Everyone wants to make a quick buck here and there, but property investment is a long-term game. Let’s hear a real-life case study on how you can make money in property.
In the early 1990s, a client bought a condominium unit that is 1,396 square feet, comprising three bedrooms and two bathrooms at Taman Tun Dr Ismail. The price after the Bumiputera discount was RM190,000. The condominium was completed in 1993.
The condominium’s latest transacted price last year was averaging RM600 to RM620 per square feet. Taking the conservative average of RM600 per square feet, it is valued around RM837,000 today.
Resident real estate negotiators advise that owners are not going to sell anything lower than RM860,000 now. It is a wait and see strategy adopted by owners with no urgency to sell, anticipating higher values post pandemic.
A simple arithmetic of the numbers brings the capital appreciation to 341%, bringing the Compounded Annual Growth Rate (CAGR) to arrive at about 5.1%
Does this sound impressive? Is is that easy to make money in property?
Make Money In Property, But…
Maybe, and if you are using the property for own stay, you will be experiencing comfortable paper gains. However, if this property has been acquired for investment purposes, you will need to take into account these factors to calculate your return on investment:
- Vacancy costs
- Agency costs
- Legal fees (for exiting or selling off the property)
- Repair & modernisation costs (it is 30 years old!)
- Building maintenance service fees
- Mortgage borrowing costs
- Yearly assessment & council taxes
- Tax (on rental income & exit cost for future capital gains)
Due to limited data on the actual Internal Rate of Return (IRR) of this property, I do not have the rental income data as this property was bought over by my cousin for his own stay a few years after this condo was completed.
But let’s give some hypotheticals:
– Rental income during the 1990’s was RM650 and it increased by 10% each year (working out to RM2,400 today, which is conservative for a fully-furnished unit today transacting at an average of about RM2,700 to RM2,900).
– Annual council and assessment taxes at RM300, service charges at RM300 per month and assuming full tenancy. (This is considered on the upside already.)
– 90% margin on mortgage financing, a 4% interest rate, real property gains tax at 5%, agency selling fees at 3%, selling at RM600 per square feet
(RM837,000) at the 30th year.
– Assume a one-off major modernisation cost for kitchen and bathrooms amounting to RM100,000.
7.16% Return Good Enough?
With that the computed annualised IRR is 7.16%. This is comparable to returns of a moderate aggressive asset portfolio.
Is this a good way to make money in property? A standard economist answer would be, it depends…
If you are the original owner, you will likely be enjoying a nice cash flow monthly as a landlord or liquidating with a net gain of capital (after deducting taxes), that could be partially funding retirement. Then you can say that by buying and holding, it is a sure way to make money in property.
But do bear in mind, it took thirty years for real estate values to reach to these levels, so it is not quite straight forward to make money in property. Having said that, it is also worth highlighting that cash flows enjoyed monthly is subjected to LHDN taxation.
The Tax Man Is Here
According to Section 4d of the Income Tax Act 1967 LHDN, “the letting of real property is treated as a non-business source and income received from it is charged to tax under paragraph 4(d) of the Income tax act 1967 if a person lets out the real property without providing maintenance services or support services (such as cleaning services and repairs) comprehensively and actively”.
In layman terms, this means that you are letting out the residential property and deriving passive income from it. If you own one or multiple properties (bought or inherited) that is not used for business purposes, you are required to pay income tax.
Net rental income is subjected to a progressive income tax rate from 0-30%. These are tax deductible items permitted by LHDN that can be used to derive net rental income for an investment property on residential properties:
- Assessment and quit rent is the annual assessment paid to the local authority and quit rent to be paid to the land office.
- Interest portion on the mortgage to finance the purchase of real property which is rented out. (Do note that it is only the interest portion of the mortgage that is deductible and not the total monthly mortgage amount).
- Fire insurance premium paid in relation to the insurance policy taken on the real property which is rented out.
- Expenses on rent collection such as rent collection fees and legal expenses incurred to enforce rent collection.
- Expenses on rent renewals to renew tenancy or change tenant.
- Expenses on ordinary repair to maintain the property in its existing state.
Other things to consider whilst keeping real estate as an investment in your overall portfolio are:
- Do you have the holding power?
- Is there a maximum ceiling price to this condo?
- Can you stomach vacancies or deal with (troublesome) tenants?
- Do you have the willpower to deal with perpetual repairs, refurbishments and maintenance related to the upkeep of the property?
To some, these are hidden costs that can’t be quantified and are not worth the time and the headache. They would rather put their capital elsewhere in an asset like a mutual fund that takes minimal effort and see it grow annually at the rate 6-7%.
The question also would be, can we expect these kind of returns for newer residential projects 20 to 30 years down the road? Is it still going to be easy to make money in property?
Now I wish I had a magical crystal ball to look in the future, so I can make money in property.
About the Author
Rozanna Rashid is a Director at Alpine Advisory, a financial planning firm. A former corporate banking relationship manager, Rozanna is currently a Licensed Financial Planner (CFP, IFP). She holds an MSc in Real Estate, Economics & Finance from the London School of Economics & Political Science. She can be contacted at firstname.lastname@example.org