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One decision almost every business owner has to make is whether to rent or buy the property they are operating out of. For most entrepreneurs, renting is the default decision as it does not require them to fork out a hefty, upfront sum of money to start or continue their business.
However, in some instances, it can make sense to buy your own commercial property. For example, if you need to make extensive renovation or upgrading works to a property before you can start operations, you may prefer to own the location. This way, you won’t need to be held to ransom if the landlord unexpectedly hikes the rent.
Similarly, if location is a big priority or your business becomes synonymous with its location, then owning the property is advantageous. This way, you don’t have to worry about rental hikes or being forced out. In such instances, your business may also be building greater popularity of a particular location, which may be used against you if you don’t own the space.
If you decide to buy your own commercial property, it also means you will be “paying yourself” rent. A significant portion of your monthly mortgage will go towards paying down the principal loan if you own the property. After servicing your commercial property loan for a number of years, depending on your loan tenure, you will own the property, and this becomes an asset that you or your company will own.
When deciding to pull the trigger on a property purchase, you also need to understand your commercial property loan. There are two main types of commercial property loans you can choose from – fixed rate or floating rate. As their names suggest, a fixed rate loan will not change typically for the first few years (and thereafter becomes floating), while a floating rate loan is tied to a reference rate or benchmark index and can change every few months.
In Singapore, the Singapore Overnight Rate Average (SORA) is one of the most preferred benchmark index that most banks use to derive interest rates on commercial property loans.
What is SORA?
SORA is the volume-weighted average rate of borrowing transactions in the unsecured overnight interbank SGD cash market in Singapore, between 8am and 6.15pm. Simply put, SORA takes into consideration the total monetary value of actual transactions by banks in Singapore.
SORA will only gain more traction, as other interest rate benchmarks like SOR and SIBOR are also in the process of being discontinued. Moreover, since SORA is computed from actual transactions, it is considered a backward-looking rate that is more predictable and more transparent than forward-looking benchmark interest rates, such as SOR or SIBOR.
MAS’ Steering Committee for SOR & SIBOR Transition to SORA (SC-STS) provides strategic direction in the development of new products and markets based on SORA, as well as oversees the transition towards the adoption of SORA. This means SORA will become the main interest rate benchmark in Singapore. Nevertheless, other benchmarks, such as bank board rates, may exist as well.
As a benchmark, SORA isn’t something new either. Since 2005, MAS has been publishing daily SORA rates on its website at 9am the following business day.
What Are The Benefits Of Using SORA (Compared To SOR Or SIBOR)?
Mentioned earlier, SOR and SIBOR are in the process of being discontinued. Since the industry is shifting away from other benchmarks and to SORA, you may face heightened uncertainties if your commercial property loan is not pegged to SORA.
What will happen is that you will find yourself relying on back up rates to determine your interest payment. For example, a “Fallback Rate (SOR)” – will be used as a methodology to determine a “back-up” SOR rate. This itself will likely become increasingly challenging to determine as usage of SOR diminishes. In any case, any fallback rate will only last until 31 December 2024, and you would eventually have to undergo a benchmark transition to a rate that may be difficult to price.
Besides this, as a benchmark, SORA is also based on actual transactions and administered by MAS, rather than based on forward-looking projections determined by local or foreign banks. This makes it a more transparent interest rate benchmark for us to base our loan rates on.
Furthermore, SORA does not have exposure to foreign currency risks, unlike SOR and SIBOR. The SORA interest rate benchmark also does not include features of term or credit risk premium, compared to existing benchmarks. However, this means a higher adjustment spread – an addition to the applicable interest rates that reflect the difference between SOR and SORA over the past three months – will be used to determine your interest rates.
Source: ABS
Compared to existing benchmarks, SORA is more stable too – as can be seen in its fluctuations compared to SOR in the charts below. This is mainly because it is based on actual transactions, rather than based on forward projects by any financial institutions on borrowing costs or inputting term or credit risk.
Source: ABS
As a benchmark, SORA is also less volatile, and therefore, more predictable compared to SOR and SIBOR. Banks in Singapore tend to offer SORA-pegged loans that are compounded over several months (i.e. the 3-month compounded SORA rate). This reduces its volatility when there are sudden changes in interest rates. Instead, any change will only be gradually reflected in SORA rates over time.
This can also be seen in the charts above. Despite both the compounded SORA and SOR rates moving in tandem, SOR rates (in orange) can experience much steeper spikes compared to the compounded SORA rates (in blue). In other words, your exposure to single day readings is heightened if your commercial property loan is pegged to SOR (and SIBOR). For example, if your loan disbursement date or loan reset date falls on a day that SOR or SIBOR spikes, your interest repayment would be higher than if it had been on other days in the month. In contrast, such single-day spikes will have less of an effect on the compounded SORA rates.
How Will The Industry Shift To SORA Affect Your Decision To Buy A Commercial Property?
For business owners who are looking to purchase their own commercial property, it is likely that you will already be considering a SORA-pegged commercial property loan to fund the investment. SOR- and SIBOR-pegged loan packages are no longer offered from early and end 2021 respectively.
Currently, OCBC offers a SORA-pegged commercial property loan package. This means that your commercial property loan will rise and fall as the SORA increases and declines.
As alluded to earlier, benchmarking your commercial property loan against SORA improves predictability of your monthly loan repayments.
What If You Have An Existing Commercial Property Loan?
If you already own a commercial property, with an existing loan pegged against another benchmark, such as SOR, you should not be affected. This is because the SOR and SIBOR will only be discontinued some time around mid-2023 for SOR and end-2024 for SIBOR.
However, if you are eligible to refinance your commercial property loan before the respective discontinuation dates, you should consider moving to a SORA-pegged commercial property loan only when the time comes. This will minimise costs and administrative efforts on your end today.
SC-STS “strongly encourages” an active transition to SORA-pegged loans because it will become increasingly difficult to price loan rates and conversions thereafter. In addition, there will also be challenges in determining the applicable interest rates as usage of older benchmarks diminish.
Read Also: 5 Things To Know Before Investing In A Commercial Property In Singapore
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