Back in 2018 I wrote about owning a home as part of one’s asset allocation strategy. A home is a unique asset because you can simultaneously enjoy staying in it while watch its value go up over time if it is in a good location. When you have retired, an unencumbered home with a paid off mortgage provides peace of mind while you relax in your golden years.
This being said, generally the prices of houses have gone up faster than incomes could keep pace over the decades. This puts extra burden to save for the home downpayment and the ensuing home renovation and furnishing. Homes in good locations are also perpetually in high demand and carry a premium price. If buying a home feels like an impossible dream, should you feel disheartened?
Stability vs Flexibility
Owning a home can provide a sense of stability and belonging that renting cannot. You become emotionally attached to it and anything that you improve on the home is yours to enjoy. There is no landlord or house owner who can suddenly decide to sell the house and evict you from the premises. If your mortgage has fixed interest rates then you will not be caught with rising monthly payments when interest rates go up. Those monthly payments also stay the same even when the prices of everything else go up due to inflation.
However, a house is an illiquid asset and buying or selling houses incur high transaction costs such as agent commission, bank’s fee, lawyer’s fee, fees to the local governing bodies and so on. The outstanding amount on the mortgage that you have been diligently paying may still be high because in the initial years, most of your monthly payments go towards paying off the interests and not the principal amount. Additionally any home improvements spent on the house may not result in a higher selling price. All these factors make it costly to sell your home if you have just bought it a few years ago.
When you are just starting out to work, it is important to be flexible on where to work because you do not want your career choices to be limited to a specific location. When I started working in Malaysia, my first work location was in Sungai Buloh, which is an industrial town located in the north Klang Valley area. Several years after that, I worked in Cyberjaya, which is a city in south Klang Valley. The traveling time between the two locations is more than an hour. If I had bought a home in Sungai Buloh earlier I might not have considered taking a job in Cyberjaya, which ultimately led to better career prospects.
Building Equity vs Paying Rent
The age old criticism of renting is that you are giving away your money to the landlord or home owner when you could have used the money to build your own equity in a home. Equity means the value that you own in your home.
When you purchase a home with a mortgage, you don’t actually own 100% of the value of your home. You own whatever amount that was paid as the downpayment while the bank owns the rest and keeps the title to your home. Legally, the bank owns your home while you pay down the mortgage. The upside is that when the value of your home goes up, all 100% of the capital gain goes to your equity.
In the initial years of your mortgage payment, you will find that the principal amount owed to the bank goes down slowly. This is because in those years, a higher proportion of your monthly payment goes to paying off the interest rather than the principal. What this means is that your equity grows slowly in those initial years even as you make timely monthly payment. If you sell your home not long after buying it, you will not get a lot of equity from the monthly payments made.
Chart generated from creditkarma.com based on a hypothetical 300K loan over 30 years at 5% interest
You obviously build no equity when renting a home. Financially, renting can thus only work if the monthly rental is much lower than the monthly mortgage payment of buying the home. The amount that you save by renting should then be invested in an asset that gives you a return higher than the appreciation of the home. If the difference is not great or if you plan to invest the difference in a poor performing asset (like fixed deposit), then it is better that you buy the home instead.
Generally, landed properties have lower rental yield compared to condominiums and apartments. In Klang Valley, it is not surprising to find terrace houses that have rental yields from 2% to 4%. In the US where I am at currently, the rental yield of single family homes in my area is around 2.5%. If you then subtract from the rental yield the 1.2% property tax and home insurance that yield goes down to around 1%.
With a low rental yield and a mortgage interest rate that is above 4% in Malaysia and 7% in the US right now, it can make sense to rent a landed property when the rental amount is multiple times lower than the mortgage amount. But never forget to invest the difference in an asset that yields better than the home price appreciation.
Lack of Alternate Investment Choices?
In Malaysia, it is common for people preferring to invest in properties over other asset classes such as equities and bonds. It is partly due to the local culture as buying a home is regarded as a step in establishing stability when starting a family.
It is not surprising for people to think that properties are as safe and certain as fixed deposits. After all prices only seem to go up and in specific locations and property types, the price appreciation outpaces inflation and even the KLCI index in the very long run.
There is a strong bias and societal pressure towards buying your first home in Malaysia. There seems to be no better alternative in Malaysia to direct your savings. As a result, sometimes you hear stories of people being over-stretched financially so that they can purchase their dream home.
In reality, there are other ways to play this game, such as renting your home while buying properties in Malaysia for investment. This is a win-win situation as landed property rental yield is low while property investments in the right location can give a decent return in the long run.
If you have a higher risk tolerance, you could also invest in foreign equities directly or through plain vanilla index tracking ETFs. The US stock market for example, out-performs the price appreciation of properties in Malaysia while the US dollar currency has been strengthening against the Malaysian Ringgit since the 1980s.
The Home Endgame
I do not think there is a straight forward, one-size-fits-all rule to determine if one should buy or rent their home. The factors mentioned above may not apply to everyone and to every location. However, personally I think, the endgame should be to secure a home for retirement by owning it 100% and not renting perpetually. This means no longer having an outstanding mortgage on the home when retired.
My key consideration is that during retirement I’d want to minimize my fixed monthly commitments and have peace of mind to enjoy my golden years. Sure, there can be occasional large expenses to maintain the home but I can minimize that by having smaller homes and generally owning less ‘stuff’. After all, the more you own, the more you have to maintain.
If I need a large space for family gatherings, I can always look for an AirBnB or book a holiday getaway for the family.
One trade off for owning the home and having no mortgages is that my wealth that goes into purchasing the home does not earn any cashflow to fund my retirement. When determining how much nett wealth I need to accumulate before retirement, it’s useful to decide how much I am willing to set aside for the home and subtract that away from my income/capital gains generating nett wealth.
Besides financial consideration, it is also important to be close to friends and family members and/or be part of a community when retired. After all, lots of research have shown that quality, long lasting relationships are key to happiness. The location of the home can therefore be different from the home where you’d worked and raised your children. Hence buying a home in your younger years does not necessarily mean that you will be staying there forever.
The Finance Durian 