I find it amazing that besides these two posts (here and here) which more or less talks about the merits of purchasing a BTO flat, I haven’t really shared my views on property investment. Especially considering this is a Singaporean personal finance blog (Singaporeans are suckers for properties) and it has been 1.5 years and counting. 🙂
Even though my investment portfolio consists of only equities and cash at this moment, I am definitely not ruling out investing in a 2nd property. After all, I believe that almost any type of investment assets (including Hello Kitty and LINE plush toys) can be a good one if you purchase it at the right price and sell it at the right time. 😉
But would it be more worthwhile to get a second property or to invest the extra cash into more equities?
I guess that’s the ultimate question and instead of joining in the endless debate of which is better, I have decided to paint an equivalent scenario for comparison by making some (hopefully realistic) assumptions. So even though there’s still almost 3 years to go before we fulfill the Minimum Occupation Period (MOP) of the flat, here’s my findings:
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Scenario:
In Jan 2018, Mr and Mrs 15HWW would have saved up $300,000 and their investment horizon is 30 years. There’s two potential investment options presented in front of them:
1. Invest $300,000 in equities
2. Use the $300,000 as a 25% downpayment on a $1 million freehold apartment
For the 1st option, if the average return on the equities is 9.5%, the couple would end up with about $4 million in 2048. Simple.
As for the 2nd option, things are slightly more complicated. The $300,000 would be used as a 25% downpayment ($50,000 for stamp duties, agent fees, furnishing etc) and the couple has to take a $750,000 loan. Assuming a fixed mortgage interest rate at 2.5% for a 30 year loan, the monthly repayment works out to be close to $3,000 a month. The monthly rental of $3,500 would probably just be enough to cover the mortgage and other miscellaneous expenses. So, cashflow is zero, just like the equity investment.
And interestingly, if the apartment appreciates at 5% per annum, it would be worth about $4 million in 2048, similar to option 1. The mortgage would also be fully paid off.
So in this example, if Mr and Mrs 15HWW are only focused on the value of the outcomes, they would be indifferent to the two options.
How realistic are the assumptions?
1. 9.5% appreciation for equities; 5% for properties
- The STI has returned close to 9% for the past 10 years and residential properties have appreciated >7% (which I argued was likely to be unsustainable here) for the past 3 decades.
- Businesses owners have to earn a higher profit than property owners. Otherwise, there’s no incentive to be innovative and everyone will just own properties (which should then lower yields of properties and make starting a business more attractive).
2. No cashflow from apartment and stock for 30 years
- Assumption made for easier comparison and for equities, one could just assume that the dividends were reinvested for a total of 9.5% return.
- As for the apartment, people who are more conservative towards property would pick on the 2.5% interest rate on the mortgage whereas those more bullish would argue that a positive cashflow is possible.
- I have to admit 2.5% is a bit arbitrary on my part and with the SOR rising rapidly in the past week, there’s some rationale to assume a higher rate of let’s say 3.0%. That would be about $200 more and even then, rentals should rise with inflation to cover the higher interest cost.
- On the other hand, theoretically, $3,500 of rental income should more than cover the $3,000 of mortgage. So it appears pessimistic to assume no positive cashflow. However, there’s rental income tax, property tax, repairs, maintenance fee and other miscellaneous fees to account for.
- I personally feel that 90% of property investors are in the game because of the potential for leveraged capital gains and any positive cashflow is just a bonus, and especially hard to find for properties with a 999 year or freehold lease.
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Obviously, if you’re a seasoned value investor with >15% compounded annual returns, there’s no reason to invest the money in a property. Similarly, if you’re a believer that the Singapore property market will continue returning 7% per annum and that interest rates will be below 2.5% for at least the next decade, there’s little rationale to be investing in equities.
Ultimately, you need to know which investment vehicle you are more pre-disposed to and obviously, it would be good to have some diversification too. 🙂
P.S.: And before I end off, I thought it would be good for me to disclose that I am pretty much a noob in property investments (haven’t done any yet) and if there’s some glaring error in my numbers or assumptions, do feel free to point it out. I am definitely still in the learning phase. 😛
Hi 15hww
Looking either way, looks like you will end up a millionaire by 2048 and a multi one at that 😀
If both properties and stocks increase by the same percentage, then properties will win because of the leverage factors. The next property cycle would be interesting.
Agreed with B on both points, that a property will do better than equity because of the leverage, and that the next property cycle is gonna be interesting! Exciting times!
Hi GMGH,
To be honest, I find it interesting that both of you feel that property should do better than equity because of the leverage.
For me, I think the leverage helps to boost the “lower returns” of property to match that of equities. And even though one has “more control” over the property rather than a stock, it’s really much riskier due to the leverage.
The biggest assumption I made is zero cashflow from the property. And that is definitely up for debate from both bulls and bears.
Hi B,
2048 is actually very far away. By then, $1 million might not be worth that much? =p
On average, the return of properties should not exceed that of equities. But of course, there will definitely be scenarios when an astute property investor buys a massively under-priced property and profit immensely from it.
