Friday, June 8, 2018
As I reach MOP for my house, I face 2 choices: To cash out and rent or to buy (another one). Conventional wisdom (or culture) states that we should always buy, otherwise we are subsidising the landlord. This mindset is especially prevalent in Singapore where house ownership is more than 90%; public housing is highly subsidised and housing instalments are paid for via CPF.
Due to the CPF restrictions, many people feel that they are not paying for housing as it is paid for via CPF contributions. This reasoning is flawed as CPF can be cashed out at age 55 and pays a respectable 2.5% risk free rate. If we were to ignore mental accounting and view CPF as really our own money, the tendency of owning a home may differ substantially.
Let's breakdown the cost of my home ownership and determine if it makes sense to rent or buy.
Owning a home (calculations exclude utilities)
20% Downpayment for a 1.2M private property: SGD 240k (add 10k for basic renovation to round up to 250k)
Yearly interest payable base on 2% (long term rate) approximately = 960k x 2% = SGD 19,200. I am assuming interest rates rising gradually but the principal is reduced hence yearly interest paid works out to be 19,200. It is hard to forecast the total interest paid but let's just simplfy it to SGD 19k.
Yearly maintainence: SGD 4000
Property tax: $400
Spending on servicing of aircon, repair/change appliances - $600
Hence per annum, the cost of maintaining a 1.2M home for own stay is $24,000.
I am not factoring monthly instalments (of $3500) as the principal paid is your own money and can be recouped upon sale of property.
They key deciding factor is whether you can generate enough returns on the SGD 250k downpayment such that renting makes more sense to buying.
Assuming a 5 year investment horizon (on non leverage basis), a 250k investment if lucky enough, can generate a 5% return or 12,500 per annum return. If we were to be risk adverse and purchase the 4.35% Astrea 4 bond, assuming a buy price of 102, redemption of 100 at year 5, total return is 49375 or 3.95% (assuming interest accumulated reinvests at 0%).
The base case scenario will be to park the funds idle in CPF at 2.5% and thus earning $6250 interest per year.
Looking at the calculations, the cost of owning a 1.2M home works out to be
Opportunity costs (6,250 to 12,500)+ Interest 19,000 + Tax, servicing, maintenance 5,000 = $30,250 to $36,500
Renting the same house works out to be $2,500 - $3,000 per month assuming it is either a 2BR in suburbs or 3BR in further flung places.
How do we make a property purchase decision if we are indifferent to buy or rent? I think a key differentiator will be a person's investment ability.
For a person who can generate 10% P.A on 250k, it is intuitive selection for him to rent and invest the rest. However, not many people I know (myself included) can invest at that rate (especially when equities markets are at record highs).
The selection is much easier (no brainer actually) when the person is deciding whether to purchase or rent a HDB. HDB is highly subsidised (and conditional, not everyone can buy) and cost probably just 2.5k/month to rent a 4 room flat (in central areas). The interest cost is halved and home ownership expenses works out only to be less than 20k including opportunity costs. (Renovation costs more for HDB flat though).
(I am not factoring utilities or other expenses which need to be paid if one were to rent as well)
Furthermore, buying a home provide you with an option (up to lease expiry) to hedge against housing/rental inflation as long as you continue servicing your mortgage. It comes with a piece of mind that you own the place and not be at the mercy of landlords when markets are rising. However, it places a unnoticed strain on retirement income due to constant depletion of CPF savings.
So how? Rent or buy?
For people who choose to stay in HDB, buying makes perfect financial sense.
For people who are at the cross roads between renting and buying private property, take note that renting is akin to shorting the property market - you borrow a house, pays interest (rental on it) while waiting for housing markets to come down. If it comes down, you can buy for instance at 10% discount from current levels thus profiting $120k savings (10% of 1.2M). The rental you have paid eg 5 years x 30k = 150k; Add on the 250k returns of 3.95% = 49,375, the difference is SGD 19,375. Not too bad since the future savings on the original 1.2M property is compounded over the long term (on purchase).
It is not an easy decision to buy or rent, long or short. If we are in the middle of a financial crisis, it is an easy decision to rent (a year) first, buy later. Since rental is low and home prices will continue to fall. However at current juncture where there are no foreseeable crisis on the horizon, shorting the housing market may not yield positive return over next 5 years. There is always the risk that investment on the initial 250k goes sour or markets run flat or higher for another 10 years. Then one would have to continue renting for even long period to ride out the market.
Buy HDB is always better than renting if you can
Rent private housing only if you can invest and earn at least 4%-5% P.A on your downpayment + reno budget
Buy private housing if market is trending upwards and be prepared to rent at least 5 years if one is timing entry into the property market. This is to provide the runway to allow cash investments to reap their intended returns while waiting for housing markets to show signs of bottoming.
That said, refer to my blog post in 2013 on HDBs. I think I am fairly accurate here. https://sgbluechip.blogspot.com/2013/01/hdb-prices-will-come-down-because-1.html