The Four Elements of Real Estate Investing

I picked up a classic book on real estate library over the past week and would like to share the four critical elements on real estate investing.

Although this book focus on real estate investing, I personally find that this can be a good guide even for REIT investors who would better understand the business of the REIT after considering these 4 elements.

1. Cash flow
The first element on real estate investing is how much cash flow the real estate can provide to the investor. Before entering into an investment decision, investor could look into rental indices published by URA to have a sense on how much rent the property could command.

Taking the rentals of non-landed residential building as an example for People’s Park Complex which is directly connected to Chinatown MRT and a transaction that occur in July 17.

Property name                   Area (sqft)        Rental    Transacted value
People’s Park Complex     1,119                  $4,823     $800,000

With a gross rental yield of 7.23%, the transacted amount for this unit translate to the highest figure achieved for the rental data set in Q3FY17 (based on 25th percentile of $41.30 per square foot per month).

Very often potential investors stop the analysis prematurely as above. However, to understand how is the investment is impacting you, one has to dive in to more details.

To name a few obvious cash out flow for the property investor are mortgage payment, real estate taxes, property insurance, maintenance and repairs, water and income tax.

For purpose of illustration, I will only include what is the impact on cash flow to the investor of this property, after taking into account the estimated mortgage payment and property taxes.
Cash inflow:                        $
Rent                                4,823  As above
Cash outflow:
Mortgage payment      2,240  $640,000 loan, interest of 1.6% and repayment period over 30 years.
Property tax                    550    Based on annual value of $58,000
Net cash inflow             2,033

Careful consideration on the cash flow impact on real estate investment is important as any costs being omitted for consideration or vacancy period may mean the investment is in a negative cash flow position.

2. Appreciation
“Singapore property prices will only go up because of land scarcity” True or False?

Being a realist, I would tend to think whether a property could appreciate is highly dependent on whether it was obtain at a reasonable price. Investors who got in at 1997/1998 only saw their property appreciate more than 10 years later without considering any opportunity cost on time value of money.

Hence, it is important to obtain objective measures that could make your property more valuable when you want to sell it.

One recent example is the launch of Punggol Digital District whereby the potential creation of jobs as well as influx of students from the university in the District could have a positive spillover effect on the rental demand and the resultant capital value in Punggol:

3. Loan Amortisation
The next element highlight the power of leverage one could yield for property investing. Drawing on the example from first element, one just need to fork out $160,000 for down payment and the rest is technically taken care of by the tenant (via their rental payment). And in exchange you would get a fully paid property 30 years down the road.

The highlight is that the monthly payment has a portion of interest payment as well as payment on the loan amortisation portion.

However, in wake of greater scrutiny over individual ability to borrow, Government has introduced measures such as the Total Debt Servicing Ratio and Mortgage Servicing Ratio which will limit the amount available to borrow from banks. Hence, to ensure there are no surprises in your property purchase, it will be wise to obtain an in-principle approval from banks to determine how much you can borrow.

4. Tax Shelter
The last element is probably the least appreciated for most investors. In essence, if one investor could structure their investment in property to be more tax efficient (i.e. less tax paid), this could effectively help them obtain a higher return.

In Singapore, the most effective tax shelter one can find is none other than the REIT structure whereby the REIT enjoy tax transparency provided the REIT distribute at least 90% of its distributable income. Similarly, individual investor of REIT also enjoys tax transparency which add up to the overall yield from the REIT investment.

On the other hand, as part of the government cooling measure, Singapore government also introduced the additional buyer stamp duties.

Hence, for Singaporean thinking of buying their second property for investment, would have to pay an additional tax of S$70,000 for a $1 million property. (Ouch*). To minimise such taxes, one approach for the more well to do couple is to sell their matrimonial house and buy 2 private properties in order to avoid the tax while achieving the goal of having an income producing property. Alternative measure would be to pool the money for investment in similar asset class (i.e. real estate) in REIT.

The book emphasised that not every income property will provide these returns (i.e. the 4 elements) in equal measure. For example, for the investment in People’s Park Complex, the tenure of the building is left with about 50 years (the building TOP in 1970). Hence, it is likely to have not much appreciation element even after the loan is fully paid up in 30-year time.

In the meantime, for REIT investing, as attractive as the yield would be, investors will not get the benefit of getting a fully paid property even after holding the shares for the next 30 years. As a minority shareholder, you would also have no direct control in determining the running of the property and how these returns should be realised (i.e. when will it be sold).

Personally, I would view the cash flow analysis as a defensive analysis by projecting what is the worst-case scenario the property would generate month on month while the appreciation analysis as the offensive analysis on why certain areas have potential for capital appreciation.

It is good to live a Singapore property dream but I hope the above sharing would keep investors more grounded in their investment decision.

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