Below is an analysis of two different people with two different investment philosophies. Ricky Renter believes in real estate investing and Steve Stock believes in putting his money into mutual funds (stock market) instead.
Yr
|
Ref
|
Milestone
|
Ricky
Renter
|
Steve
Stock
|
0
|
A
|
Initial
Capital
|
Home sale
price is RM500k. A 10% DP of RM50k is required. Ricky starts off with a total
Fixed Equity of RM500k (Home Value) – RM450k (Mortgage) = RM50k
|
Steve
invests the RM50k into his stock portfolio.
|
0 - 35
|
B
|
Appreciation
|
Ricky's
home appreciates at a rate of 1% p.a. against his initial home value
of RM500k.
|
Steve's
stock portfolio has a return rate of 5% p.a. against his 50k initial
investment.
|
C
|
Mortgage
Repayment
|
Home loan
interest rate is about 4%. For a RM450k loan to be repaid in 35 yrs, it works
out to be a flat RM2k/month. Luckily for Ricky, inflation & home value
increase has no affect on the repayment amount.
|
Steve has
no mortgage repayment obligations.
|
|
D
|
Maintenance
& Repair
|
The home
will require a yearly repair cost of about 1% of the home value. So for the
RM500k home, the yearly maintenance cost is about RM5,000. The 1% p.a.
increase will take inflation into account.
|
Steve has
no home repair obligations.
|
|
E
|
Property
Occupied (10m/yr)
|
Ricky gets
to collect monthly rental. We also gave Ricky the benefit of yearly rising
rental rate (1% p.a.). During occupied periods, the tenant is essentially
paying for Ricky’s mortgage. However, to be realistic, we assume tenancy of
10 out of 12 months only.
|
Steve has
no rental income.
|
|
F
|
Net Cash
Flow
|
Ricky’s net cash flow sums up (C) + (D) +
(E). Although Ricky gets an increasing rental rate every year (1% p.a.) and
his mortgage repayment is fixed, the net cash flow is still negative due to
(1) Maintenance cost also increasing 1% p.a. and (2) During vacant periods,
Ricky has to directly service his mortgage loan.
When Ricky
derives a negative cash flow, he needs to withdraw that amount from his
savings.
|
For a fair
comparison, Steve gets to withdraw the same amount from his savings. But
instead of paying off the maintenance and outstanding mortgage (which he does
not have), Steve contributes it into his stock portfolio.
|
|
35
|
G
|
Mortgage
Paid Off
|
Ricky’s
property would have appreciated to RM708k. At the same time however, Ricky
would have withdrawn a total of RM217k for maintenance and servicing his
mortgage loan during vacant periods. His total equity comes up to RM491k.
|
Steve
initially started off with RM50k in his stock portfolio and makes a yearly
contribution of Ricky’s net cash flow (F). His portfolio returns a rate of
5%. His total equity (i.e. his stock portfolio), sums to be RM956k.
|
35 - 50
|
H
|
Ricky Reaps
the Rewards?
|
Ricky no
longer has outstanding mortgage loan. All the rental income now goes into
Ricky’s pocket minus the maintenance cost. He is now at a net positive cash
flow every year. The additional income will go to stock investment (5% p.a).
The home continues to appreciate at 1% p.a.
|
On paper,
Steve no longer has the upper hand here. Unlike Ricky, Steve does not have
any rental income. And since Ricky no longer needs to withdraw cash from his
savings to fund the negative cash flow, Steve will also stop his yearly
contribution to his stock portfolio. Steve will rely solely on the 5% p.a.
return rate on his portfolio for equity increase.
|
50
|
I
|
Ricky Wins! Not.
|
Ricky now has a home value of RM822k and
stock portfolio value of RM486k BUT we must not forget the RM217k accumulated
expense from point (G). That sums up to RM1,091k.
|
Steve’s stock portfolio that started off at
RM956k at year 35, grew 5% p.a. with zero cash in. How did he do? His
portfolio grew to a whopping RM1,989k at year 50!
|
Steve Stock comes up way on top. There are several other scenarios where Ricky Renter could possibly win this one instead:
- Stock Market rate of return goes down to 3.4% p.a. However, any decent mutual fund portfolio could return 5% p.a. or more.
- The occupancy rate goes up to 11 months per year (92%). This would take mix of a good property agent, a good location and a bit more spent on maintenance & renovation.
- Maintenance rate reduced to less than 0.4% of home value per year. Be warned that skimping on home repairs may reduce the rentability of your property (i.e. reduce your occupancy rate).
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