Does an increase in your property value translate to real wealth? Ikhram Merican explores further.
Many years ago, my father built his dream house in Petaling Jaya. It was a masterpiece of its time. He hired a well-established architect from Canada, and together with my mum raised a beautiful structure. Not so many years later, my father’s company was forced to restructure. Top management was laid off, including my father. Keeping the house became a burden. Eventually, my parents decided that they would have to sell it.
Although they were not very happy at the prospect of selling the house, they were not too worried. They knew that after they sold this house, they would still have enough equity to buy another bungalow, with cash to spare. It was going to be a small downsizing exercise that is all. They were very wrong. Two years passed without a buyer in sight. By this time, they had gotten desperate. The house was eventually sold at a loss.
This episode taught me an important lesson – understanding liquidity is crucial to your financial well-being.
Valuation has little meaning
In any investment, there is a big difference between paper gain and real gain. Many investors do not realize this and if they do, it is easily forgotten. Everyone buys property with the expectation that the value of that property will increase. Most of the time it does. But does an increase in your property value translate to real wealth?
I know of a person who wants to sell his apartment. The market value of the property is RM3.35 million. He bought it at RM2.2 million. The gain looks great on paper. However, he has been trying to sell it for over a year now. The property value means nothing to him in the present.
Until he can sell the apartment, even a value of RM5 million would mean very little to him.
If his circumstances were to become difficult and the bank forecloses his apartment, he may not have a property and still be in debt.
Properties are not very liquid
Amongst the many investment vehicles out in the market, properties remain one of the best. It is relatively safe, and through leverage can yield fantastic returns. However, properties are not liquid. You can convert shares into cash almost immediately. You could make a withdrawal on your fixed deposit as soon as the bank opens if you urgently need funds.
But you cannot convert a property into cash overnight. Even if you found a buyer for your property today, it would take anywhere from 3-6 months to complete the transaction.
Avoiding liquidity pitfalls
You may be tempted to think that only high-end properties have liquidity problems. You would be wrong. Apart from the fact it takes 3 months or more to complete a sale transaction, there are other factors that can prolong the sale of any property. A RM300,000 house in the Klang Valley may be difficult to sell because it is next to a sewerage treatment pond.
An otherwise attractive and affordable apartment may be impossible to sell because there was a suicide on the same floor. Some liquidity factors may be outside your control but with a bit of planning, you can make it easier to liquidate.
1. Remember that property is not very liquid
Never plan to rely on your capital gain for emergencies. You need to have very liquid assets like cash, stocks, or insurance as contingency reserves, not property.
2. Plan your exit
When you buy a property, plan your exit strategy. You may want to sell it after 10 years to upgrade or perhaps sell it to pay your son’s college tuition. Either way, knowing when you want to exit is important to realise a gain.
3. Look at demand factors
Buy properties with strong potential for demand. You should consider infrastructure, connectivity, affordability, and layout of the property.
4. Emphasize perceived value over market value
Your property may have a market value of RM500,000 but if it is perceived to be worthless because it is rundown, you will have a tough time finding buyers.
Properties are great investment vehicles but it is very important to know how to manage its liquidity factor. The ability to manage this is the difference between a sound investment and a risky investment.