Singaporeans cannot resist putting their money into property investments. The idea of renting out several properties and collecting income while still seeing its price shoot up is a life many people here dream of.
While these dreams are innocent enough, and perhaps provide a goal for some people to aspire towards, many may embark on them without fully understanding the risks and costs that comes with it. Just because property prices increase over time does not mean property investors will definitely make money.
This is why you need to fully understand property investments and do your sums before putting in your money. To help you crunch your numbers, we highlight five ways that you can use to calculate your property investment returns.
What To Think About When Buying An Investment Property
Before diving into calculating your returns, you should be fully aware of the costs and risks that come with investing in properties.
Some Of The Costs You Will Be Bearing
Some cost areas to take note, and eventually include in your number crunching is the Buyer’s Stamp Duty (BSD) and the Additional Buyer’s Stamp Duty (ABSD). The BSD works out to about 3% of the cost price of your property investment while the ABSD is added depending on the number of residential properties you already own and can go up to 10%.
Other transaction costs include legal fees of close to $3,000, property agent commission of up to 2% of the transaction price, administrative cost of up to $1,000. After you have bought a property, you also need to consider interest costs on the amount you have borrowed (as well as repayment of your capital), any maintenance fees, renovation costs, property agent commission for renting out your property, property taxes, insurance, and also an emergency fund that will cover repairs that you may be required to fork out from time-to-time as a landlord. You also need to know that any income you receive from your property is subjected to income tax, with the exact amount varying depending on your current income. Lastly, you need to think about arranging the 20% down payment on the property.
With a simple recap on some of the costs that you will be bearing, you can immediately see that property investing isn’t as cheap as you may think it is.
Some Of The Risks You Will Be Taking On
Whether you purchase residential properties or other types of properties in Singapore, or you are considering investing in an overseas property, there are also many risks that come with it. These may include a stagnant property market that fail to deliver on price appreciation, an economic downturn that sees you having to cough up cash top-ups if you have over-leveraged yourself or a tough rental market that sees your property vacant for extended periods of time.
When making your property investments, you should also think about certain government restrictions such as the Seller’s Stamp Duty (SSD), of up to 12% if sold within a year and nothing if sold after three years, the Total Debt Servicing Ratio (TDSR), where investors have to ensure that your total property loans and any other debt you have to repay is within 60% of your monthly income and the Loan-To-Value (LTV) ratio, where you may be limited, as low as 20%, on the amount of loan you can receive on a property purchase.
Remember to include some relevant numbers into the following calculations for your property investment returns. We will make some assumptions in our calculations below and base it on there being no government restrictions these calculations for simplicity.
#1 Price Appreciation
This is one of the simplest and most commonly used ways to measure your property investment returns. If you’ve ever heard friends, family members or even property agents tell a story of how a friend of theirs earned a 50% return selling a property at $1.5 million after buying it for $1 million a few years later, they are most likely using this method of calculation.
Due to its simplicity, this method is not the most accurate measure for property returns – it does not take cashflows, both positive and negative, into consideration. This includes rental income and also expenses related to the property transactions and upkeep discussed earlier.
This method of calculation is best used for homes that you are living in but also expecting prices to rise or if you are investing in a property with strong en-bloc potential.
#2 Return On Investment (ROI)
The total returns method adds on the price appreciation method by including positive and negative cashflows in the calculation. It takes into consideration the fact that you will receive rental income as well as have to fork out for expenses related to purchase and rental transactions, for maintenance and upkeeping the property and for interest expenses, taxes and insurance.
In this scenario, we take the property purchase price (Assumption: $1 million) and other relevant costs highlighted in the above discussion (Assumption: $100,000).
Our returns in this scenario is the property sale price (Assumption: $1.5 million) and rental income (Assumption: $4,000/month).
If we sell this property in one year, our returns come up to $500,000 from price appreciation and $48,000 from one year, or 12 months, of rental income and we also realise a negative cashflow of $100,000 in costs.
We can use the formula ((sale price + rental income) – (purchase price + other expenses)) / purchase price to work out this amount. This translates to (($1.5 million + $48,000) – ($1 million + $100,000)) / $1 million, delivering a return of 44.8%.
