A report released by DBS on May 16, 2018 forecasts private residential property prices to grow annually by 1.5 to 3.2% over the next 12 years, backed by rising homeowner incomes. In other words, a property that fetches $1,500 per square foot (psf) in today’s market could cost $2,300 to $2,900 by 2030. Given optimistic projections released by authoritative sources, buyers nevertheless have avoid putting on rose-tinted glasses and consider the potential downsides of a property investment. By being aware of the risks, they can focus on the potential gains.
Singaporeans are often accused of being over-optimistic when it comes to property investment and its associated upsides. The truth is, this is not a trait unique to Singaporeans or even Asians. The truth is: Excessive optimism with regard to property profits is a global phenomenon. In 2006, for example, the total debt owed in home loans in the US was equal to 99%(!) of their GDP. In fact, by comparison, Singaporeans are nowhere near as crazy with their properties (our governments have the correct control measures in place). Regardless, there are many misconceptions that need to be cleared up:
How does residential property investment work?
The typical way to invest in property is to purchase a house by taking a home loan with a low interest rate (preferably lower than the rate of inflation). The house is then rented out. In an ideal situation, the income generated from rent will more than pay for the property loan. Further down the road, when the property price appreciates, the investor can then sell off the property at a profit. For example:
Say you buy a condo at $800,000. You have a bank loan, which costs you $3,000 in monthly repayments.
You rent out the condo, getting a rental income of $4,000 a month. This turns your property into a cash generating asset; after repaying the loan, you still have an excess of $1,000 every month.
After 15 years, the value of the property rises; it is worth $1.2 million. You can then sell the house, making $400,000 in profit (the difference between the buying price and the resale price) plus $180,000 ($1,000 a month for 15 years, assuming no vacancies during this period). You would’ve made $580,000.
This is an eye-popping return of about 72.5% over 15 years. By contrast, a typical fixed deposit at the bank might give you an interest rate of just 0.8% per year.
In contrast, if you had put the $800,000 in a bank instead of investing in a house, you would have around $901,560 after 15 years – a measly gain of around $101,560. That’s a fifth of the profit that your condo made.
Even better, you would not need the full $800,000 to buy the house. You would only need a downpayment of 20 per cent, or just $160,000. The rest of the house is paid for by the tenants, since the rent they pay is used cover the mortgage.
On a more complex level, you can also consider that the rate of inflation (the rising cost of goods) is around 3% in Singapore. Your property loan interest however, is far below this; home loan rates have been below 2% for more than a decade (although the rates have been trending up recently). Since inflation rises faster than the property loan rate, it means the real value of your debt is diminished.
If you think this sounds too good to be true, and there must be a catch… you’re right. What we’ve described is an idealised situation. Don’t get us wrong — the above method has worked for thousands of property investors, and is one of the tried and true methods of growing wealth. Nevertheless, there’s a huge caveat:
Under the wrong conditions, property investment can turn into a wealth-destroying liability.
For some investors, housing profits turned out to be an illusion.
In the 2015 property slump, we have already seen a number of mortgagee sales. These occur when a property owner is unable or unwilling to make mortgage repayments, and the bank forecloses on the property. The bank will then attempt to auction off the property at the best price it can get.
Some of these include a four-bedroom unit at The Sovereign in Meyer Road (indicative price of around $4 million), a two-storey terrace house at 19 Bedok Walk (around $3.45 million), and a three-bedroom unit at The Bayshore (around $1.5 million).
By the time a bank forecloses on a property, the former owners should count themselves lucky to escape with minimal financial damage, let alone profits.
There were 241 mortgagee listings in 2015, of which 80% were residential. This is the highest recorded number since the Global Financial Crisis in 2008.
Even outside of mortgagee sales, there have been incidences of steep losses in the property market. The most noteworthy is the sale of a three-bedroom unit at The Ritz-Carlton Residences Singapore in Q1 2016. The seller, a Permanent Resident from China, bought the unit at $3,815 per square foot in 2013, and resold it at $2,508 per square foot this year. This translates to a total loss of $4.3 million, one of the worst recorded in a decade.
