Things to consider when buying a property

In Nov 2017, Maybank Islamic launched its Rent-to-own (RTO) scheme, the first bank in Malaysia to do so. The scheme was designed to ease the burden of potential buyers from securing a housing loan, by waiving the required down payment. While RTO is quite new to Malaysia, this scheme has actually been around for decades, overseas. With RTO, a property buyer is given the option to purchase the rental property at a future date.

There are many articles about the pros and cons of the RTO scheme. It is generally agreed that the RTO scheme will result in a total higher cost for the property owner (down the road) compared to the conventional mortgage. But for those with cash flow problems, especially millennials who are unable to fork out monies for the initial down payment, the RTO is an avenue to own your own residential property.

Furthermore, in the initial rental period, there would be some savings under the RTO scheme. The Aug 2020 Maybank HouzKEY Product Disclosure Sheet gave an example where the difference in payment between the HouzKEY scheme and a housing loan was about RM 120,000 less. This was for a RM 500,000 home and during the initial 5 years of the loan.

A couple of months ago iProperty.com published a summary of the RTO scheme in Malaysia titled “A Complete Guide on Rent-To-Own (RTO) scheme in Malaysia”. Look up the article if you are not familiar with the benefits of RTO and how it works. All these articles focus on the cost side. There is an alternate perspective – the opportunity side that has not been talked about. Don’t get me wrong, the RTO is a good scheme for those with financial constraints. But like all ideas, there are unintended benefits and I would like to point out one such possibility. This is a contrarian view but given the economic climate, it is an option worth considering.

Do keep in mind that this initiative should only be considered by those who have the means to pay for the down payment and make the monthly payments under a conventional housing loan. The idea is that:

- Instead of using his own monies/savings for the property down payment and monthly mortgage payments, a person can use the RTO scheme to finance his home purchase.

- The savings from the down payments and monthly mortgage payments during the rental period can then be channelled to make money from stock investments.

An analysis using the Maybank HouzKEY example shows that you gain by investing the RM 120,000 with a 5% annual return. At the end of the 33 years period (3 years construction and 30 years loan), you will have about RM 256,000 in your bank account. Compare this with the situation considering only the cost where you lose money.

Getting a 5% return should not be an issue as the EPF had an average annual dividend of 5.6 % from 2000 to 2020. Also, Amanah Saham Malaysia (ASM) had an average annual dividend of 6.5 % for the same period. The amount of gain will of course depend on your investment returns. The chart below illustrates the amount of cash you will have for annual investment returns ranging from 5% to 7%.

How did I arrive at these conclusions? By comparing the cash flows under Maybank HouzKEY

with those under a conventional housing loan.

Maybank Houzkey Vs Conventional Housing Loan

Since the launch of the HouzKEY scheme in 2017, there have been some amendments by Maybank. You can refer to the HouzKEY Product Disclosure Sheets dated Feb 2018 and Aug 2020.

The aim of this article is not to discuss the terms and conditions or the pros and cons of the RTO. Rather I want to illustrate that it can be looked at as a way to finance your stock investments. I will illustrate my point using the Maybank HouzKEY scheme as per Maybank Product Disclosure Sheet dated Aug 2020. The table below compares the payment between HouzKEY and a conventional housing loan based on a RM 500,000 property.

Notes:

(a) Under HouzKEY the figure is for Deposits + Upfront costs. Under Mortgage the figure is for Down payment + Upfront costs + payment during construction

(b) Under both HouzKEY and Mortgage, the figures are for Monthly instalment X 12

Based on the table above, the cash available looks like a financing scheme. Now, what happens if you use the cash available to invest in the stock market? The gain will of course depend on your stock investing skills. But let us take the simple case of investing in the KLCI.

Calculation of profits made from the investment of Houzkey monies

The gain from the stock market investment was derived as follows:

- First, I computed the annual cash flow required under a full housing loan plan (3 year construction period and 30-year loan period).

- Next, I computed the annual cash flow under HouzKEY (scheme covers 3 years construction period and a 5-year rental period). Thereafter it was converted into a conventional mortgage. For an apple-to-apple comparison, I assumed that the housing loan was for 25 years to have a total of 33 years.

- I then derived the annual cash flow difference between the full housing loan and the HouzKEY combo. These differences for the construction and rental period were treated as funds available for investing.

- I assumed that the available funds were invested in the KLCI.

Based on the rates in the Product Disclosure Sheet and assuming a 5% annual return from the KLCI, you will have RM 256,205 at the end of the 33-year period. So instead of having to pay more (in terms of interest) under HouzKEY, you will actually gain more money.

