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Tuesday, September 3, 2019

Another theoretical exercise on Property Calculations -- is it good for financial gains now?

In recent times, there are many ads on Facebook, on property forums, on developer residential condo launches, how one can profit from buying properties, or specifically, ECs, and have it as an asset in which you could cash in to retire. Specifically, sell and downgrade to a HDB and retrieve cash for retirement.

The question is, in terms of financials, is this really a much better move?

So I decided to do a theoretical exercise on how this really works out. As there are multiple variables involved for different people over different time period, I decided that since this is my blog, I shall take myself as an example, on my own scenario 7 years ago and how it may pan out. Specifically, back to HDB vs Esparina condo again. 

To simplify matters, I will set some variables for my theoretical exercise. 
Starting amount for property = $160k. That was approximately the amount we put into HDB from our CPF at that time, in addition to the renovation we did for the HDB back then. This excludes additional furniture and electrical appliances.

Target timeline: 30 years later. That's the typical bank loan time, plus I would have been 61 years old by then. I highly doubt I will like to go through the hassle of moving house around 70 years old, so I think 30 years timeline should be good. 

Assumed average interest rate over 30 years: 2.5%
I am taking the CPF OA floor interest rate here as a comparison. 
There are also a few other assumptions that are needed to be taken into consideration.

Assume HDB price remain relatively stagnant, or even, depreciate over time. 
For private property prices, I am unsure. But I shall take data from SRX website, on their price index from 1995 to 2019 for the OCR region (https://www.srx.com.sg/price-index). There was approximately a 97% increase in price over 24 years on resale price. So for 30 years, we could assume a 125% price increase. 

Lastly, the biggest assumption is that money not used to pay the property, is put into the bank. 

I exclude other misc fees like carpark and town council fees as they are roughly similar to condo management fees.  

Now the calculations start. 

HDB Calculations
For the HDB, it is simple and straightforward. It was $325k for me, plus renovation or around $25k. 
The loan started at around $190k back then. 
So over 30 years, the amount we fork out would be the following

Initial payment: $135k
Renovation (including air con): $25k
Stamp duty + misc: $5k
$190k loan + 30 years of interest @ 2.5% = $270k (using MoneySense mortgage calculator)
30 years of property tax: $500 * 30 = $15k (It is actually lesser than $500 currently).

Selling price doesn't really matter if staying in the HDB all the way, but let's assume that it becomes $450k by then. Currently, the market price is about $550k.

Upfront: $165k
Total forked out over 30 years about $450k


Condo Calculations
I find this a wee bit more tedious because we need to consider buying and selling the condo, to buy back a HDB for retirement in order to have cash for retirement. 

For Esparina, for a unit almost the same size as my current 5-rm HDB, it would have costed $880k.
Renovation costs not considered as it was generally in move-in condition. 

Initial payment: $176k (20% downpayment)
Stamp duty + misc: $21k (back then)
$704k loan + 30 years of interest @ 2.5% = $1001k (using MoneySense mortgage calculator)
30 years of property tax: $1500 * 30 = $45k (I am doing an underestimate here, without consider potential increases in property prices).

Upfront: $197k
Total forked out over 30 years about $1243k
(That is additional $793k forked out. We will have to take this into account later.)

We assume that by 30 years later, this condo can be sold for $880k * 2.25 = $1.98 mil, roughly $1800 psf in the year 2044  (125% price increase, which may or may not materialise.)

To draw down on the amount, one will have to sell the condo and buy a HDB.
So we assume that the sale goes through at $1.98 mil.

Upon selling
Agent's 2% commision: $39.6k
Amount received: $1.94 mil

Upon buying HDB in full without loan
(downgrading to cash out from the condo)
HDB Price: $450k
Stamp duty: $8.1k 
Renovation: $10k (assuming just basic renovation and moving)

Cash left: $1472k

Versus buying a HDB, the amount would be an additional $679k in cash to retire with after a lifestyle downgrade. 

If we consider fixed deposits of 1.5% giving an additional of $213k to the initial $793k if we put in $26.4k annually, it would be an additional $466k cash.


Conclusion Part 1
Honestly, without doing my mathematical calculations, I had thought that the bank interest rate would somewhat erode the amount that would have been gained, while stamp duty will erode it even further. Afterall, 125% is roughly 2.7% per annum compounded on the backdrop of a 2.5% bank interest rate. 2.7% per annum also makes sense as inflation rate for Singapore is around 2%~3%. 

The bulk of the difference in amount comes from two amounts.
(1) $325k of the HDB yield 1.1% per annum over 30 years on a backdrop of interest rate of 2.5%, vs $325k out of $880k yielding at 2.7% p.a. 
(2) Another $555k of the condo yielding 2.7% p.a. While the bank loan is at 2.5% such that there is only a gain of 0.2%, every time the loan is paid down, the yield for that amount turns into 2.7%.

Financial bloggers have been talking about yielding 5% or more generally. For the $793k (average of $26.4k per annum, or $2.2k per month) to achieve the same amount of gain, it would have to be a compounded 3.8% per annum over 30 years. In other words, I have to consistently beat 3.8% per annum compounded for 30 years just to match the gain that an EC like Esparina would potentially have.  This is because of the difference of 1.6% p.a. for 30 years for the $325k. 

But we have to consider that to yield 5% consistently over 30 years, the amount of effort to achieve that is more than the amount effort to just buy and stay in the condo for 30 years, before finally downgrading. Buy and stay is definitely much more passive, on top of being able to enjoy the condo facilities for 30 years. 