Another significant loss was a sale at Hillview Regency, during which the seller bought a unit at $1,263 per square foot, but resold it at $776 per square foot. In addition, the seller only purchased the unit in 2015, but sold it earlier this year. This incurred a Seller’s Stamp Duty (SSD) of $137,600. In total, the seller is estimated to have lost over $677,000 from the transaction.
But given the seemingly logical scenario outlined above, how could these losses have happened? The answer is that, in the following situations, profits from property investments are likely to become illusory:
- The buyer loses a crucial source of income
- Rental income falls below mortgage payments
- The buyer cannot cope with rising interest rates
- Selling during a downturn
1. The buyer loses a crucial source of income
If you lose your source of income, can you still manage to pay the mortgage? If you can’t pay, you will be forced to sell your property investment. And should this coincide with a market downturn (e.g. Q1 2016), you would have to sell at a loss.
The same situation could face you if you lose your income, and cannot cover the mortgage payments. This is why holding power is essential – if you lack proper insurance to cover events such as critical illness and job loss, or if you have no emergency savings*, it can be dangerous to stake too much on your property investment.
(*It is advisable for all property owners to build up an emergency fund, which can cover at least three to six months of their mortgage payments, in the event of lost income.)
2. Rental income falls below mortgage payments
In the event of a vacancy, there is no rental income to cover the mortgage. Your property investment then becomes a liability instead of a cash-generating asset. Even putting aside vacancies, there is always a chance that rental prices can fall, such as due to competition from properties being built nearby. Rental prices can fall to the point where they no longer cover the mortgage payments.
However, this is avoidable with prudent property selection. Engage a reliable property agent if you have issues finding tenants. Also, browse and compare property based on historical rental rates in the area. You can do this for free on 99.co.
Some developers provide rental guarantees — they will compensate you if you cannot find a tenant within a stipulated period. Speak to the property agent about the terms and conditions.
3. The buyer cannot cope with rising interest rates
There are no perpetual fixed rates for property loans in Singapore. The interest will fluctuate based on the Singapore Interbank Offered Rate (SIBOR). While the interest rates in Singapore have been low since 2008, note that historical rates in Singapore have hit up to 4% per annum compared to the current three-month average rate of 1.5% (as of May 2018).
Home loan packages tend to give low “teaser rates” for only the first three years. Most seasoned investors undertake the somewhat bothersome task of refinancing their home loans every four years to keep their interest low. If you want to invest in property, it is essential to do the same if you want to profit . Remember: the more interest you pay on your loan, the greater your eventual profits diminish.
4. Selling in a downturn
In relation to Point 1, do not assume the property market will be bullish when you sell. Many unpredictable factors, such as the current property loan curbs, cooling measures, and weak economic conditions can cause a market downturn and affect your property investment.
This does not mean it is impossible to make a profit by selling during a downturn; but it is difficult and much less probable.
So, you should ensure you have the finances and patience to ride out a downturn. On the bright side, whenever Singapore’s property market has rebounded, it has reached a peak that is higher than the last.
Most investors, however, do make a good return from property.
The key to success in any property invesment is to have holding power; ensure that you sell when you want to, never because you are forced to. If you don’t have the savings, insurance, and temperament to ride out market fluctuations, your profits will go from eventual to illusory.
As a final word of warning: home owners should think twice before playing the property investor. Home owners do not generate rental income from the property, nor can most afford to sell the house in a pinch (where would they live?)
A property investor needs to make two correct decisions, not one – they must buy at the right time, and also sell at the right time. If a first time home owner gets makes one decision right, they are still likely to get the other wrong.
Furthermore, home buyers should be aware of what they’re doing when they pour their entire capital into one property investment: they are making a significant, unhedged bet on a single asset. This throws out a cardinal rule of investing, which is to diversify. Home owners should not rely on their property alone as a retirement fund.
But for investors who meet the right conditions, property may be the safest, high-return investment available.
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