Rising property prices - paper gains mean nothing

In our article last month, we highlighted the report by Khazanah Research Institute on ‘Making Housing Affordable’, which showed that the Malaysian all-house price index grew steadily at a compounded annual growth rate (CAGR) of 3.1% from 2000 to 2009, and suddenly accelerated at a CAGR of 10.1% between 2009 and 2014.

Many existing property owners are overjoyed to see steep price increase in their properties compared to the cost of acquisition. These gains are referred to as ‘paper gains’ as the gains have yet to be realised and only exist on paper. However, we at the National House Buyers Association (HBA) are of the opinion that steep price escalations especially within a relative short span of time are not necessarily a good thing. For purpose of case study, we use the real life stories of some of our volunteers who were willing to share some data of their property purchase.

An overview of the type of properties bought by our volunteers together with their income levels and current property values are outlined in Table 1.

Based on Table 1, it would be reasonable to assume that Deepak, Ismail and Rachel should be happy with their ‘paper gains’, but looking at it deeper will reveal a very different situation.

Shrinking target market

In 2004, Deepak, Ismail and Rachel managed to buy their first home based solely on their salaries and the price was within the three-times annual income, which was considered as ‘affordable’.

However, just 10 years later and despite climbing up the corporate ladder, all three of them would find it ‘seriously unaffordable’ to ‘severely unaffordable’ to buy the same property based on their current salaries. This would also mean that other executive level wage earners to the senior management wage earners will also find it ‘unaffordable’ to buy the same property.

This will effectively mean that the target market for Deepak, Ismail and Rachel should they want to sell their current house has shrunk significantly. With a median annual household income of RM91,4402 in Kuala Lumpur for 2014, Rachel will discover that half of the population in Kuala Lumpur cannot afford to buy her modest apartment. Rachel can only hope to find joint-buyers in the middle management position with annual household income of at least RM166,667 to buy her apartment to be deemed as ‘affordable’.

The situation is equally bleak for Deepak and Ismail who could afford to buy their landed property just a decade ago whilst only in middle management position. Deepak and Ismail must also hope to find joint-buyers in senior management position with combined household income of at least RM183,333 and RM266,666, respectively, to buy their intermediate link house.

New purchase is also out of reach

We have ascertained that based on their current salaries, Deepak, Ismail and Rachel will find it ‘unaffordable’ to buy their current properties. This would mean if they want to acquire another property, they would have to dispose of their current property and hopefully, with the gains and cash from selling their current house, be able to afford something bigger and better.

However, based on our calculations in Table 2, even after disposing of their current properties, Deepak, Ismail and Rachel still cannot afford the ‘upgraded property’ that they desire.

From Table 2, we can see that back in 2004, the loan instalment was about 16% of their respective salaries. This is well within the range that Bank Negara’s ‘rule of thumb’ that the maximum single loan instalment is a third of the borrowers’ income and maximum combined loan instalment is half of the borrowers’ income.

From the above table, we find that despite disposing of their current property which has enjoyed steep gains, the new loan instalment as a percentage of their respective incomes is much higher than before, ranging from 43.47% to 55.07%. This would imply that to buy their upgraded property, buyers like Deepak, Ismail and Rachel will have to spend a larger chunk of their income and reduce on other spendings and possibly have no spare cash or savings to weather any sudden emergencies.

Increase in market value does not equate to increase in built quality or living quality

Without insulting any house buyer, a property that cost RM140,000 to buy from a developer will always be a “RM140,000 property”. Just because the market price has increased to RM500,000, it does not mean that the quality has suddenly improved, giving the new buyer a RM500,000 ‘built quality property’. This is the situation faced by many prospective house buyers; that the prevailing prices of properties, both existing and new properties offered by developers, do not reflect their built quality and living environment. Basic ‘bread and butter’ properties that were affordable for the lower- and medium-income earners just 10 years ago are now even unaffordable for the high-income earners.

As a result, many younger house buyers are willing to settle for smaller but cheaper units. Capitalising on this new trend, developers are building more smaller units that are actually studio-styled shoe-boxes with one or two bedrooms of no bigger than 650 sq ft, and priced them at around RM500,000 so that joint middle-income earners can afford it. But is it really worth paying so much for something so small? In the long run are such small units conducive for family living?

Is there a magic number?

Conventional wisdom has taught us that investing in properties is the best hedge against inflation in the long run. Many prospective house buyers want to invest in properties as a retirement fund or to fund their children’s education and hope that the returns from investing in properties are higher than merely keeping their money in the bank. Hence, every house buyer wants to see healthy appreciation in the value of their property.

However, when property prices escalate too fast within a short span of time, it can be harmful even to current owners, as shown above, when it is difficult for owners to sell their current property or upgrade to a larger property. Paper gains are only paper gains until the property is sold, but when your ‘bread and butter property’ is no longer affordable to half of the population, something has gone terribly wrong somewhere. Existing property owners cannot afford to upgrade their current properties and buy something ‘bigger and better’ and are stuck with their current homes. Clearly, such a situation does not benefit even existing property owners.

There is no real magic number per se on what is the acceptable or maximum annual increase in property prices. So long as the annual property increase is higher than the inflation rate and the rate of fixed deposits offered by banks, and still affordable to its intended target market, house buyers who buy for their own stay and for long term investment should be contented. - By National House Buyers Association (StarProperty)

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