Growing up normal, I do not come from a family of wealth and there is no quick cash for me to invest into the property market. While I did come from a family where my parents started investing in properties in their later years, their struggle made me appreciate how difficult it is to earn a living and for some, having just 1 property is considered a huge fortune.
Having such a background, it has never occurred to me that a regular salaryman like myself can one day afford to pay for a home with cash. Yes, you hear me right, with my hard-earned cash from work and other streams of income. However, having considered such thoughts, I began to wonder if it is truly worth it to be debt-free? Is there a cost to be truly debt-free?
As a general rule, buying a home with cash is rarely a good idea. For a property investor whose business is building wealth through the real estate market, the idea of paying cash and being debt-free is perhaps detrimental to the business. Not leveraging on the bank’s money will put you on the slow lane, setting you back by years in building a substantial real estate investment portfolio.
Below is the result from my study and analysis where I explore how buying a home with cash affects the following factors,
- Financial flexibility
- Leveraging on bank’s money
- Tax deduction
- Impact of opportunity cost
- Being high on Inland Revenue Board’s target list
1. Missing out on the financial flexibility
The biggest concern I have when it comes to managing my business or finances is to have sufficient financial buffer and flexibility for the rainy days. Property as an asset category does not provide you with liquid cash in the shorter term. Even if I am to consider flipping a property for quick cash, there is at least a significant waiting time of 2 – 3 years before any new development is complete and ready for vacant possession. On top of that, you will need to take into consideration how long it takes for the property transaction to happen, all the way from listing, negotiating a deal, sealing the deal and waiting for the final payment can easily take anywhere between 6 – 12 months.
When you pay for a property in full, with cash, you are essentially pouring all your hard-earned savings into 1 single illiquid asset. While it is an interesting notion that you do not need to pay for the monthly mortgage and you do own the house outright, it also means your money is tied to the property. Having mentioned earlier, property investing is a really long term game and the money you sunk into the property will be stuck there for years.
To me, from a personal finance standpoint, it just makes no sense to sink 5 – 10 years’ worth of savings into 1 single property and tie yourself to no free cash for emergencies. At the same time, you need to remember that this cash will be stuck there for at least 5 – 10 years before you see healthy capital gain to offset the opportunity cost. This financial trapping is not something I will want to put myself in, not especially when I have other commitments to the family and potential emergencies where funds are needed. Not having these buffer/savings for those times will also mean needing to take up a personal loan and putting myself into debt at a higher interest rate.
If I am to compare a mortgage loan and a personal loan, I would rather opt for the mortgage loan because the interest rate is significantly more competitive than a personal loan. At the time of writing, a mortgage loan is around 3.15% per annum while a personal loan is at least 4.5% per annum, which is a good 50% more cost to borrow money!
2. Missing out on the power of leveraging
Now that I’ve touched on the topic from a personal finance perspective, let us take a look from a business perspective and how borrowing money from banks can actually be beneficial to our business in running a real estate portfolio. As you could have guessed, obtaining financing has significant benefits and one of the biggest benefits is to leverage other people’s money to make more money.
When you leverage on a mortgage loan to invest in a property, you are essentially keeping your capital invested to a low level while using the bank’s money to generate better returns. If I am to put it into simpler terms, keep your cash as much as you can by using the bank’s money to buy property so that the return on investment is greater than if you are to buy a property using cash.
To make better sense of it, let me attempt to put up a simple analysis on why it is worthwhile to get a mortgage loan to improve your return on investment.
| Purchased using Cash | Leveraged using Bank | Remarks | |
|---|---|---|---|
| Property Purchase Price | RM 1,000,000 | RM 1,000,000 | |
| Capital Invested | RM 1,000,000 | RM 100,000 | Down payment of 10% from purchase price |
| Borrowed Money | - | RM 900,000 | |
| Interest Rate Per Annum | - | 3.1% | I did not consider opportunity cost in this analysis, but a complete analysis should consider how much your money could earn in the same period, lost for not doing it. |
| Interest Cost in 8 Years | - | RM 223,200 | To make things simple, I am not adding the rental returns into the calculation to compare it apple-to-apple. Calculation is RM 900,000 x 3.1% x 8 years. |
| Total Capital Invested in 8 Years | RM 1,000,000 | RM 323,200 | |
| Property Disposal Price | RM 1,650,000 | RM 1,650,000 | Assuming property value goes up by 65% in 8 years |
| Capital Gain over 8 Years | RM 650,000 | RM 650,000 | Capital gain is determined as disposal prices over purchase price. To keep the analysis simple, the transaction cost is not included. |
| Return on Investment after 8 Years | 65% | 201% | Leveraging on bank’s money yields a significant return on investment. |
From the simple comparison, leveraging on the bank’s money gives us 3 times the return on investment against a situation where we pay cash in full for the property. While there are other factors to consider, such as rental yields and transaction cost, these numbers do not move the needle on the situation and the reality stands.