Seems like over a longer time span, the rental rates should also be going up?
Hi Lizardo,
Maintenance fees, taxes and misc fees will also be going up?
I think my point is that the amount of positive cashflow is likely to be insignificant as a percentage to your downpayment. Especially if you compare it against capital gains. I just assumed zero for an easier comparison.
Hi,
I I have a few comments. It is likely that you are very aware of your assumptions and thus you have discuss them. My feeling is that after reading Thinking, fast and slow, we tend to plan with a planning fallacy, that is using the best possible scenario. In the case of the 9% it is a matter of a rather pick from a very small sample size, in that Singapore’s operating history is only from probably 1965 to 2014. The same for the housing.
You perhaps have better data then me on the housing growth. At the end of the day, i felt that you are having a little recency bias when it comes to finance rate, rent rate. While my latest check yields that based on the recent rental figures a condo of 900 sqft in suburban can rent for 3500 to a 1250 sqft can rent for 4500.
But i guess what you are planning is that for the housing price to abnormally fall from 1.3-1.5 mil to 1 mil BUT the rental yield to stay the same and resilient. I want you to evaluate if that is a safe assumption.
Secondly, there is a recency bias in many people, including those in the united states. the season property people are saying that the 3-4% mortgage loan right now is too low by historical standards and a safe planning should be 8% (gasp). I did a survey of the experience investors who were buying their homes in 92, 04, and the interest rate is 5% (at a favorable rate) and 4% respectively. your figures will look very different in that scenario
Hi Kyith,
Thanks for your comments.
I agree that as a whole, my numbers and assumptions can be considered a tad optimistic. But the main purpose is to compare the two instruments against each other. If I revise the returns to 8% for equities and 4% for properties (and some small negative cashflow for the property), I get a similar equivalent outcome.
I would just like to make one counter-point.
Generally, the rate of return for stocks and equities should be higher than the interest rate. Otherwise, the real value of stocks and equities will decline. In the short-term (I believe it might happen in the next couple of years), that’s very possible and prices of these assets will just drop till a level when it becomes attractive again (i.e yield higher than interest rate). But if this were to persist for 3 decades, it’s really scary although not impossible.
So if interest rates go up to 5%, the rate of return on properties could go up to 8% and equities higher than 12%?
I might be wrong, but I do believe the analysis should still hold water at that stage. =)
hi,
growth and cost are not always relative. you have to play around with it. i am just providing some quantifable perspective.
another way to think is that if your goal is FI, you need to think about whether you want that mortgage around.
Hi Kyith,
Good to hear your perspective.
And I do understand that you feel that some of my assumptions on the numbers are way too lofty. But at the same time, as you can see from the comments, there’s another group that feels that I am way too conservative. Impossible to please everyone. =p
True that FI is a goal and unless property valuations become super attractive, I have to admit it’s unlikely for me to have the albatross of a second and bigger mortgage around my neck.
hi, its not that i think its too out of touch. its just consideration. my data shows me at differing time periods the property price growth is 7%, so you are not being overly optimistic.
whether that needs to factor in the interest cost is another matter.
you know something, you said cost go up by right the return should be even higher. i used to think that way.
but i was thinking. they say the sibor rate prior to 2008 was 3%, so the borrowing rate is around 4%. the cost changes but the price appreciation is a bit independent of the cost of borrowing. for sure if sibor goes back to a norm of 3-4% this will temper with demand.
what i am thinking is that if we eliminate the period from 2008 onwards, housing price go up 7% pa but cost is 4%. the price appreciation is in this case rather independent of the cost. something to think about.
Hi 15hww
You and Kyith (per his comments) make some good points. Personally I think now with interest rates just beginning to creep up (not sure what kind of housing loan you are taking up but if it’s pegged to SOR then I’m feeling the pain with you), gross rental rates going down, number of foreigners accepted going down, a government that thinks that a “meaningful” correction in property prices has not yet taken place, and supply of housing expected to reach unprecedentedly high levels in 2015 and 2016, this does not smell like a good time to go into property at all (unless you want to get a luxury property where I see some good bargains being transacted from time to time now). It should be a very different story in about two years’ time though. By then your MOP would almost be up 🙂 so it’s pretty good timing for you.
Hi RetailTrader,
My current home loan with POSB is pegged to SIBOR with a 10 year guaranteed rate cap of 2.5% (still left with 8.5 years).
If rates really surge, I will probably pay it down aggressively with my cash hoard. I personally think it’s quite tough to both pay down the current mortgage and have enough for a decent downpayment on a decently-sized 2nd property.
So even with good timing, might not have the resources to benefit fully from the opportunity. =p
Hi My 15 HWW,
I used to consider to change my current HDB Loan with 2.6% interest per annum to POSB HDB Loan. The interest was <2% at the moment and I have confidence to fully paid it in 10 years time.
