[This article is written by Timothy Ho, and first appeared on Dollars and Sense] If you have been thinking about buying a condominium, or are intending to upgrade from a smaller apartment, you may have met a few enterprising real estate agents claiming they can help you buy your “dream condo for free”. You may even have seen Facebook ads from agents that claim you can easily own multiple properties with little or no money. But just how genuine are these claims?
As the saying goes, nothing in life is ever free. In this article, we will explore some of the promises that overzealous real estate agents sometimes tell their prospective clients. We will also highlight some of the risk areas that may not have been mentioned by the agents. Hopefully by understanding all these, you can make a more informed decision for yourself.
Scenario A: Using your CPF to fund your property purchase
You and your spouse have a sizeable sum of money in your CPF Ordinary Account (OA). Both of you are working and are contributing to your CPF. You have enough money in your OA to pay for your down payment. Your monthly OA contribution is sufficient to cover the monthly mortgage repayment. You do not have to fork out any cash. Thus, your real estate agent claims that you can live in a condominium for “free”.
What Is NOT Being Highlighted
The logic behind this strategy is fundamentally flawed. Even though using your CPF OA to fund your property purchase has its merits, the money that is being used is ultimately your own retirement money.
Moreover, the implicit assumption here is that both you and your spouse will continue working and are able to earn at least the same salary for the duration of the mortgage. If either of you loses your job, or have to accept a lower salary, you will no longer be able to service the monthly mortgage fully using just your CPFOA.
The property purchase is far from “free”.
Scenario B: Rent out your HDB, use the rental to cover your monthly instalment
You and your spouse own a HDB flat. You have enough for a down payment for a condominium. The agent suggests that by buying and living in a condominium, you can rent out your HDB flat and use the rental money to cover the monthly instalment for your condominium. This way, you get to live in your condominium for “free”
What Is NOT Being Highlighted
Unlike the first scenario, the logic here is sound. But there are two key assumptions that this strategy is based on, failing which, the strategy can quickly backfire on you, the property owner.
The first is that the actual rental income you can expect from your HDB flat is likely to be much lower than what your agent may estimate for you. That’s because most new property investors do not consider 1) agent commission (usually one month), 2) rent-free period (one month), 3) upkeep cost and 4) tax.
Once you add these costs up, the net rental income you receive will be a lot lower than the gross rental income generated by the property.
The second assumption is the expectation that your HDB flat will always be rented out at all times. Even after accounting for a rent-free period of one month, it’s likely that you will encounter periods of time where you may need two to three months to find a suitable replacement tenant. Even the best managed Real Estate Investment Trusts (REITs) do not enjoy a 100% occupancy rate at all times. During these challenging periods, you may also need to accept a lower monthly rent in order to find a tenant.
To err on the side of caution, we recommend that you should expect to receive a net rental income of no more than eight months of your gross rental income. In other words, if you expect your HDB flat to fetch you a gross rental of $24,000 a year (or $2,000 per month), you should expect to only receive a net rental income of $16,000, or $1,333 per month.
Scenario C: Buy a condominium, rent it out to cover your instalment
You have enough to make a down payment for a condominium. Your agent suggests that you can easily own a condominium by paying the down payment, and then renting it out to cover the monthly instalment. This way, once the mortgage is fully paid up, you get to own a property for “free”
What Is NOT Being Highlighted
Basically, this strategy is all about employing leverage. Leverage is when you use borrowed money to make investments that are larger in size than the capital you have. In property investing, the use of leverage is fairly common.
However, leverage is a doubled-edged sword. If used under the right circumstance, you can make large gains in your investments. At the same time, losses will also be magnified. For example, if you pay a down payment of $400,000 for your $1 million property, and subsequently sell it at a loss of 20% at $800,000, half of your initial capital (half of $400,000) would be lost.
The use of leverage also means incurring interest costs. A $600,000 loan over a 20-year period would cost you $142,000 in interest, by the time the mortgage is fully paid up.
Similar to scenario B, the strategy works only based on the assumption that 1) you are able to rent out your condominium apartment at all times for the duration of the mortgage and 2) that you get the rental income that you want. If either assumption fails to hold, you, the property investor, will be liable to pay for the mortgage yourself.
The Risks Of Property Investment
Contrary to what some property agents may suggest, property investing is far from risk-free. As with all investments, there are risks that you should be aware of, before you even consider investing in properties. These risks include interest rate risk, liquidity risk, market risk, policy risk and of course, the risk that you may lose your job and be unable to service your monthly instalment.
Of course, this isn’t to say that property investing isn’t without its benefits. Many Singaporeans have grown their net worth through prudent property investments. The trick here is to understand the risk-reward trade-off that you are facing, manage them well and avoid over-leveraging yourself.
[DollarsAndSense.sg is a website that aims to provide interesting, bite-sized financial articles which are relevant to the average Singaporean.]