In my opinion, my business as a property investor is to generate the most return on investment for the capital invested. Hence, it is never going to make sense from a business perspective to pay for a property with cash.
3. Understanding the true impact of opportunity cost.
In the above segment, we did a simple comparison for 1 property, to understand the difference between paying cash and leveraging on the bank’s money. What if we do another analysis, assuming we have RM 1,000,000 cash in hand and the main intention is to maximize return on the sum we have readily available, within the same timeframe.
| Purchased using Cash Property 1 | Leveraged using Bank Property 1 | Leveraged using Bank Property 2 | Leveraged using Bank Property 3 | Consolidation from Property 1 – 3 |
|
|---|---|---|---|---|---|
| Property Purchase Price | RM 1,000,000 | RM 1,000,000 | RM 1,000,000 | RM 1,000,000 | |
| Capital Invested | RM 1,000,000 | RM 100,000 | RM 100,000 | RM 100,000 | RM 300,000 |
| Borrowed Money | - | RM 900,000 | RM 900,000 | RM 900,000 | |
| Interest Rate Per Annum | - | 3.1% | 3.1% | 3.1% | |
| Interest Cost in 8 Years | - | RM 223,200 | RM 223,200 | RM 223,200 | RM 669,600 |
| Total Capital Invested in 8 Years | RM 1,000,000 | RM 323,200 | RM 323,200 | RM 323,200 | RM 969,600 |
| Property Disposal Price | RM 1,650,000 | RM 1,650,000 | RM 1,650,000 | RM 1,650,000 | |
| Capital Gain over 8 Years | RM 650,000 | RM 650,000 | RM 650,000 | RM 650,000 | RM 1,950,000 |
| Return on Investment after 8 Years | 65% | 201% |
Before we discuss further the above analysis, it is always important to consider risk over profit. Using the same RM 1,000,000 to invest into 3 properties by leveraging on the bank’s money, a property investor stands to gain a whopping RM 1,950,000 against a measly RM 650,000 within the same 8 years, if the property is paid fully in cash. However, this is true only if the investor can sustain through the 8 years without defaulting on his monthly mortgage payments.
From both the analysis we did, there really is little to almost no benefit to investing in property using cash. This is especially true if you are making property investing your business, where generating returns takes a higher priority over financial security and comfort.
4. Missing out on rental income exemption.
Also, have I mentioned the rental income exemptions? There is a list of deductible expenses for rental income and part of that deductible income, includes interest on the mortgage loan. According to Inland Revenue Board, LHDN, they include the following,
- Interest on mortgage loan
- Assessment tax
- Quit rent
- Fire insurance premium
- Expenses incurred on rent collection
- Expenses incurred on rent renewal
- Expenses for maintenance and repairs
By paying cash upfront for the property, not only are you losing money on the opportunity other investment vehicles are providing, but you will also be losing out on the tax deductions and depending on where you are on the tax bracket, that can be a substantial amount paid to the government on the fact that you are not utilizing available resources to the fullest.
Since we are on the topic of taxation and the Inland Revenue Board, did you know that paying for a property in full will also put you on high alert for the government? While I do not doubt you as a law-abiding citizen, it is never worth the hassle and time to have the IRB digging through your financials, to risk being fined unnecessarily.
When is it truly better to buy property with cash?
While we did go into an extensive discussion on why leveraging on the bank’s money is better than buying a property with cash, there are some benefits to paying cash for a property.
As a general rule, buying a property with cash does eliminate the need to pay interest on the mortgage loan and any early settlement fees built into the terms and conditions. At the same time, a cash buyer is usually more attractive to sellers where developers are seen to give a higher discount to cash buyers.
When it comes to the sub-sales market, a seller is likely to take the cash offer over other offers as there is significantly less worry of a buyer backing out of a deal due to financing rejections. A cash purchase transaction is also significantly faster as it does not involve the bank process in this matter. Most property transactions involving bank financing will take 50% longer than a cash purchase due to the slow paperwork required to complete a loan agreement.
Final Words
Buying a property with cash is rarely going to make sense from an investment perspective. The return on investment by leveraging on the bank’s money will always beat any property invested with cash. On the other hand, the government tax structure is also in favour of citizens borrowing money from the bank to finance their property purchases.
Now that I have done the analysis, the best advice when considering whether cash or mortgage makes the most sense is to go for the option that gives you the greater return on your investment.
If you decide to purchase a property with a mortgage loan, please make sure you can comfortably afford the principal and monthly mortgage payments.
If you decide to purchase a property with cash, make sure you have enough buffer saved up for the rainy days, including home insurance, maintenance fees, repairs and possibly a big-ticket personal emergencies.
Until then, take care.
