How rising Compliance Cost is impacting Housing Affordability in Malaysia

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Many are quick to blame developers for rising property prices but fail to realise that most developers’ financial burdens have been steadily increasing over the years as well.

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Houses in Malaysia are getting more and more “expensive”. This has been re-litigated for years, especially in the past decade, as homeownership became more and more out of reach for the younger generation. High property price is often blamed upon “profit-seeking” developers who are in favor of building overpriced houses and eventually causing a high number of overhangs in the housing market. 

While such an argument is prevalent, it is, in fact, biased and incomprehensive – in the sense that it overlooks an important cost factor that is incurred in housing development. Other than land cost and construction cost (including labour and building materials cost), the compliance cost (which is referred to as an expenditure derived from complying with set regulations) is also the main contributor to today’s high house prices. 

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What is compliance cost?

In common practice, compliance cost is levied on developers, in order to shift the responsibility of funding new growth-related infrastructure from the government to the developers. This cost can come in different forms, with the common one incurred from land conversion premiums and contribution charges paid to utility companies.

Part of these costs goes to the Improvement Service Fund (ISF) for purpose of the beautification, construction or laying out of any public infrastructure, open space or water-course; whereas the capital contributions go to utility providers (Tenaga Nasional Bhd, Telekom Bhd, Indah Water Konsortium Sdn Bhd and water authorities such as Syarikat Bekalan Air Selangor Sdn Bhd) for the provision of sewerage, telecommunication services, water and electricity in their projects. In either form, this cost will eventually be passed on to the free market house buyers, causing a relatively higher selling price.

How has compliance cost influenced property prices in Malaysia?

Looking back at house prices and development costs over the past 20 years, the growing wedge between these two illustrates that the cost of doing business has been trending upward over time, especially in those high-growth urban areas. The accumulation of regulatory barriers such as Bumiputera quota, mandatory building of price-controlled social housing, rigid planning requirements, one-size-fits-all housing standard – are all the main causes of growing development cost. As these artificial limits on housing development are increased or tightened, so does the cost and the time required to efficiently produce houses.

How expensive is building/construction cost in Malaysia? 

It is pretty low. Figure 1 shows the average per square meter of building cost for selected global economies. It is derived from six different building types: (i) medium standard terraced house, (ii) detached house, (iii) medium standard low-rise apartment, (iv) medium standard high-rise apartment, and (v) affordable unit. The average building cost per m2 recorded in Malaysia – USD650 – is on the lower end, which is much lower than Hong Kong (USD4,237), Singapore (USD2,250), Japan (USD2,093) and South Korea (USD1,586). Correspondingly, these countries do have a relatively higher house price compared to Malaysia. 

Figure 1: Average building cost (USD/m2) for selected global economies (Source: Turner & Townsend)

When comparing the per meter square of average house price (USD/m2) among countries worldwide on NUMBEO, it is found that the house price (per m2) in Malaysia (USD1,668) is actually not as “expensive” as it is commonly perceived by locals. It is far behind most Asian countries like Hong Kong (USD23,977), Singapore (USD12,505), South Korea (USD8,311), Taiwan(USD6,149), China (USD5,205), and Thailand (USD2,689).

Even if Malaysia’s house price is compared with other developing Asian countries, which have a relatively lower GDP per capita like Vietnam, Iran, Philippines, Sri Lanka, Nepal, India, Iraq, and Indonesia; house price in Malaysia is still not “expensive”, considering the quality, standard, and the size of houses being offered. This justifies that Malaysia is pretty much relying on labour-intensive cast-in-situ construction methods to keep the building cost as well as house prices low

READ: What is a Sales and Purchase Agreement (SPA) in property?

What about preliminary (compliance) cost? How expensive is it in Malaysia?

This is where things get interesting. When the average building costs are cross-referenced with the average % of preliminary costs (the driver of overall construction costs) – one can find that the preliminary costs in Malaysia (11%) is on the high side; not only that it is higher than Singapore’s 8% and China’s 7%, but is also close to the one in Hong Kong (12%) and South Korea (12%) (Figure 2). This implies that the cost pressure in the country’s housing market is high, and is likely to be derived from a high degree of restrictions caused by regulatory barriers. If house prices in Malaysia are perceived as expensive – which is not true based on the international standard – while having a rather lower building cost and higher preliminary cost; it is clear how significant the impact of artificial limits can be on the overall house price.

Figure 2: Percentage of preliminary costs for selected global economies. (Source: Turner & Townsend)

What are the effects of high compliance cost on house prices?

One should be aware that as a “profit-oriented” organisation, developers would not simply suffer any losses. Any costs imposed by the government will eventually be transferred back to the buyers, causing a higher unit selling price. Homebuyers will then be forced to take out larger home loans, and end up paying more interest over the life of the mortgage. 

The significance of the impact of compliance cost on the unit selling price is illustrated in Figure 3, where the amount of compliance cost can range from RM9,000 to RM150,000 or from 2.1% to 35.1% of the typical unit selling price. As one can observe, the impact of compliance cost to unit selling price tends to be more significant in landed development, as it involves the opportunity cost of land surrendered for infrastructure or public services associated with the development.

