Bread & Butter Properties

Bread & Butter Properties
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Tuesday, March 1, 2011

Rent vs Buy; You decide

Recently, I visited my friend William at his house in Kota Kemuning, Shah Alam for Chinese New Year. He lives in in a very nice super-link house (double storey, 28 x70') in a gated & guarded community, right next to an idylic lake. He and his family have lived there for about a year now and he was thinking of buying it instead of renting. The prices being quoted astonished me although I have been reading about escallating prices of landed properties in the newspaper of late. Property experts have been advising potential buyers to look at the potential price appreciation of such properties to justify the high prices (instead of the low rental yields).

Here is what the buy vs. rent scenario looks like - you make your own decision whether its better to buy or to continue renting.
- At launch, the house was sold by the developer for RM515k, and,
- according to my friend, the last transacted price of a similar house around the corner, was RM650k a few months ago.
- the offer he made to the current owner was RM850k! and this was rejected.
- owner wants a cool RM1.0m for the super link house!

Here's how the numbers look like:
- Assuming property is transacted at RM1.0m, the down payment would be RM100k (90% LTV). Loan amount is RM900k,
- Your instalment would be RM5,002.49 monthly (@4.5% interest rate, for 25 years).
- After 10 years, loan amount still outstanding would be: RM653,926. And, you would have paid RM354, 166 in interests and principal (or your equity in the house) is RM246,074.

Now, get this, the rental for this superb property is RM2k per month only! yes, cheaper than the repayment to service a brand new BMW 3 series car. And, that's with the RM180 / mth maintenance fee included. I think this is an absolute bargain and wouldn't mind living there (but my wife thinks it's too far away from KL - approx 30kms). The gross yield on the property is 2.4%! (calculated as 24,000 divided by RM1.0m)

In any case, the rental paid after 10 years would come up to RM240k (assuming there is no increase in rent, of course). And, if you could afford RM5k per month for loan repayment in the first place, you would have saved RM360k -- which you could have invested in other investments like shares or buying other rental properties. And, hopefully this yielded higher returns than the 2.4% yield on the Kota Kemuning million ringgit house.

Now, lets assume that the property experts are correct and there is massive appreciation - e.g the price of the house doubles to RM2.0m in 10 years -- the return on this would be 7.2% p.a. (Rule of 72) which is pretty reasonable. But, the big question is: can it double in 10 years?

So, what's the house like that worth? this is a difficult question to answer, but I decided to search for some guidance on this. In the UK, rule of thumb for a house's worth is calculated as 15 times its annual rental (not sure why its 15 times? - but, prob the houses don't last as long as they are made from timber?) but lets say our super link house is 25 times, similar to our average loan tenor.  The value should be closer to RM600k (25 x 24,000 per year rental) now, which is a far cry from RM1.0m asking price.

In summary, the decision really comes down to:
- do you think the property can appreciate (in this case, doubling in the next 10 years) to justify the higher price you are paying? and,
- if you could afford the RM5k / mth instalment, would you be better off investing the extra RM3k to get higher yields, while continue to rent the house at RM2k/mth instead?

Feb 2011

copyright Chris Gan@2010,

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