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Buying a private property as an owner-occupier? Think like an investor!

Friday, December 9, 2011

This blog post is in response to a comment by a reader, Jaime. See it here.

Hi Jaime,

How to buy a private property for self stay? I am most probably considered an amateur when it comes to buying private properties but I am happy to share my thoughts with you.

Just keep visiting showflats if you want to buy new. Or keep viewing apartments (look through the classifieds in the papers or search sites like Property Guru) if you do not mind buying from the resale market.

So, when you finally find a property you like and within your budget, do you just buy? That is a million dollar question, isn't it?

Even as a potential owner occupier, to answer this question, we have to think like an investor. This is the only way we do not end up overpaying for that dream home. We can pay but do we want to overpay? Remember, it is never about affordability, it is always about value.

A property's value is determined by the rent it is able to fetch if it were rented out. The higher the rent, the higher the property's value. Putting it simply, we will always value highly anything that is able to benefit us more, right?

Annualise the potential asking rent and calculate the yield based on the selling price of the property. This gives you a very rough idea if a property is worth buying.

To get a more accurate picture, ask how much is the monthly payment to the MCST, property tax and find out how much would insurance cost. Deduct all these from the annualised rent. What is left is net property income (NPI) or income after all maintenance costs have been accounted for. Calculate the NPI yield based on the selling price of the property.

If a housing loan is taken to finance the purchase, interest rates must be given due consideration. In the current low interest rate environment where housing loans could attract interest rates of 1% or lower, a NPI yield of just 3 to 4% is probably enough to make a property investment worthwhile.

If interest rates should bump up by a percentage point or two, investors would demand higher NPI yields as well. This could be achieved either through higher rents or lower selling prices. In a weak economy, prices across the board would likely take a hit since higher rents are less likely to come by. Lower rents and prices are even more likely when coupled with oversupply.

Some might ask why I say 3 to 4% NPI yield is enough to make a property investment worthwhile if interest rate is low? Isn't inflation in Singapore in excess of 5% now? Shouldn't we be invested in assets that could outperform inflation rate?

Well, theoretically, real estate should see its value at least keeping pace with inflation. So, investing in real estate should give us returns over and above inflation rate. Remember, however, that this is in theory. In reality, this is an imperfect world and there will be times when things go out of sync due to decisions made with imperfect knowledge; and these are times when savvy investors capitalise on the imperfections either as a buyer or a seller.

There will be times when things could go horribly wrong, when things go out of sync for a prolonged period. When something is stretched to an extreme, it does not just return to the mean. It is likely to overshoot to the other extreme as it tries to find equilibrium again. Sounds scientific, does it not?

You might be thinking of buying a home for self stay but think like an investor and look for value. You might one day monetise your home. Who knows?

Oh, yes, it could be lots of legwork but have fun in your search in the next few years. It is going to be a buyers' market. So, sharpen your bargaining skills. ;)

You might also be interested in these blog posts:

1. Making your first million dollars in real estate investment.

2. New or resale property?


serendib said...

"think like an investor" Hi AK, I cannot agree with you more - in fact I've used this very phrase on my wife, some extended family and a number of friends whenever they questioned my decision not to buy but to rent instead for the past couple of years.
To further refine your NPI calculation, one can take into account other expenses which may be incurred such as agents, asset enhancement - and of course dont forget that you will have to pay income tax on the rental income too.
Your point about interest rate risk is very true. In S'pore one can only get a fixed-rate loan for max 3(?) years. This ultra-low interest rate environment cannot persist indefinitely, and I'd factor in an average rate of 3.5-4% over a 30-year loan.
I'm looking forward to buying the ST regularly on Saturdays again (speaking of which, SPH looks pretty beaten down even considering it went XD....)

financialray said...

Just to share.
Bought my EC in 2000 as owner occupier. Prices dip as much as 10 per cent during 2003 SARS after sep 11 and IRAQ war. Wave after wave of bad news.
But when you owner occupier, you not selling you suffer only paper loss. Similarly, in a property upswing, if still a owner occupier, the upswing means nothing but a paper gain.
Once there is an upswing, the rental returns will go up beyond any imagination.
One thing to take note is how many more good years Singapore has. Our population is dwindling. We cannot have too many foreigners coming into SIngapore to boost the population as there will be social and political costs.
LKY says Australia will survive another 100 more years but he ponders if Singapore can survive that long.
Can we accept a CHina born or India born Prime Minister?
Freehold vs 99 ?
Long term?

AK71 said...

Hi serendib,

I try to run my personal life like how I would run a business. I have recently been accused by a good friend of being unfeeling when I discussed my decision to sell my properties, including my home, months ago.

