I am sure you have come across ads from social media where gurus preach about how you can buy properties in Singapore with little or no money down. In addition to doing that, these properties can even generate positive cash flow and put money into your wallet every month. Properties like these do sound like no brainers. All you need to do is to put in a little bit of initial investment, and you can now collect returns for the rest of your lifetime. While I did discuss the usage of lease options, they are more applicable to other countries. Furthermore, having an option to purchase does not translate into ownership.
While the numbers of these properties may look good at first glance, there are some risks you must understand before you start investing. After all, if these properties are so profitable, wouldn’t it make sense for these gurus to do the following?
- Buy all the properties in one zoning with little or no money down.
- Create a monopoly and thereby raise rental rates
- With the rental rates higher, you can now sell the properties for a significant markup. Thereby effectively playing monopoly in real life.
Unfortunately, scenarios like these do not happen. Some of these gurus have even shifted their focus on these commercial properties to residential ones. Nobody seems to be talking about purchasing properties with little or no money down these days. So, what happened to all these previous buyers who purchased such properties? Are they still able to get their positive monthly cash flow? Was it a good investment in the beginning? To help you understand the risks involved, I will run through the attributes for these types of commercial real estate.
Singapore Commercial Property Price Index
Whenever you talk about purchasing a big-ticket item and only coming up with little or no money, you must understand that the rest of the money must come from somewhere. That “somewhere” is always in the form of a loan from a financial institution. Now, to secure a loan, you will need collateral. While it is possible to put up various assets such as stocks, gold, etc. as collateral to secure this loan, most of us use our income. In other words, although you may be using little or no money down to book this property in the initial phase, you are ultimately paying it back with a massive chunk of your lifetime. With a larger loan quantum, your mortgage and interest cost are higher.
2. Rental Yield
The rental yields for commercial properties are vastly different from residential ones, especially for retail. Take Orchard Road; for example, rents can vary from $5psf to $80psf. And yet they are all along the same road. Why? Because the amount of rental a retail shop can pay largely depends on the sales, which is a function of footfall. The same thing goes for industrial buildings and offices; rentals are only dependent on the profitability of the company. What happens when your lease renewal falls during this Covid-19 period? The tenant has the power to request that you lower their rentals, or they can move into the empty unit next door. When this happens, you can expect to see your unit empty or drastically reduce your yield for the next few years.
3. Cash Flow
When the economy is chugging along, everything will work fine, and your tenant will pay you rental regularly. However, with a black swan event like this pandemic, several things can happen. Let’s assume that your tenant is in a business that supports the airline, oil, tourism or F&B industry. Since they are badly hit, they would have two choices. The first one is to shut down its operations. The second one would be to reduce expenses as much as possible. That might entail a reduction of office space and rotate members to work from home. Either way, both will severely impact you as a landlord. Because finding a next tenant to fill your current space will be incredibly difficult at this point. Instead of collecting passive income monthly, you are now facing a prospect of paying the full mortgage plus maintenance fees until the situation improves.
4. Valuation Drop. Margin Call
With the drop in rental prices, there is a possibility that the banks may revise their valuation for your commercial property. Valuation revision happens when there is a new unit transacted at a significantly lower price.
Let us assume that you have bought a commercial unit at $1mil and manage to borrow up to 90% of the property price. Your neighbour next door has no holding power and sold their unit cheap. As a result, the new valuation of your place is now at $800k. With this new valuation, the max loan to valuation of your unit at 90% is currently at $720k. To reduce their risk, the bank will now trigger a margin call and request that you come up with the difference of $180k. Now, how are you going to come up with the amount since you paid for the property with little or no money in the first place?
5. Decaying Lease
In my earlier article, I have written that there is a rationale behind these cash flow positive properties. The reason you can find them is not that you looked hard enough to find a polished gem among the dirt. But instead, it is because there is a limited number of years left on the lease. Capital upside may be little, and purchasing these properties is more of long-term rental.
Take industrial properties; for example, these days, the majority have a tenure of 30 years or less. The purpose of such a short lease is to discourage speculators from purchasing these properties and flip it around later for a higher price. Why? The government has a responsibility to keep business costs low. Only by doing that can companies remain competitive, which is crucial to Singapore’s survival.
The Main Reason Why The Gurus Have Shifted To Residential Properties
The main reason why these gurus have started to focus on residential properties is straightforward. The risk is lower. Your yield is not directly dependent on the profitability of a business, and you do have significantly lesser leverage due to all the government’s cooling measures. Besides, you can choose to work from home, but you cannot afford not to have a roof over your head. These are some of the main reasons why residential properties are less risker than commercial ones. And it is due to this lower risk that it is possible to purchase residential real estate at any time in the last ten years and remain profitable.
Singapore Residential Property Price Index
However, due to leverage, investment in all types of real estate do carry significant risk. You must understand the risks involved before purchasing your next piece property. Because if you do not do enough research, not only will you lose your entire capital, but also spend a good portion of your life paying for something you thought that require little or no money. I hope you find this article useful and help you with your research in understanding the market better. Meanwhile, stay safe, protect your capital and always look at the numbers!
Article contributed by Jerry Wong.
Jerry Wong is a realtor with Propnex Realty. He loves coffee, cookies and condos and has been in real estate for ten years. Most importantly, he loves connecting people to properties and gets enormous satisfaction when they acquire their dream home. Or making well-informed decisions that see their assets grow. Book a video call appointment and Jerry will share with you the following.
- How certain factors affect real estate prices. Why some condos can make a million dollars while others can lose that same million.
- Why timing is not the most important thing. Because some people can buy the same condo at the same time, but one end up making $100k to $200k while the other suffers losses of the same amount!
- Understanding your requirements and craft a solution for your real estate needs. Be it in the form of asset progression, tax planning, financial calculations, rentals, sales, etc.
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