Figure 3: Impact of compliance costs on house prices. (Source: REHDA Selangor)

From a wider perspective, planning requirements and other man-made regulatory restrictions not only increase the cost of doing business but also pose huge pressure on urban land use and development. In an attempt to quantify the impact of planning requirements on land use, simulations are carried out. Four scenarios are developed, comprising of 50 acres, 100 acres, 150 acres, and 200 acres square flat land, with each of these scenarios containing the following conditions as stipulated in the Selangor New Planning Guidelines (Table 1).

Table 1: Conditions and requirements used for simulation

Land Use Requirements
Residential
  • 80% of free-market unit yield for 20’ x 70’ terrace houses
  • 20% of free-market unit yield for condo @ 60 units per acre
  • 50% of total unit yield for RSKU @ 60 units per acre
Commercial
  • 1 shop of 22’ x75’ for every 60 houses
  • 30% of number of shops dedicated for 18’ x 65’ low cost shops
Community facility
  • By catchment, household size is 4
Open space
  • 10% of total land area
  • 5% buffer (assumed 6m along the perimeter of site boundary, 30m buffer for sewerage treatment plant (STP) and 12m for water tank)
Roads & infrastructure
  • 50ft (15.24m residential road) as stipulated in new planning guidelines
  • 5% detention pond / KTA

As shown in Figure 4, the larger the development scale, more acres of land are devoted to the development of community facilities and infrastructure & utilities, with the percentage of land use increases from 31.65% to 44.56%. Meanwhile, land used for residential and commercial development is declining, from 48.81% in a 50-acre development to 40.51% in a 200-acre development, indicating losses of developer due to fulfilling the planning requirements. In order to compensate for the lost acreage, as well as to maximize the revenue with the set land price, developers tend to launch high-end houses rather than houses that meet the mass-market buyers.

Figure 4: Percentage of land use with varying development scale (Source: REHDA Selangor)

In another example, assuming 500 units of 900-square foot average standard apartment dwelling, with the selling price of RM300k for each unit, are to be constructed on a 5-acre parcel of land that is subject to the density of 100 units per acre (Figure 5). The total development cost per dwelling unit will be RM255,069 and the respective profit margin is 11% of the unit selling price, which is relatively lesser than any other common average standard high-rise developments with a profit margin of 15%.

Figure 5: Breakdown of development cost for an RM300k affordable apartment unit. (Source: MKH Berhad)

In this sense, we can conclude that high housing prices not only reflect high consumer demand for a particular area, but also reflect some sort of restriction on supply. In places where housing is expensive, building restrictions appear to have created these high property prices. As such, in a climate where housing affordability is a policy objective for the government, it is imperative for the government to review and lower down or even abolish unnecessary charges. When the costs of doing business are reduced developers would be more incentivised to build more houses with affordable pricing.

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Why is the compliance cost so high for developers in Malaysia?

Often, there is little to no recognition from the government that the housing industry is heavily regulated by various laws, policies, guidelines and standards. These regulations are imposed at federal, state, and local government levels; and have been ever-tightening and served only to increase the challenges faced by industry players to maintain their survivability. If the cumulative costs are too high, it will have long-run negative impacts on housing affordability as well as availability.

Based on a survey done by REHDA Selangor on 8 projects in Klang Valley, compliance cost is found ranging from as low as RM4.6 million to as high as RM471 million. The survey also revealed that compliance cost can make up the bulk of the development, ranging from 2.8% to 19.9% of GDV in high-rise development, or from 9.5% to 35.1% of GDV in landed development (Figure 6).   

Figure 6: Range of compliance cost for projects in Klang Valley, benchmarked with GDV. (Source: REHDA Selangor)

Such compliance cost is contributed by: (i) processing fee; (ii) statutory contribution; (iii) land matters; (iv) development of price-controlled social housing; and (iv) external Infra upgrading work. In high-rise development, statutory contribution is the major contributor of compliance cost, ranging from 30.5% to as high as 93.2%, mainly attributed to development charges, utility contributions, premiums for substation and so on. 

Figure 7: Components of compliance costs. (Source: REHDA Selangor)

In the case of landed development, land surrendered for the development of price-controlled social housing and social amenities infrastructure are the main major contributors of compliance cost (Figure 7).  

Why is it imperative that the government bring down the cost of housing production?

Most of the time, projects that do not meet the developer’s “reasonable profit margin”, where compliance costs play a significant role in influencing the project’s viability, will usually not come to fruition. As shown in Figure 8, a 20% reduction in compliance costs, in whatever form, can increase the profit margin to 12%; while, a 50% reduction in compliance costs can increase the margin to 14%. A reduction of compliance costs as high as 70% can even increase the margin up to 15%, which will inevitably incentivise developers to get involved in the affordable housing market segment. 

Figure 8: The impact of reduced compliance cost on project viability. (Source: MKH Berhad)

To note, the above calculation only considers the impact of direct compliance costs on project viability, without taking into account the indirect costs incurred by land surrender, subsidies for price-controlled social housing and Bumiputera quota, as well as restrictions imposed by various planning and building requirements. 

But, one can foresee that the sun-setting of any outdated and onerous rules while implementing thoughtful and cost-effective ones, will be sure to assist in further reducing the cost of housing production, and thus, preserving housing affordability.

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