I don't think I am wihout emotions but I reserve emotions for situations in which they are appropriate. Does this make me sound unfeeling? ;p

Yes, thanks for highlighting other costs involved in property ownership. The blog post was very much off the cuff and not well researched. Just thoughts off the top of my head. :)

Nothing stays low or high forever. Ultra low interest rates will one day be a thing of the past and you are right to highlight that home loans are usually pretty long in nature. So, I shudder to think what will happen to people who borrowed to the max and who do not have much in terms of reserves. Refinance?

I suppose I would not be the only one combing the classifieds on Saturdays. ;p

As for SPH, it is still my largest single investment in a blue chip. Lower prices could entice me to buy more. :)

AK71 said...

Hi financialray,

We should still think like an investor because buying a piece of real estate at the height of a property boom could mean more than a 10% decline in valuation. It could see a decline of 30% or more.

In such a situation, people who borrowed to the max might have bankers knocking on their doors to top up the difference. Without rental income to cushion the blow, owner occupiers who bought at high prices could really suffer.

I am speaking from personal experience because my parents bought our current family home just before the Asian Financial Crisis. It is only now that price has reached the same level as their purchase price back then.

It is fortunate that my parents had the resources to fully pay up the loan. Some other people were asked to top up the difference because our property value plunged by 33% during the Asian Financial Crisis.

I do worry about Singapore's future but that is not within my control. What I do have control over, I will do my best to make the best of it. :)

Serendib said...

Hi AK, I do believe you meant personal financial life? :-) well for me I've got kids - which frankly speaking is a major financial expense and risk in itself, who definitely can't be handled like a business! Heck they're tricky customers!
Anyway I'm not sure if these measures will impact prices adversely. Rather, transaction volumes will plummet further, but with mortgage costs so low, owners will hold pricing. It'll take an external shock, like another recession, for sellers to finally give in. I think the govt knows there's a good chance that tough times lie around the corner, and they are merely trying to keep prices where they are so the fall will be less steep.
To add to your response to financial ray, being stuck with negative equity and thus unable to sell will impact ones choices in life - eg migration or overseas posting, and in general less willing to take risks in ones career.
As for SPH, you think the Sept lows of sub-3.50 could be retested?

AK71 said...

Hi Serendib,

I should only run my personal financial life like a business, shouldn't I? However, I suspect this mentality has spilled over to other aspects of my life too.

In recent years, I have tried to be less uptight about money as my finances have improved. This is not so easy as many ideas are ingrained. It is easier when I spend money on my family though. I tend to be less calculative with them.

I am not married but whether I have any kids, I have no idea. ;p Yes, I made a decision very early on in life not to have kids as each one would cost at least $250k by my estimate (and that was 15 years ago) from birth to university, a local university. This amount is probably too low now.

I am a lazy guy by nature and I work because I don't have a choice. I work hard to achieve passive income so that I don't have to work hard anymore. Hahaha.. ;p

I am looking forward to bagging a couple of properties in the next few years at more reasonable prices. Sellers still have unrealistic expectations after the latest round of cooling measures. There will always be speculators who are very marginal in financial abilities. These will go first. I have no doubt that prices will weaken. The rate and duration of the decline is anyone's guess. I will act when I feel the price is right.

Thanks for sharing your insights on the impacts of negative equity. They throw light on the subject from angles I have not thought of before. :)

SPH. I got some SPH shares at $2.80+ in the last crisis. So, am I suffering from memory effect? Haha.. I hope not. ;p

I did continue to buy up at $3.20+ and $3.50+. After the latter, I decided SPH shares were no longer cheap.

I do not know if it would retest $3.50 but if sentiments continue to be bearish, $3.50 is only another 5% fall from current levels. I would probably deploy funds in my SRS to get some then. :)

Calvin said...

Hi AK,

Agreed that even if you are buying for own stay, it is important to make sure you are buying at a good value. That's because historically, banks like UOB and DBS have been known to ask house owners to top up their when they house value fall below the loan value (negative equity).

The primary basis of value should be based on rental yield and should be compared not to current prevailing interest rates (less than 1%), but average historical interest rates of 3-4%. Ideally, your yield should be significantly higher. There are many other valuation methods such as comparison methods and so on, but cash flow in my opinion is the most important.

Recently, I was interviewed by Leong Chan Teik at NextInsight regarding my property investments. Check it out here.


Anonymous said...

Although thinking like an investor helps to align activities, we must also understand that we are human beings in the first place.

That is what makes us different from many other living & non-living things

Not having children is a personal choice and one can use cold and calculated arithmetics to validate that decision. It challenges the emotive experience that humans must have.