As I do not know what are the consequences for doing this in the long run, I didn't take any action till now. I am worried that can I go for HDB Loan in the future let's say I downgraded my HDB when I am old or facing any financial difficulty down the road. I worry that I will only left with the choice of taking bank loan that might be 8%…Too much worries for me to take any action.
Hi MSAPersonalFinance,
I understand your concerns and indeed, there’s nothing wrong with sticking to the HDB loan all the way.
But that said, if you’re really confident of paying off your home loan within 10 years, the POSB HDB loan could be a superior instrument. Even if you downgrade in the future, it’s likely that the proceeds from the sale of the previous flat should cover >60-70% of the cost of the new flat.
Hello 15HWW,
“After all, I believe that almost any type of investment assets (including Hello Kitty and LINE plush toys) can be a good one if you purchase it at the right price and sell it at the right time.”
Ain’t it the truth!!!
Whether we want to count it or not, the property we are staying in is already one of the major “investment” for most Singaporeans.
You are only in “equities and cash” if you are renting your existing abode 😉
So the question is whether we would like to ADD more property weightings into our total net worth 🙂
But I am with you on a 2nd investment property.
Without a 2nd unit we can “buy and sell”, seeing property prices go up and then go down is quite boring….
Something to think about for those buy and hold equities investors 😉
Hi Jared,
You’re definitely not wrong although many people do not see their home as an investment (i.e. not prepared to sell it and rent another place).
Regarding “more property weightings”, I thought about that too and my last point on diversification addresses that. Excluding the home, most people tend to be “all-in” on either property or stocks.
A ideal scenario in 2018 for me would be to have an equities portfolio worth $300,000 and a 25% downpayment on that $1 million 2nd property. I think I must be daydreaming. No? Oops.
Great thinking. Perhaps may I offer another dimensions to property and stocks.
Property is a business stream. You put a 100k in and you have the rights over the use of the space for the next 99 years or freehold. It is not a buy and hold concept, waiting for the asset to rise in value. It is not. You have to select potential space people require, improve its marketability, renovate to improve its intrinsic value. Of course, there would be a financial partner i.e. the bank whom you need to pay fixed dividends to, regardless of how you do in your ‘business’.
Stocks / equities are basically putting in money into some market leaders who makes money for you. You cease ‘control’ to another ‘more qualified’ person. Imagine you buy into coke, you can’t start to drink more coke so the company can earn more money and you get a higher stock price?
Being in Control does have its problems and issues and its not totally stress free, but its a learning journey and I enjoy learning through property selection, learning financial instruments and applying techniques to improve its values. Likely with stocks, I will not have more fun in the learning process. Bottom line, I hate ceasing control.
The main difference between the 2 would be control. The returns over long term would be quite similar for a reasonable active trader and a reasonable active property investor. If you are passive for both, likely, you cease all control of your life and likely you gonna get into trouble. It is not about which tools is better but its all about which tools you know how to use and use them effectively.
Well said. Property investment requires creativity and effort to create value. Skill is required. The execution edge can provide additional gains for the labour put in.
Stock is more passive. More time for the rest of your life, but no room for additional gains as well.
Hi Anon,
Actually, I do think that investing in stocks can be more “active” than property and could be more lucrative too.
There’s some examples of stocks tripling in their value within a couple of years but it’s really quite impossible to do that with a property. And similarly, the unleveraged potential downside of a property is lower.
Two characteristics of property you need to consider are: 1) illiquid, & 2) indivisible.
1) Equities are traded on a market where the bid-ask is usually tight, & u know the price of your equities at any one instant in time. With property, you will face illiquidity. Ask any seller in the sg market in the last one year. With property, whem you want/need to cash out, buyers may not like the fengshui, the interior decor, the facing, the neighbours, etc. Whereas with stock, one lot is exactly tje same as another lot.
2) Divisibility is important for a few reasons. One is that when you want to cash out, you may not be able to time perfectly. Or you may jeed funds when the market is not so good. Qith equities I can sell x% every month over a period of time. The opposite of dollar cost averaging. Two is that I can exploit any market irrational exuberance. If the market is seeing a bubble, I can sell fractional amt of equities to take profit. I want to keep some because I am unsure of the exact timing (in case I sell and it goes higher). Finally, if you retire and need cash (more than the dividend / rental), you can slowly liquidate equities. Whereas for property you sell off the property to use a bit of cash, then youre left holding a bunch of cash.
Not to say that I’m against properties. They have attraction because of leverage and control.
Correction. My point about illiquidity should highlight that to transact a property takes 8-12 weeks while equities cam be transacted in seconds (settled in days).
The point about choosy buyers is a separate one illustrating a third characteristic of property, which is differentiation between units. It is related to liquidity (because some units are harder to sell than others); & control (because you can spruce up a unit to enhance its value). You can put curtains and repaint your equities to increase their value.
Thanks M15WW for putting this discussion up. Although it’s still a long way before I can purchase my first HDB, I have learned a lot in this post and reading all the comments.
Seems like I would go for the equity way as I am more of a technical person (TA)..
Also appreciate all who shared their part in the discussion above ^ 🙂
Regards,
The IA