First thing, I have to agree that most of the time, rental yield is higher than putting your money in the bank. Traditional thinking to buy property with cash and do not want to pay interest to the bank is not a bad option if you are a rich cash generator. One point that I would like to raise is whether or not we are trained to maximize our return this way?
Let’s look at the down side, if we put our money in one asset, this causes high risk, no liquidity and no tax advantage. On the other hand, mortgages helps to spread your investment to multiple properties to maximize the returns through appreciation and rentals while mitigating the risk such as vacancy rate better. Take note on two things here:
- Holding power to pay your mortgages on time
- Tax advantage to deduct your interest payment from your rental income
Case Study
Cash buy a RM100k property with RM600 per month. Another alternative, RM10k downpayment, 5% for other costs, RM500 installment and RM600 for rental income (6%). Monthly cash flow of +RM100. Total money spent was -RM15000.
With RM100k in hand, you can purchase 6-7 properties be it same type or different type of assets. You will get at least the same amount of cash flow (~RM600) from rental income compared to cash buy but you have the probability to exceed that amount if you get to rent one of your properties at a higher rate or you have another type of asset which have better rental yield. Take a look at the total asset value you have acquired through mortgages, say RM600k compared to RM100k. Thus can be very very different as property values compound over the years. You will know the magic of compounded values if you plot a graph of 20 years for 6 rental properties with loan and 1 cash buy rental property with appreciation rate at 5%.
In conclusion, cash buy or loan are both great strategy as long as you can judge which one makes you greater return at your side. I will go for ‘managable’ loans to leveraging purpose. To make this method successful especially for rental property investment, remember one rule of thumb, make sure that your rental return is higher than your loan installment.