Buying a home is simply that.
If you like its orientation, location, design, buy it, and enjoy it. Live in it.

If its value rises, so be it.
If it doesn't, so what?

Buying a 2nd home is another story.
That, is investment and it should be apporached in that frame, with cold hard numbers... even algebra!

A home is what we make of it, and it should be enjoyable..comfortable and safe.
It should not be a worry at all.

I bought a new HDB Executive apartment in 1989 at an age of 31
along with my girlfriend and now my wife. I was not sure if I could pay for it: $150,000. It now sounds terribly cheap.

But my pay then was just $2500 gross! and my wife's $2000.!
Prudence and dogged savings coupled with the belief that I must do a good job in evrything I do, helped my promotion.

I paid off the mortage in less than 12 years from a 15 year loan.
Debt free by 43years old and a father of 2 boys.

I had a car too. 2nd hand Mercedes
5yrs old paid in cash $20,000.( from bonus) in 1986.
I have since given up the car which gave me 18 years of pleasure.
My friends teased me for driving such an old car ( 115 series 1976)
But it lasted far longer than their Honda Quintets and Alfa Romeos.

Buy what you need, keep what you want and go for quality.

serendib said...

Hi AK, well we all make our own choices in life dont we? As long as we dont harm others (and I'm excluding emotional harm), we each trod our own path.
The phenomenon of negative equity tying people down to a particular city is (from what I hear in the oil & gas industry) apparently one reason why there's such a mismatch of jobs and workers across the US. A lot of skilled labour who could work in the oil & gas sector (either in the fields or in factories making equipment) are stuck in places like the mid-west where they used to work for auto companies. Now they find it difficult to move to where the jobs are (shale gas/oil regions and Texas)
tks for the reminder - off to buy the ST now =)

AK71 said...

Hi Calvin,

I have been known to give in to temptations once in a while such as a full HD LED TV and blu ray player at full price. These are small change compared to a million dollar property, however. ;)

Thanks for sharing the link to your interview with Next Insight.

AK71 said...

Hi Anonymous,

"Buy what you need, keep what you want and go for quality." I like this. It describes probably the philosophy of someone who would live life to the fullest.

As for a home: "If you like its orientation, location, design, buy it, and enjoy it. Live in it." I simply cannot accept this. ;p

Since selling off earlier this year, I have been looking around. I am definitely not buying at current prices although I saw a couple of developments which I like.

At the time of the viewings some two months ago, I told the agents I would come back in 2014. It might have to be earlier now. ;p

I cannot bring myself to buy something if I think the price is inflated even though I might like it very much. OK, if it were a LED TV or blu ray player, I might give in to temptation but a million dollar home is very different altogether. :)

Could you include your name or initials in future comments? Thanks :)

AK71 said...

Hi Serendib,

"We have a responsibility to ourselves to be happy but at the same time, we should not hurt the people around us."

Since my university days, I have been saying this. I believe it is not easy to perfect this approach and I can only try.

Happy classifieds combing. I think I will start a few months later. ;p

Anonymous said...

thank you so much for this post:-)
i will start with the first step first, that is to visit show flat and read the classified and visit the property website.

what you have shared is a lot to digest. I'm really new to this.


AK71 said...

Hi Jaime,

Investing in real estate requires a relatively long time horizon. With prices looking as if they have peaked, there is certainly no need to rush as a buyer.

I went to look at a showflat earlier today and the asking price is still very high. Well, the recent bout of cooling measures have yet to bite. Also, the project I visited was launched a few months ago and already 90% sold. Therefore, the developer isn't desperate to sell.

I will wait for new projects to be launched which I expect to be more reasonably priced. Then again, I am really waiting for at least a 20% correction in price from current levels before I would even consider investing in properties again.

It is now a waiting game. Who will blink first? Buyers or sellers? ;)

AK71 said...

The number of returned condominiums is at its highest in about a year, according to property research firm Square Foot Research.

Data shows there were 152 units returned in April. This slightly pips the previous high of 150 units returned in May 2012.

It also brings the total number of units returned for the first four months of this year to 415, about 10 per cent higher than the same period in 2012 -- there were 378 units returned in the same period last year.

Buyers who choose to return their units have to forfeit 1.25 per cent of the property's price.

Some analysts attribute the increase to the record high private home sales in March, where 2,793 units were sold. The government's property cooling measures, may have also led some buyers to back out of their purchases.

Analysts added that those who made impulse buys could have also contributed to the high figure.

David Poh, senior director at PropNex, said: "Even before you view a property, you know you'll be influenced by salespeople and advertisements. So it's best to do your homework and financial planning, and know what you can afford before viewing a place."


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