Thursday, April 5, 2012

Future of shoebox apartment units in Singapore

In Singapore, where property investment is a national sport and owning a private property is a part of national dream, persistently high prices forced many to invest into a type of property which was virtually non-existing 10 years ago: show-box or mickey mouse apartment units. These units are less than 500 sqf some are as small as a master bedroom of an old HDB flat.

Introduction of small units to Singapore property market is a positive thing. In this little island, land is always said to be limited, average household size is only 3.5 but most public housing units are 3+1 or 4+1 units so shoebox apartments provide a better utilization of scarce space in Singapore.

Currently the only way to own a piece of private property for less than $600,000 is going for shoe-box. Investors are also forced to invest into these units since rock bottom interest rate and unusually high inflation rates eat up their money if they do not invest it into something like property. And since government's property cooling measures restrict the second loan amount to 60%, many investors with an existing loan goes for a shoebox. Let's look at the rationale by the below calculation appeared in the Straits Times:
A back of the envelope calculation goes like this. As summing the price is $650,000 assuming already have a property loan, I will have to fork out $260,000 in cash and take out a 60 per cent loan of $390,000. Taken over say 25 years, this comes up to a $1,560 monthly repayment at an interest rate of 1.5 per cent.  
Assuming rent of say, $3,500 a month, this makes for a return of around $1,940 per month after paying off the loan or $23,280 per year. 
One way of looking at the return is the total rent divided by the total investment ($42,000 divided by $650,000), which makes for a yield of 6.5 per cent. 
Another way is look into the rent after deducting the loan repayment divided by the actual cash outlay. This comes to the gross yield on the investment of about 8.9 per cent ($23,280 divided by $260,000 of capital). 
These returns are far more attractive than any fixed deposit currently. Throw in the promise of capital gains and it sounds like an even better deal.
All well and good, but look at the assumptions behind this handsome return: Such a return assumes that interest rates will stay low and that there will not be periods when the apartment is vacant. 
All these are standard considerations when buying a property for investment but in particular, for a shoebox apartment, a very important factor is the tenant, and a tenant willing to pay $3,500 at that.   [1]
The problem is that these units fetch these rents because there has been a supply problem in rental private property since 2006 and there was an increased demand thanks to higher than usual inflow of foreigners into Singapore. Shoebox units can get these much rent because the higher units can get much more now. But this year onward there is a huge supply of private property flowing into the market. Many of them are investment units which will compete for the tenants. It is not surprising to see the prices to go down when supply of something increases since prices were rising due to a supply decrease.

It is very likely that in the future the interest rate - rental price situation will change dramatically and at that time the positive cash flow generated by property investment will likely turn to a negative cash-flow. Current Singapore property market is a text book example of resource misallocation in artificially low interest rate environment. If you have no other choice but to invest in property, make your calculations for a high interest rate and lower rental yield environment. While doing this do not fool yourself that the historic average interest rates are the future "high". Future high rates will probably be much higher than historic average.

This blog article is to provide general information only and should not be treated as an invitation to buy or sell any property or as sales material.  Users of this report should consider this report as a one of the many factors in making their investment decision. Users should make reference to other sources of information and specific investment advice to obtain a more objective view of the property market. Asia Singapore shall not be responsible for losses suffered.

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