4 reasons why property may not be the best asset for retirement
Property investments have long been favoured in Asian cultures, and Singapore is no different. The appeal is as much psychological as it is financial: you can stand inside a house you own, but you can’t see a stock or bond (well, not unless you bother to get the certificate). But take away this appeal, and what’s left in terms of real numbers?
The pros of property
Let’s look at the basic upsides to property:
- Over time, property prices tend to rise. In most countries (not just Singapore), property prices tend to rise over time. As a country’s population and wealth increase, the available land space tends to decrease. In particular, central areas (such as districts 9, 10, and 11 in Singapore) become overcrowded, and demand for housing starts to exceed supply. As such, the prices of properties naturally rise. This happened quickly in Singapore, due to our rapid rise from developing to first world nation. A combination of land scarcity, fast rising population, and an increase in wealth helped property investors to make big returns, up to the last peak in 2013. In general, almost any property will rise in value if you wait 15 to 20 years. This applies in almost every major city, whether it’s Singapore, New York, London, Hong Kong, or so forth.
- Property can be a regular cash generator. Assuming the rental income from your property exceeds the monthly cost (mortgage, maintenance, and tax), it can be a regular cash generator. There may be a bigger sense of satisfaction compared to dividend paying stocks or bonds, as a landlord can collect cash every month. Whether the pay outs are predictable is another issue; that comes down to the rental market, the length of the lease, and the reliability of the tenant.
- Rental income can move with inflation. Unlike a bond coupon, or fixed pay-outs from CPF, rental income can rise with inflation. As prices go up, landlords simply raise their rates to match.
- There is a greater sense of control. There isn’t much you can do to improve the value of a stock (in theory you have a say at the annual general meeting, but you’re seldom heard unless you own a jaw dropping amount of equity). With property, you can take steps to renovate the rooms. You can also extend the house or add floors, in the case of some landed properties. Of course, there is no guarantee that such improvements will “pay for themselves” upon rental or resale.
Some of the main drawbacks to owning property are:
- Illiquidity. The main problem with property assets is the lack of liquidity. You can sell a stock with a few clicks of a mouse, and get your money in three days. You usually can’t do this with a house, not without incurring a major loss. Most of the time, property is bought with a mortgage. You will be making repayments every month for your investment, and the money that you pay this way is locked down till the end of the loan tenure. There are some ways to get it back out, such as cash out refinancing, but even these methods can take months to get approval. To simplify: if you invest in property, and you need money for an emergency, you probably can’t take it out of the house. And if you end up in a personal financial crisis, such as an unexpected retrenchment, you must sell if you can’t service the mortgage – that sale could lead to a capital loss, if done in a hurry.
- High maintenance costs. HDB flats have conservancy charges and private housing has maintenance costs. In general, the fewer the units in a development, the higher the cost (as it is shared by fewer residents). First time property buyers are often shocked by how high these costs are. Even a 20-year-old condominium, such as Changi Court, can cost about $250 a month in maintenance. Luxury condominiums in districts 9 and 10 can have maintenance costs that run into thousands as they often have concierge services.
- Capital intensive. The maximum loan-to-value (LTV) ratio that a bank can give you is 80%. This means you’ll have to fork out 20% of the property price as down-payment, of which 15% can be drawn from CPF. There is a minimum of 5% in cash. However, as we are discussing property as an investment, we will assume you already have an existing property (your home) and are buying a second one. Having an outstanding home loan reduces the LTV to 60%, and Singaporean buyers pay an extra 7% for the additional buyers stamp duty (ABSD). This is a huge amount of money to commit and you can build a sizeable portfolio of stocks for such an amount.
- Returns are deceptive to a layperson. Lay investors are often confused by the returns on their property. This is because they’re taught a simplistic way to view it. Here’s an example.Let’s say you purchase a condo for $800,000. You wait 25 years, and then resell it for $1.4 million. It’s easy to think that’s a profit of $600,000, but it isn’t.First, consider the interest on the loan. Assuming you got the full LTV (a loan quantum of $640,000), at 1.8 per cent interest per annum, for 25 years. You would have paid $155,236 in interest by the end of the loan.So now, your profit is really ($600,000 – $155,236) = $444,764.Next, consider the cost of renovations. Assume that the first renovation cost $30,000, and that you subsequently pay $10,000 in renovations on the 15th year. Your profit is now ($444,764 – $40,000) = $404,764.What about the maintenance fees and taxes? We’ll be conservative and say these all come to around $5,000 a year (it’s usually much higher). At the end of 25 years, that’s $125,000. Now your profit is ($404,764 – $125,000) = $279,764.
Over 25 years, that’s roughly an annualised return of 1.2%. For comparison’s sake, the typical insurance policy will get you 3% per annum (and also give you health coverage). A well-diversified portfolio of stocks can net you 5-8% per annum, as can your CPF Special Account. (For more on how to start building such a portfolio right now, check out The Investment Quadrant on The Fifth Person).
So does that mean property is bad?
This doesn’t mean property is a bad retirement asset. It just means we shouldn’t assume property is always the best or that it’s automatically “safer” than other forms of retirement assets.
The fact is, we cannot predict the final price that a property will sell for. We cannot even predict the mortgage repayments over long terms as Singapore banks do not have perpetual fixed rate mortgages. Finally, we cannot predict when an emergency might require us to sell the house, which could mean a potential loss.
In light of that, a property asset should be treated as just another asset, not a sure-fire solution. Don’t sink every penny you have into a house and assume you’ll be set for life.