Tweaking some variables
The above scenario are based on some historical data, and are overly simplified and optimistic, at least for the condo part. 

So I played with some number changes. 

Variable change 1: Condo value increases 2.0% p.a. instead, less than bank interest rate of 2.5%. 
In this scenario, we can assume the HDB value does not change (it might go lower).
The condo buyer would be able to sell for $1.594 mil (around $1450 psf) and receive $1.56 mil after agent fee. 

After downgrading to HDB, there is still a $1.092 mil left. 
The same $793k would need ~2% p.a. to give the same amount. 

Which means to say, if we do not expect the condo price to increase more than 2% p.a. after 30 years, then staying in the HDB and putting the cash into fixed deposits (currently 1.7% for CIMB), and maybe some into corporate bonds, etc, may yield better results. 

This scenario is likely if we bought at a property price high, i.e. during the 1996 era of high property prices. 

Variable change 2: Bank interest rate rises a little past 2.5%, assume 3.5%. 
This has a little more considerations. All else being equal, it would be the interest amount that will affect.

For the HDB,
$190k loan + 30 years of interest @ 3.5% = $307k (using MoneySense mortgage calculator)
Total forked out would have been $37k more.

However... HDBs have the advantage of HDB loan at 2.6% fixed, so if we go by this path, it would be only $4k more. It only make sense to go with a HDB loan in this scenario. 


For the condo
$704k loan + 30 years of interest @ 3.5% = $1138k (using MoneySense mortgage calculator)
Total forked out would have been $137k more.

This would erode the $672k advantage to $539k.

Comparatively, fixed deposits of 1.5% will have give an additional of $213k to the initial $793k if we put in $26.4k annually.

Variable change 3: Bank interest rate rises way past 2.5%, assume 5.0%. 
For the HDB,
$190k loan + 30 years of interest @ 5.0% = $367k (using MoneySense mortgage calculator)
Total forked out would have been $97k more.

However... HDBs have the advantage of HDB loan at 2.6% fixed, so if we go by this path, it would be only $4k more. It only make sense to go with a HDB loan in this scenario. 

For the condo
$704k loan + 30 years of interest @ 5.0% = $1361k (using MoneySense mortgage calculator)
Total forked out would have been $360k more.

This would erode the $672k advantage to $316k. Still better than fixed deposit. 

Variable change 4: Condo value increases 2.0% p.a., while bank interest rate is at 3.5%. 
The condo buyer would be able to sell for $1.594 mil (around $1450 psf) and receive $1.56 mil after agent fee. 

After downgrading to HDB, there is still a $1.092 mil left. Because of forking out $137k more, there will only be $955k left for the downgrader, $162k more than $793k. This is less than the fixed deposit gain (and assuming the fixed deposit rates doesn't rise).

Variable change 5: Condo value increases 2.0% p.a., while bank interest rate is at 5.0%. 
The condo buyer would be able to sell for $1.594 mil (around $1450 psf) and receive $1.56 mil after agent fee. 

After downgrading to HDB, there is still a $1.092 mil left. Because of forking out $360k more, there will only be $732k left for the downgrader, less than $793k. 


Conclusion Part 2
The variables change give an additional perspective. 

The scenario painted above gives an additional $466k cash because of two assumptions
(1) Condo resale prices rise at the same rate as before for the OCR region over past 24 years. 
(2) Interest rates remain at 2.5% or lower. 

Looking deeper into the data, both catalyst may not hold.

Assumption (1)
The greatest rate of increase (160%) was between 2005 to 2012, a 7 year period. This was in line with the Singapore population growth spike from 2003 to 2008, and remained above 2% until 2012. With population growth comes higher demand for properties, so it makes sense. 

However, since 2013, there was a very slight, or minimal growth rate till now, 2019, a 6 year period. With the release of more land in the Great Southern Waterfront, Paya Lebar Airbase, etc, I am unsure whether condo value will still rise at 2.7% p.a. for the next 30 years. 

Assumption (2)
A quick google search currently shows the property interest rates between 2.48% to 2.78% across different banks (source: MoneySmart blog). My guess is, the low interest rates of the past may not come back for now. The low interest rates previously were due to the 2009 financial crisis, where there was a liquidity crunch. Interest rates were lowered to increase the liquidity (or make borrowings cheaper) to help the economy recover.

Will the interest rate be lowered again? That's anyone's guess, but I think the likelihood is low. Ultimately, banks want to earn more $$. Why charge an interest rate so low?

Because of the economical and political events in Singapore since 2005 till 2013, property prices were increasing fast while interest rates were low. Any comparisons with that time period will show a nice property yield gain, and get buyers very sold on it.

My guess
I am guessing Variable Change 4 to be the most likely for the next 30 years. Another way this could be sold is the big numbers and the potential gain in absolute dollar terms. It does look very nice on numbers because the numbers are large.

However, based on percentages (an E Maths topic btw), the yield may not be that nice afterall. 

So in summary, in terms of financial gain, I don't think one would be much better off financially in 30 years time by buying a condo now. That does not even include the stress of higher monthly repayments for some. 

Of course, buying a property to stay does not always mean it must be for financial gain. The objective of this theoretical exercise is to do a personal self-check on whether buying a property for financial gain/retirement really works the way it was described. I think I have my answer.

What it also means for me, is that I can take my time slowly if I am looking to upgrade my property. No rush at all.

Then again, markets can remain irrational than we can remain solvent. So... who knows?

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