This also puts your calculations into context as someone who earns $448,000 on a $1 million investment would have done a lot better than another person who earns $448,000 on a $10 million investment.
As you can see, this method of calculating returns gives us the percentage gains that we receive at the end of the investment. However, it does not take into consideration the amount of time we spent in the investment. It also does not take into consideration that we may have borrowed money to fund the investment, which is very likely with property investments.
#3 Cash-On-Cash Return
As stated in the above example, our calculations have been assuming that we funded the entire property investment. This often not the case with property investments in Singapore.
Many of us would take the maximum property loan we can get when we invest in a property. If this investment property is a residential property, we may only be able to take up to 80% (if it is the first property we own) or even 50% (if it is the second property we own). If it is a property other than residential, we may be able to take a loan of up to 80% of the property value.
We’ll assume an 80% loan for this scenario. This means that we would only be paying $200,000 of the initial $1 million investment. In this case, we will assume that out of the additional $100,000 in costs, $40,000 was paid in mortgage, and of this amount, $26,000 was for principle repayment while $14,000 was for interest payments.
This means if we sold our property after one year, we would be left with a loan of $774,000 to repay. Deducting this off our sale price of $1.5 million, we would be left with $726,000 in cash.
We can use this formula to calculate our cash-on-cash return: (total income) / (cash outflow). In this scenario, this translates to (sale price – outstanding loan + rental income – cash outflow) / (initial cash outlay + additional expenses)
This translates to the following calculation, ($1.5 million – $774,000 + $48,000 – ($200,000 + $100,000)) / ($200,000 + $100,000), giving us a cash-on-cash return of 158%. Of course, we are able to achieve this return primarily because we were able to leverage on debt for the purchase of the property.
This calculation gets trickier as we move into future years as we have to take into account additional rents, any principle paid back to the bank during our mortgage repayment and any additional cash utilised in upkeeping the property.
#4 Simple Payback Period
When you invest in a property, you may also be looking at how long it takes for a property to pay for itself. Many people may want to use this method to relieve themselves of worrying over price fluctuations and to just focus the long term.
We can see that between the fifth and sixth year, we would have recovered our initial down payment. At this point, many investors see the property as paying for itself. For those who are more conservative, they will likely include expenses such as the additional expenses incurred at the time they purchased the property and even any expenses such as interest payment and other miscellaneous costs such as agent fees, maintenance fees or even taxes.
By the time we reach year 20, whether the price of the property has gone up or not, it would have been more or less fully paid, even after taking into account additional expenses we incurred throughout the years.
#5 Net Rental Return
Many times, when people choose to invest in a property, they are looking at earning passive income. The highlight of owning an investment property is that it will deliver returns in the form of rental income for these investors.
In our earlier examples, our property costs $1 million and delivers a rental income of $48,000 a year. On the surface, it delivers a yield of 4.8%. Not bad in this low yield market. However, this is the gross yield of the property.
To calculate the net yield, you need to take into consideration the costs involved as well. This means that you need to deduct the interest portion of your mortgage repayment and other expenses related to owning and upkeeping your property. This could amount to $26,000 a year.
Using this amount, your net rental yield falls to close to 2.2% actually. On top of that, any unexpected big-ticket expense related to the property will eat away at this return.
Understand Your Property Investment
These are just five common ways to understand the return your investment property delivers. Of course, there may be many other ways you can go about to calculate your returns.
What matters is that you know the limitations of certain calculations and have catered sufficient buffer to be able to ride out any economic downturn that may see valuations suffer or rents squeezed.
Using these methods to crunch your numbers can also help you better plan for your future cashflows and even retirement by using your investment property as another source of income.
DollarsAndSense.sg is a website that aims to provide interesting, bite-sized financial articles which are relevant to the average Singaporean. Subscribe to our free e-newsletter to receive exclusive content not available on our website. Follow us as well on Instagram @DNSsingapore to get your daily dose of finance knowledge through photos.
Bonds and Fixed Income