How are Singaporeans using their first property as an investment?

Let's start by defining what we're talking about - how does the typical Singaporean use their first property as a pure investment asset?

The simplest way to do this is to buy a private property, but not move into it. Instead, you continue to live with your parents, while renting out your private property. Ideally, the rental income from your property will more than cover the mortgage repayments - and when you sell the property in five to 10 years, you will profit as the property has appreciated.

Another way to treat your first home as an investment is to still live in it, but simply hope that you've picked a property that will appreciate. An example of this is choosing to buy in a non-mature estate, where many amenities (shopping centres, train stations, hawker centres, etc.) have not yet been built. This is based on the theory that, as these amenities are built up, the property value will rise.

Finally, some daring speculators will even buy an aging development (one with 40 years or less left on the lease) as their first property, all the while speculating that an en-bloc sale will leave them richer.

There are, however, many risks to this profit-driven approach.

HOW ARE SINGAPOREANS USING THEIR FIRST PROPERTY AS AN INVESTMENT?

Let's look at some of the main risks, in treating your first property as an investment:

• The rental income may be lower than expected
• The property may not appreciate as well as expected
• If you decide to settle down, you may not have a home of your own
• If buying an old property, don't assume an en-bloc will happen

THE RENTAL INCOME MAY BE LOWER THAN EXPECTED

You cannot assume that the rental income will suffice to cover the mortgage repayments. If you would be unable to handle the mortgage without the rental income, you're quite likely overleveraged.

For example, say you take out a loan for S$700,000, at 1.8 per cent per annum, with a 25-year loan tenure. The monthly repayment amount is S$2,899 per month (it can sometimes be lower; visit SingSaver to find the lowest mortgage rates on the market). You assume that the rental income will be S$3,300 per month, thus generating S$401 a month.

However, a few years in, the rental market softens. Soon, the rental income falls to a mere S$2,500 per month. On some months, there is no rental income at all, which leaves you to pay the entire mortgage.

What will you do when your "investment" starts to cost you S$399 to S$2,899 per month? This may interfere with your ability to save or invest - and if you have dependents, such as parents or siblings to look after - the added cost can be devastating.

You may think you can just sell off the house at this point, but that's easier said than done. It can take months to sell a house, and you will need to pay the agent a commission of around two per cent (selling an S$800,000 unit would cost you S$16,000).

Also, when the rental market is weak, the property prices might be low as well. You may rush to sell the house, and find that you're making a loss. This disastrous "investment" could set you back financially, by several years.

THE PROPERTY MAY NOT APPRECIATE AS WELL AS EXPECTED

What makes a good investment? Let's consider the simplest way to determine this: by using straightforward Return On Investment (ROI).

Let's say you buy in a non-mature area, where private properties are a little cheaper. Let's also say you are an owner-occupier; you live on the actual property without renting it out.

The total price of your property is S$700,000, inclusive of all the stamp duties and relevant renovation works; this is quite cheap for a full-suite condo.

You hold on to the property for 10 years. During this time, you bear with inconveniences such as lack of a train station, or the lack of malls and markets. Finally, after 10 years, you decide to sell.

Unfortunately, property prices are in a slump at the time. Your house has appreciated, but just to around S$800,000. Your ROI is:

(sale price) - (purchase price) / purchase price x 100

This means it's (S$800,000 - S$700,000) / S$700,000 x 100 = 14.2 per cent

Is this a good ROI? In truth, given the amount of time you waited (10 years), this is a terrible figure. It means there's an averaged out return of just (14.2 / 10) = 1.4 per cent per annum.

If you had just left the money in, say, your CPF, you would have gotten 2.5 per cent per annum; and that would have been guaranteed. Even a simple endowment policy can provide returns of around three to four per cent per annum.

But at least you haven't lost money, right?

Wrong. The rate of inflation in Singapore is around three per cent per annum, and your investment has not kept up with that. And this is after you've put up with various inconveniences for a whole decade.

IF YOU DECIDE TO SETTLE DOWN, YOU MAY NOT HAVE A HOME OF YOUR OWN

You may have plans to hold on to your investment property for five years or 10 years, but life still carries on in the meantime. What happens if you meet your soul mate, and want to get married?

If you want to move into your investment property, you will lose any rental income from it. This means you'll have to bear the full cost of the mortgage on your own. Also, if your investment property is small - such as a shoebox unit you rented out to single expatriates - it may be impossible to raise your family there.

(Do note that you cannot apply for an HDB flat, if you own a private property).

These conditions could force you to sell off your investment, even if the property market is in a downturn. Either that, or you and your partner will have to wait several years before you can sell and get a home of your own.

IF BUYING AN OLD PROPERTY, DON'T ASSUME AN EN-BLOC WILL HAPPEN

The most dangerous thing you can do is assume an en-bloc will happen. There is no guarantee that this will happen, even if a developer is offering a high price.

You must consider that the emotions of other owners play a part. The development may be home to many retirees, who have no desire to move at this stage in their life. The community living there may also be close knit, and may refuse to budge even in the face of high sales proceeds.

There is also another risk to consider: the en-bloc may occur sooner than expected. If an en-bloc sale occurs within three years of you buying the property, you are still liable to pay the Sellers Stamp Duty (SSD). This is 12 per cent of the property sale price on the first year, eight per cent on the second year, and four per cent on the third year. Note that this applies even if you vote against the en-bloc sale.

DOES THIS MEAN THE FIRST PROPERTY SHOULD NEVER BE AN INVESTMENT?

Not at all. It can sometimes be viable to treat your first property as an investment. However, it's highly advisable that you meet you certain criteria first. These are:

- Don't sink every penny into the property. Make sure you have other assets in your portfolio, such as equities, bonds, unit trusts, etc. The property should only constitute one part of your long-term investment portfolio.

If you can't afford to invest in anything else after buying the one property, you should rethink your decision. You are putting too many eggs in one basket, by making a one-way, unhedged bet on the property value.

- You are certain you won't need a home of your own, while your investment is ongoing. If you need to move into the property, or you need to sell it off because you're settling down, that could derail all your investment plans.

- You are not at the total mercy of the rental market. If you cannot afford the property without rental income, you cannot afford the property at all. Never buy if you are totally dependent on the state of the rental market, just to make your mortgage repayments.

This being said, our recommendation to first time property buyers is to look for a home first. It's safer to start playing landlord later, when your first home is secure, and you can start to consider a second property.

However, if you have high income or a different lifestyle (e.g. you are a committed lifelong single), you can speak to a financial advisor/wealth manager on whether to dive straight into property investment.

This article was first published in Singsaver.