for 2011 will be tabled on 15th October 2010.

Is there a bubble brewing? 
Unlike stock market, it is difficult to comprehend whether there is a bubble in making for the real estate market. Thus we need to be on the lookout for signs or clues that gives us possible hints on the current market condition. One of them is from NAPIC (National Property Information Centre). There is a wealth of information in its website, do check the publications section.

Property Overhang Statistics by Quarter

The other clues are the government's reintroduction of RPGT and BNM proposed move to enforce a 80:20 loan-to-value ratio for house financing. From NAPIC, checks on developments completed this year also show that vacancy rates remain at 50 per cent or higher. Such high vacancy rates tells me possibly two things: foreigners buying our property and leaving it empty & Malaysian abroad who have higher purchasing power due to foreign currency. The second is quite possibly as we have as much as 350,000 working abroad and they might buy for retirement which explains the higher vacancy rates as well.

What I do know is that most of the units are taken up by employees of the developer hoping to sell for a profit when the development is completed. Act of greed and greed fuels speculation which in turn results in a bubble. With 2/3 of the Malaysian population surviving with less than RM4,000 a month with another 1/3 earning less than RM700 per month how long can the prices be sustainable in the long run? Asians in general have the habit of family helping other members even in their financials. Ask the current generation of young families and some will tell you their house is not entirely financed by them but helped by parents. Again how long can this go on?

A good chart to show whether bubble is forming would be to compare three things: country GDP growth, house property price appreciation and salary increment in a single index chart. As you can see China's property market is still in good shape with property appreciation in line with household income. I really like the Chinese govt's actions in taming speculative activities. Sadly I have not yet finish on getting US and Malaysia's chart. I will post them as soon as possible.

China property vs GDP vs household income

With that in mind, it would be most wise to keep in touch with the property news, perform meticulous research and not follow the herd or listen to rumours. Always buy within your means and don't buy first and regret later. We all know that the rich or to be rich do things differently than the not so rich people. The same goes to investing. In due time I will develop my own strategies just like how I trade in the stock market.

*I did once say that to borrow money to invest is bad but I would like to expand it further by saying that leveraging is ONLY good provided it has a positive cash flow instead of becoming a liability. Don't borrow if it saps your cash flow for other investments or your savings.