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In the previous two articles in this series we've examined the differences between buying and renting from a financial perspective, and looked at the calculations behind a real life example. Our analysis was however focused on the short term, so now we need to delve deeper and look at long term implications.
We're going to continue on from the previous example, so if you need a refresher, the articles are here:
One of the biggest problems for Malaysians today is the lack of affordable housing, especially in major urban areas. Property prices have soared over the years and even with the recent slow down are still beyond the means of the majority of the population. In this market, is renting better than buying, long term? How do the numbers work out?
To recap briefly, with a fixed amount of savings in hand, we had the choice of either renting or buying the same property. We could rent it for RM 1,500 a month, which would effectively cost us about RM 14,531.5 a year (and this number would decrease every year) or we could buy it outright for RM 600,000, which would cost us RM 33,600 a year (without including any principal payments, i.e. this figure is solely for interest payments, service fees etc, or in other words the cost of borrowing money and holding the house, not the cost of the house itself).
Now, on a short term basis its quite clear that in this scenario, renting is much cheaper than buying. Who would pay RM 33,600 when you could just pay RM 14,531.5? That's a difference of RM 19,068.50 which is a whole lot of nasi lemak and cendol in your tummy.
But of course there is a big variable in this, which is that property prices can change, and hence the value of your equity in the house can change too.
If the value of your RM 600,000 property went up by 3.17% every year (ignoring real property gains tax (RPGT) for the moment), it would cover the difference of RM 19,068.5. And we all know that is possible; in 2015 alone house prices rose over 5% and even that was the lowest annual rise since 2009. In 1995 house prices rose 18.4% in a single year, and in 1991 they rose a heart stopping 25.5%!
So 3.17% per year is well within reason right? Sadly, this is not the case. In bad years, we've seen property value drops of over 30% in many areas. Many buyers from those heady days still haven't recovered in 2016.
There need to be catalysts for house prices to rise or decline, whether its interest rates, market demand, a good / bad economy, supply issues, tax incentives, speculative activity, willingness of banks to extend loads and so on. It isn't a good policy to just assume house prices will keep going up for no reason. Malaysia has seen a huge headwind of positive catalysts in recent years, resulting in the housing boom, which then acted as a self fulfilling prophecy.
People were increasingly willing to pay outlandish prices for property, knowing that whatever they paid, next year someone would pay an even higher amount. But it would be very unlikely for house prices to continue increasing non stop without a break, without very strong supporting fundamentals (which in Malaysia's case are generally not present).
We all know of terrace houses that not too long ago cost RM 400,000 which now sell for RM 1,600,000. If you were to extrapolate the same amount of time into the future, in order to see the same percentage gain, we'd be talking about a value of RM 6,400,000! If people can't afford RM 1,600,000 today, how are they going to be able to afford RM 6,400,000 in the future, for the same property, unless incomes dramatically increase? It is therefore unlikely that prices just keep increasing for the sake of it. Incomes and other factors need to play catch up first.
Now, let's look at what happens if the value of your house drops by only 3%. You still have to pay the difference of RM 19,068.50, but in addition, your house is now worth RM 18,000 less. Considering that many people in Malaysia are already spending up to 80% of their income on their mortgages, its easy to see how even a small percentage drop in the housing market can spell serious trouble for homeowners.
In our example, if the house price were to keep increasing at a good rate, say 10% a year, then without a question buying is better than renting, the house will pay for itself and you shouldn't rent, even if its for free because the amount you get from the house still exceeds the free rental. But if house prices fall, stay stagnant or even appreciates at a low rate, then the equation favours renting, because the cost of buying the house will never be less than the cost of renting, and you'll actually lose money when you sell.
There are a number of calculators online that help you work out this very problem, so now that we've taken you through the basic principles, we won't bother reinventing the wheel. The calculations are perfectly applicable for the Malaysian context, just assume that $ means RM and you're good to go.
Here are some of the better calculators we've looked at:
So that finally concludes our series on the subject.
Till next time, stay safe and be jolly!
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Part 2 of our series on whether to buy or to rent in Malaysia (and anywhere really!). We go through a real life example to compare the financial impact of the 2 scenarios.