The cash position will of course depend on the investment returns. The table below illustrates what is possible under various KLCI returns.

*Houzkey Campaign Rate = 2.88%

*Housing Loan Rate = 3.2%

Factors that will affect your stock investment

Assuming the 33 year period, there are 3 variables that can affect the final cash position:

- The housing loan rate.

- The campaign interest rate. My analysis is based on a campaign interest rate that is 10% lower than the housing loan rate.

- The return from the stock market. Note that this comprises the capital gain (from changes in the KLCI) and dividends.

Over the past 20 years, the Malaysian banks’ lending rate had varied from about 3% to 8 % as can be seen from the chart below. The median would range from 5% to 6%.

From 1990 to 2020, the KLCI had a CAGR of 3.9%. This is before you factor in any dividends. Historically the median annual dividend ranged from 2.75% to 3%. As such a total annual return of 5% from the stock market seemed very conservative. I would expect a realistic total return to range from 5% to 7%.

As can be seen, in all scenarios, you are better off taking up the HouzKEY combo plan. The lowest return came from when the campaign rate = mortgage rate = 6%. In fact, the breakeven under this scenario is when the KLCI annual total return = 2.6%.

Are there any alternative investments?

You may argue that investing in the stock market can be risky. Then, I would suggest that you consider alternative investments, where you can invest in Amanah Saham Malaysia (ASM)or even make additional contributions to the Employee Provident Fund (EPF).

The chart below shows the historical returns from Amanah Saham and EPF. From 2001 to 2020, the average annual dividends were:

- 6.52% for Amanah Saham Malaysia.

- 5.57 % for EPF.

As you can see achieving a 5% return over the long term is not difficult. Given the findings, you should not withdraw your EPF savings to reduce the housing loan amount or even to part refinance the HouzKEY property. This advice is consistent with what I have said in my article “Better to invest or pay off your housing loan?”.

Methodology used

The financial model comprises 3 components:

- Housing loan plan with 33 years cash flow.

- HouzKEY combo. This involved 5 years under HouzKey with another 25 years refinancing with a conventional housing loan. The 25 years refinancing is to have the same 33 years as the full loan plan.

- Investment of the “excess cash”. This is based on 33 years of investment in the KLCI.

Housing Loan

I assumed the following parameters to develop the financial model for the mortgage plan. These were based on the HouzKEY Product Disclosure Sheet.

I assumed the following payment formula

- Upfront payment = Down payment + Upfront costs = RM 50,000 + RM 17,500 = RM 67,500. Refer to Chart 2 for the details.

- Interest = Interest payable for the year = O Bal X interest rate.

- Payment = Payment for the year = Monthly payment X 12.

- C Bal = O Bal + Interest – Payment.

- O Bal for Year 1 to 4 = Cumulative progress payment. The cumulative progress payment for each year is assumed to be based on some progress payment schedule as shown in the financial model.

- O Bal for Year 5 onwards = Closing balance the previous year

The total payment you make during the construction period is only for the interest and the total is equal to RM 25,000 as per the HouzKEY Product Disclosure Sheet. The total payment period = 3 years construction + 30 years loan = 33 years

You will note that the financial model has about RM 10,034 at the end of year 33. I assumed that this is paid in one lump sum at the end of the 33 years. Overall total payment = Upfront + Payments for 33 years + Final lump sum = RM 67,500 + RM 725,560 + RM 10,034 = RM 803,094.

Maybank HouzKEY combo

In this part of the financial model:

- The Upfront payment = Security deposit + Upfront costs = RM 3,600 + RM 17,500 = RM 21,100.

- Year 1 to 3 is the construction period with the same progress payment as the full mortgage scenario. However, you do not incur any cost for the progress payments.

- Once you take vacant possession at the start of Year 4, you pay the monthly “rent”. This is based on property value X interest rate = RM 500,000 X 0.0288 = RM 14,400 per year. This rental is payable for years 4 to 8 (total is 5 years).

- The payment in Year 8 is reduced because you get back the security deposit. Payment = RM 14,000 – RM 3,600 = RM 10,800. Note that the Closing balance is still RM 500,000.

- I assumed that after the end of Year 8 (ie the end of the 5 year RTO plan), you refinance the property based on the same interest rate as for the full mortgage plan. The interest for Year 9 = RM 500,000 X 0.032 = RM 16,000.

- The payment in Year 9 = monthly mortgage + refinancing charges = (RM 2,375 X 12) + RM 10,360 Since the loan period is 25 years instead of 30 years, the monthly repayment is higher at RM 2,375.

