Rising property prices – Paper gains means nothing

Steep price escalations, especially within a relatively short span of time, are not necessarily a good thing.

A report by Khazanah Research Institute on ‘Making Housing Affordable’  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 by 10.1% between 2009 and 2014. Many existing property owners are overjoyed to see a 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 realized and only exist on paper.

However, here at the HBA, we are of the opinion that steep price escalations, especially within a relatively short span of time, are not necessarily a good thing. For purpose of a case study, we use the real-life stories of some of our volunteers who were willing to share some information and personal data of their property purchase.

An overview of the type of properties bought by our members, as well as their income levels and current property values, are outlined in Table 1 below.

Based on table 1 would be reason able to assume that Deepak, Ismail and Rachel should be happy with their ‘Paper Gains’. Delving deeper, however, will reveal a very different circumstance.

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.

Shrinking target market

In 2004, Deepak, Ismail and Rachel managed to buy their first home based on their sole salary and the price was within the 3-times annual income and was considered as ‘affordable’. However, after just a span of 10 years, and despite climbing 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 all the way up 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 in 2014, Rachel will discover than 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 as bleak for Deepak and Ismail who could afford to buy their landed property just 10 years ago, whilst only in middle management position. Deepak and Ismail must also hope to find joint buyers in a senior management position with a combined household income of at least RM183,333 and RM266,666 respectively to buy their intermediate link house.

Next/additional property 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, they will be able to afford something bigger and better.

However, based on our calculations in Table-2 below, even after disposing their current properties, Deepak, Ismail and Rachel still cannot afford the ‘upgrade 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 Malaysia previous ‘rule of thumb’ that the maximum single loan instalment is 1/3 of the borrowers’ income and maximum combined loan instalments is 1/2 of the borrowers’ income.

From the above table, we find that despite disposing off 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 upgrade property, buyers like Deepak, Ismail and Rachel will have to spend a larger chunk of their income and compromise on other aspects of their lifestyle and possibly have no spare cash/savings to weather any sudden emergencies.

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

Home buyers have to remember this – a property that costs RM140,000 to purchase 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. Capitalizing on this new trend, developers are building more smaller units- studio styled shoe-boxes selling 1 or 2-bedrooms in a unit no bigger than 650 sq feet and pricing it around RM500,000 so that joint middle-income earners can afford it.

But is it really worth it to pay 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 such monies in the bank. Hence, every house buyer wants to see their properties experiencing a healthy appreciation in value.

However, when property prices escalate too fast and within a too short span of a time, it can be harmful even to current owners as shown above when it is difficult for owners to dispose their current property or upgrade to a larger property. Paper gains are only paper gains until it is sold and realized 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 be affordable to its intended target market, house buyers who buy for own stay and for long-term investment should be contented.

ALSO READ: Traits of a responsible housing developer

Notes:
1. The Household Income and Basic Amenities Survey 2014 by the Department of Statistics revealed that the Median Monthly Household Income for 2014 in Kuala Lumpur was RM7,620 or RM91,440 per annum.

2. This article is courtesy of Chang Kim Loong, Secretary General of National House Buyers Association ( HBA).

 

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