A common Singaporean dream is to own a second property that we can rent out to earn rental income. Many of us see this as a gateway to achieve financial freedom earlier or to provide an income in our retirement, or even enabling us to indulge in greater luxury.
What many of us don’t realise is that owning an investment property can be very costly. It’s not as simple as buying a property and ensuring we receive decent returns on our investments or renting it out at the market rate. There is a lot more at stake and we need to go in with our eyes open.
Overstretching ourselves may be a bad decision that ultimately cripples our financial future. Here are 10 things we need to consider when we’re looking to buy an investment property.
#1 Mortgage Repayments
Everyone knows we will have to take a home loan when we buy an investment property. In fact, it’s what enables us to buy such a property in the first place, by putting down as little as 20%. However, we should not use this to overstretch our financial resources.
Regardless of the rent we receive, if we don’t crunch our numbers tightly enough, we can end up in a situation where we have to fork out a substantial amount of the mortgage out of our pockets.
This situation usually arises when we are limited on the number of years we’re able to stretch our home loan or the amount of loan we’re able to take because of the number of properties we currently own or even the amount of debt we’re already carrying.
We should also avoid scenarios where we’re at the edge of our finances, as any slight blip in the economy, rental market or property valuation may suddenly put us in a situation where we cannot afford to keep the investment property. This may end up with us having to selling it urgently, and receiving a lousy valuation.
#2 Property Agent Commissions
While this is not a hidden cost, it can be overlooked when calculating our cashflow and returns from our investment property.
This entails paying a commission to our property agent for his or her work renting out our property. This typically amounts to a month’s worth of rental every two years, or just under 5% of our monthly rent.
On the bright side, the property agent knows that this is a recurring business and we’ll need to engage him or her each time renewal comes up or if we need to find a new tenant. This way, our agent may be incentivised to manage our property well, including getting a good rental rate, ensuring prompt payment, helping with sprucing up the place to rent it out and several other ways.
#3 Maintenance Fees
Majority of condominiums in Singapore require us to pay a maintenance fee each month. This fee is no small matter and can easily amount to approximately 10% of our rental income each month.
This fee is usually used to maintain condominium facilities, such as swimming pools, tennis courts or gardens, ensuring adequate security measures as well as hygiene and cleanliness. It can also vary depending the kinds of common facilities in the condominium, size of the condominium and age of the condominium (older condominiums usually require more repairs and upkeep). It also differs according to the size of the properties in the condominium – where larger units have to pay more.
#4 Wear And Tear
Miscellaneous costs are quite important to account for but not very apparent in everyone’s calculations. This cost component includes furniture, if included in the rental package, water heater, carpets, air-conditioner as well as any repairs or maintenance works required within the home. There is usually a small deductible for these expenses that the renter has to bear, typically in the range of $100 to $200, with the owner having to bear the rest of the cost.
I actually stayed in a condominium where the water pipes in the bathroom burst one day. This nearly $8,000 cost, which came out of the owner’s pocket, was worth several months’ rent the owner must have had sufficient money to pay for it as well as had to take into account a reduced yield for the year. A few months later, the tiles popped up…
We should definitely watch out for this cost as it can be very unpredictable. Also, whenever we renew tenancy agreements, both existing and new tenants may have requests for a fresh coat of paint, repairing broken lights, replacing an old furniture or something to that effect. Of course, for older apartments, this type of expenses can add even quicker.
#5 Property Tax
Property taxes on properties that are rented out (non-owner-occupied) are applied very differently to those we live in (owner-occupied).
For investment properties (or non-owner-occupied properties), we have to pay approximately 10.7% on the first $45,000 of our property’s annual value, and incremental percentages for every $15,000 increase in our property’s annual value up to $90,000 (where anything above it will incur a 20% charge). This compares to under 4% for properties we live in (or owner-occupied properties).
The IRAS (Inland Revenue Authority of Singapore) defines the annual value of a property as the “estimated gross annual rent of the property if it were to be rented out”. This is usually applied to investment properties even if it is not rented out.
Just because you’re not living in the property does not mean you don’t have to buy insurance for the property. Fire insurance is the basic type everyone should buy – this covers the building’s structure, fixtures and fitting. This insurance will basically reinstate your property back to its original condition.
Since you’re not living in the property, you may not have much material possession to insure, but a home content insurance policy may also be sensible to cover your furnishings and renovation works.
This is an affordable cost component that will insure you for a potentially large liability. Premiums may amount to less than 1% of your rental income.
#7 Income Tax
Income tax is another cost component we may overlook. Any rental income counts towards our personal income tax. If this causes us to jump into a higher tax bracket, it may be even more costly for us.
If your rental income inflates your income by $40,000, you will definitely be pushed into a higher income bracket. At bottom end of the spectrum, this means even you’re a retiree, anything above $20,000 will be counted as taxable income.
Conversely, if you’re renting a property, you cannot deduct it off your income tax. So consider this carefully if you’re gunning for such a strategy.
#8 Monitoring Costs
Imagine renting out a condominium and realising two years down the road that it has not been well-kept and is in a poor condition. Not only will we need to spend money to spruce it up for the next tenant, we will also quickly realise that its value may be heavily affected.
This is why it’s so important to monitor the condition of our properties. Also, any illegal activities taking place may have implications on us as the property owner. While we’re not living in a large country like the US, where we may need to fly down to another state to check on it, we still need to spend time and money going to our unit from time to time.
#9 Weak Economy
This is another area many people tend to conveniently overlook. In the event you’re not able to rent out your property, you may fall into seriously financial stress with mortgages and all other costs still due every month.
According to the Urban Redevelopment Authority’s latest statistics, vacancy rates of private residential units (excluding ECs) stands at 8.4% as of 3rd quarter 2017, slightly higher than the 8.1% recorded in the previous quarter.
The statistics also highlighted that 12,200 private residential units and close to 3,000 executive condominiums were completed in the first three quarters of 2017, with close to 6,000 more due in the fourth quarter. In 2018 and 2019, there is also an estimated 11,500 and 10,500 more units that will be available in the market.
With this stock coming online in the next couple of years, it may cause some weakness in the rental market. This is especially so if the government continues to tighten foreign labour policies.
#10 Administrative Expenses
It might be a good idea to have an accountant to take care of your investment property matters. You may not have the experience of knowing everything that is deductible (or those that you should be depreciating) or even the time to take care of it.
This usually comes up to a small fee and may be worth your time if you have more than one investment property to juggle.
You Should Also Consider Other Factors
In today’s low interest rate environment, an uptick in rates could affect our monthly mortgage payments, and make it suddenly unaffordable. Similarly, as discussed above, any change in government policies (including additional cooling measures or foreign labour policies) may also adversely affect our financial situation.
All this means we have to cater a buffer and not try to stray on the limits of our comfort levels when purchasing an investment property.