- The annual payment for Year 9 to Year 33 = RM 2,375 X 12 = RM 28,500.

- Note the Closing balance at the end of year 33 = RM 10,033. This is almost the same as that under the full housing plan.

- The interest in Year 9 = RM 500,000 X mortgage interest rate.

Overall total payment = Upfront + Payments for the 33 years including the Refinancing charges + Final Payment = RM 21,100 + RM 791,263 + RM 10,033 = RM 822,396.

Investment in the stock market

I assumed that you have the money for the Upfront costs and monthly financing payments required under the full housing plan. Instead of using the loan to finance your house, you use HouzKEY for Years 1 to 8. At the end of Year 8, you refinance under a conventional housing loan. For Year 1 to Year 8, you have excess cash. This is from the difference in the payment under the full housing loan and the HouzKEY combo. This is reported under the Excess column in the worksheet. Refer to Table 6.

- Upfront = The difference in the Upfront = RM 67,500 – RM 21,100 = RM 46,400.

- O Bal for Year 1 onwards = C Bal + Excess for the Year. For example, for Year 3 this is = RM 66,660 + RM 12,800 = RM 79,460.

- Gain = O Bal X Stock market return. For Year 4 assuming 5 % annual gain this is = RM 92,385 X 5 % = RM 4,619.

- C Bal = O Bal + Gain

The results of the financial model above are as follows:

- The Excess becomes negative from Year 9 onwards. This is because you are paying an additional monthly sum under the refinancing scheme.

- The Closing Balance increases every year including the period when the Excess is negative. This is because the gain from the investments more than offset the shortfall in the Excess.

- At the end of 33 years, the cash position in the example is RM 256,205.

What can we learn from this analysis?

In summary:

- Overall cash payment under the full housing loan = RM 803,094.

- Overall cash payment under the HouzKEY combo = RM 822,396.

- Additional cash payment under the HouzKEY combo compared to the full loan = RM 19,302. You can see why the general view is that you pay more overall with the HouzKEY scheme.

- But if you invest the initial savings, at the end of the 33 years, you have cash of 256,205. You have made money.

The final cash position will of course depends on the investment returns. The table below summarized the final cash position at the end of 33 years under different return scenarios.

Limitations to take into consideration

This analysis assumed that the purchase price of the house remained unchanged at RM 500,000 in Year 9 when you transitioned to the housing loan plan. I also assumed that there was no down payment. When the RTO scheme was first unveiled by Maybank, the house purchase price was fixed at RM 500,000. However, there was no mention of the house purchase price under the Aug 2020 Product Disclosure Sheet. I have assumed it to be the same as for the 2018 scheme.

I have done a similar analysis assuming RM500,000 house price but with a 10% down payment in Year 9. The result is still that you are better off with the HouzKEY combo. You will break even with the HouzKEY combo if the house purchase price goes up to about RM 580,000 during the transition year. If this happens, it defeats the purpose of the RTO. The main reason why you are better off with the HouzKEY combo is because of the compounding effect. You benefit by re-investing your annual gain. Effectively it is an interest-on-interest effect.

- The benefits of compounding come from two factors:

- Long-term investment.

- Consistent annual returns.

Do you benefit from a shorter investment period?

Consider the case where you invest for only the first 8 years rental tenure period (3 years construction + 5 years rental).

- Total amount available for investment = RM 119,760 (as per Table 1)

- Cash at the end of Year 8 = RM 162,203. You have made money from the amount available for investment.

You are still better off with the HouzKEY combo. This of course assumed that you are able to achieve a 5% return annually over the 8 years period. Some may argue that this could be challenging because of the pandemic outlook. I would argue that it would be socio-economically difficult for EPF or Amanah Saham to deliver less than 5% average dividends.

The whole investment scheme is viable because the amount of “savings” from the HouzKEY scheme is very large. The accumulated cash is more than enough to offset paying a larger monthly sum when you transition from the rental stage to the mortgage stage. You can see from Table 6 that the closing cash every year keeps on increasing from Year 9.

No doubt there is a drop in the cash position from Year 8 to Year 9. But if you invest for the long term, this drop is negligible. Of course, the RTO scheme was not set up to finance stock investments. But I think this is a loophole that has yet to be addressed. Until then, there is still the opportunity to take advantage of it.

Disclaimer: The author is not an investment adviser, security analyst, or stockbroker. The contents are meant for educational purposes and should not be taken as any recommendation to purchase or dispose of shares in the featured companies. Investments or strategies mentioned here may not be suitable for you and you should have your own independent decision regarding them.