Here’s the story/scenario that property agents or financial advisors tell you to convince you that investing speculating on a condo in Singapore to get rental income is always a smart thing to do. “If you buy a condo, then rent it to a ready and willing expat tenant, he/she will pay rent that will cover your mortgage payments and even give you some extra pocket money. And after the term of the loan (usually 25 or 30 years), the home will be yours free, paid off with passive rental income.” The story is often followed by the agent giving you a wide-eye/gaping mouth look that suggests, “everyone is doing this, this is the only way to get rich, and you would be a complete fool if you don’t do it too.” Here’s where they’re wrong:
NOTE: This article is referring only to private condos as rentals (not as primary homes). It also does not refer to BTOs or HDBs.
Gross Rental Yield Does Not Take Into Account Other Costs & Expenses
Most property agents calculate Rental Yield as a straight-forward GROSS calculation. Simplified Example: A $1,000,000 property that rents for $2800 a month (or $33,600), has a gross yield of 3.36%
What’s Wrong with this Calculation?
This gives you the impression that rental yields in Singapore are not that bad, considering that you get to keep the property after your loan term. Remember that property agents and financial advisors make money from transactions. In general, you should not think of them as your friends or as unbiased money managers who have your best interest in mind. The reason why this calculation fails is because it does not take into account any of the expenses:
1. Purchase expenses (one-off) that add to the total cost of the property: 2. Rental expenses (recurring) that can vary widely from year to year. And they are particularly vulnerable to changes in interest rates and overall market conditions.
The Actual Rental Yield (Includes Other Costs & Expenses)
From the earlier example, here’s your REAL yield More Realistic Example: The Total Cost of Property for a $1,000,000 purchase is:
In this example, the rental income is $2800/month (or $33,600 per year) and rental expenses are roughly $47,000!!! (This assumes a mortgage interest rate of 1.8%, ½ month agent commission, NO vacancies, NO repairs, $3000 in annual insurance, and $4500 in annual condo fees – see the table below.)
|Maintenance/sinking fund ||$4,500|
This type of real rental yield is actually quite typical in Singapore. Some people will lose even more because interest rates are higher now than they were just a few years back. Rents have also dropped. I was also a bit conservative since I didn’t factor in vacancies or repairs. I also didn’t factor in income tax (on the rent income).
Had I factored in vacancies (½ month per year on average) and repairs ($500 per year on average), and used a more typical interest rate of 2.8% rather than the teaser rate of 1.8%, the Net Rental Yield would be -1.74% per year.
Is a Negative Rental Yield Still Worth it?
Some agents and advisors would still say, “It’s ok, since your property will appreciate by more than 1.2% a year”. This is a gamble. Nobody actually knows for sure that your property will appreciate and by how much. Judging from historic trends, it seems like property prices have been artificially propped up since ZIRP (zero interest rate policy) began. This means that it’s likely for prices to decline when interest rates rise again to their typical historic levels (as shown in the above chart).
Property agents and financial advisors cling on to the dogma that property prices always go up in land-scarce Singapore. But they often forget that private residential property prices have dropped many times in the past. Just take a look at the period during the Asian Financial Crisis (in 1996 through 1998).
But Don’t I Still Get a “FREE” Property After 30 Years?
If you manage to get an annual yield which is consistently equal to 0 (your rental income covers your rental expenses completely) throughout the term of your loan, yes, you will essentially pay off your loan after the term ends (since your mortgage payment includes the equity-building principal portion).
However, had you invested your initial cash payment of $317,600 (total cost of property – loan amount) into a 2.5% investment (CPF/bond/fixed deposit/etc) for 30 years, you would have roughly $666,000 without the burden of being a landlord or the risk of changes in interest rates and market conditions. If you invested that amount at 5% (which is not an unusual rate of return for ETFs), in 30 years, that $317,600 now becomes $1,373,000.
Remember that a property is an asset and a liability. You are liable for the mortgage no matter what happens throughout the term of the loan. A term of 25 or 30 years is very, very long. It’s hard to imagine that your life would remain unchanged or just keep improving during that entire time. Remember that the iPhone has not even been in existence for a decade; how much has your life and the general economy changed since before the iPhone?
What Should You Do?
The example here takes into account a lot of assumptions while also neglecting inflation and the use of CPF as the funding source (as well as the need to replenish your CPF along with the interest portion that would have been earned). We live in unprecedented times and things can change, especially over the course of 25 or 30 years. Here are some thoughts to consider:
- With such low net yields on rental income, by investing in a second property, you would be banking almost completely on appreciation in order to make your investment worthwhile.
- Property prices have actually come down over the last few quarters. Most people agree that this is primarily due to the cooling measures, since we’re still deep into ZIRP. When ZIRP ends, and interest rates rise, repayments on loans will go up. And property prices will likely dip even further.
- A mortgage uses leverage, which can be really good when it works for you. Or it can be a complete disaster when conditions are not in your favour.
- Investing the money that would have been used as a cash down-payment into CPF (or ETF/bond) could be a better option. It might give you the same or even higher returns, in addition to being more safe (or liquid).
- Being a landlord is not always a bed of roses. I’m currently taking on both roles. And while I enjoy collecting income on my investment properties (which have positive yields, because they were paid off a long time ago), I also enjoy being a renter and having the freedom to shift to a new location and change my environment and living conditions every couple years.
- If you bought your property a long time ago (when housing was more reasonably priced), then you probably have a positive rental yield on your investment since your total cost of purchasing and your rental expenses are both low. And in this case, much of this article doesn’t apply to you.