I realised that my blogging frequency has been going down recently. It has been a busy time at work with the deadlines for the deliverables of a few tax advisory projects overlapping. I just want to get through this week before we fly off to Seoul (South Korea) for a short holiday. Looking forward to that!
Anyway, I just read this post by Budget Babe on understanding home loans in Singapore and started thinking about our home loan. We bought our apartment in the East in 2011 and the interest rate then on our housing loan was 3-month SOR (Swap Offer Rate) + 0.75%. It has since increased to 3-month SOR + 1%.
The 3-month SOR has increased over the years causing our monthly mortgage amount to increase. The current interest rate on our housing loan is 2.2% and we expect this to go up in time. This goes to show it is critical to consider increases in interest rates when working out the housing loan amount you can take out.
In our case, an interest rate up to 5% is manageable with slight changes to reduce the rest of our expenses. Once the interest rate exceeds 5%, we will have to make more significant changes to our budget. In fact, we might even consider paying down a portion of the housing loan to reduce the monthly mortgage payment.
All these considerations got me thinking about whether we should invest in real estate as an asset class in the future. To be fair, this apartment was purchased in 2011 with the option of either renting it out when it was completed in 2014 or us staying in it if we move back to Singapore by then.
Since we started working in Singapore in Jan 2014, we decided to stay in the apartment instead of renting it out it even though this was before our wedding in Nov 2014. After all, we enjoyed living with each other and wasn’t used to living with our parents anymore.
You could argue that this property was purchased for the purposes of home ownership rather than investment. This means we have technically not made our first real estate investment i.e. purchasing a property and rent it out for income. Should we do it?
Commercial/Residential real property as an asset class
It is possible for a retail real estate investor to invest in commercial and residential real property. I’m going to focus on residential real property since I have more experience in looking for an apartment to rent/buy in Melbourne, Sydney and Singapore.
The biggest problem we have with real estate investing is the downpayment required. The amount of downpayment can vary depending on the laws in the city and how expensive the housing market is. More often than not, it will require a significant sum of money for the downpayment.
This causes the rental property to form a significant portion of your asset portfolio once you make the investment. Unless we have been preparing to invest in real estate, it would end up overweighting our asset portfolio especially when we already have a certain portion allocated to REITs. It would also drain quite a bit of our cash holdings at one time and this can cause cashflow problems if not properly managed.
Entry and exit costs
There are monetary costs (stamp duty, legal fees etc) in entering and exiting a real estate investment, which are much higher than an equivalent investment in equities for example. This is not forgetting the length of time required to enter and exit the real estate investment, which makes it difficult to react to changes in personal and employment situations.
Local vs Overseas
Your residency status can impact the cost of investing in real estate. Currently, a Singapore PR has to pay 5% in Additional Buyer’s Stamp Duty (ABSD) when purchasing his first residential property. It’s even worse for a Foreigner who has to pay 15% in ABSD.
Although it might be more cost efficient to invest in your local real estate market, it would be risky to have such a big portion of your asset portfolio exposed to fluctuations in a single country. Even if you try to diversify by investing in overseas real estate markets, it is not as cost efficient and you can incur significant monitoring costs. Imagine having to deal with real estate agents and repairs to your rental property when you live in another country.
Real estate investing usually involves the use of property loans i.e. one of the few asset classes that almost always requires you to incur quite a bit of debt to invest. This increases the interest rate risk in your asset portfolio and might cause cashflow problems in servicing the debt in a rising interest rate environment such as now.
Admittedly, real estate is probably one of the best asset classes to generate wealth over a long investment horizon. If you time the real estate market well (e.g. buy at a low point of the cycle and use leverage wisely), the growth in the value of the real property and generation of passive rental income can be greater than any other asset class. However, making mistakes with real estate investing can have serious financial consequences that will take much more time to recover from.
Our view is that we will only consider investing in real estate after our asset portfolio (i.e. Investment, Retirement & Cash and excluding our current apartment market value) reaches S$1 million. It’s currently at less than half of this size. This means that it will probably be many years later before we even consider buying a rental property.
We will hopefully have gained much more investing experience by then and be more mature in our investment outlook to manage such a risky asset class. To overestimate our knowledge and skill in real estate investing will be to do so at our peril which might derail our journey to financial independence.