How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case. Robert G. Allen – Creating Wealth
Excerpts from the previous article on The Diary of a Sudden-Rich:
“..my home value has recently appreciated and doubled in value! I am thinking of selling it so that I can upgrade my home. And my property agent friend has also calculated that I will have some spare cash to purchase another smaller unit for investment purpose since I don’t have any other investments. So this is my plan: I will sell my home, upgrade to a bigger unit and purchase a smaller unit for investment. The government is building an MRT system near the location. I know that the price is high today but with the new MRT under construction, I think the price will not depreciate much in a downturn. Years later, when my children grow up, I will sell away the bigger home, take the proceeds upon capital appreciation and move into the smaller unit for retirement.”
If you remember yourself reading the article, you must be thinking about Adam’s investment plan. Adam is 45 years of age and a Chief Operating Office of a MNC. I met up with Adam recently and get to know some details about the two properties he may want to purchase:
- A 4 bed room unit that he is eyeing on (recently TOP) will cost at least $1.7m. This will be his new home.
- A 2 bed room unit (an older project estimated to be about 7 years old) will cost about $850k. This will be his ‘investment property’.
- Currently Adam has outstanding loan of about $300k for his current home. He bought his current home for about $650k during the low times of 2005.
If Adam is able to sell his current home for $1.3m (His target selling price), he will stand to gain $700k in capital gains (after paying off outstanding loan of $300k and at least a $200k to CPF with interests plus other miscellaneous payments). Adam aims to put in at least $500k as downpayment for his new 4 bed room unit which commands a price of $1.7m. Hence, Adam will need to take on a larger mortgage loan of $1.2m for his new apartment.
My considerations for Adam:
- A check with the URA transaction history shows that Adam’s property is not likely to be transacted at $1.3m. The latest transaction of $1.3m is a penthouse in July this year. Similar units were transacted at a maximum of $1.15m a couple of months back.
When projecting the value / target selling price, always check with the relevant authorities. The most reliable source is the URA website. Unfortunately, Adam and Adam-alike depends more heavily on the numbers shown on the popular websites such as Property Guru or iProperty. Bear in mind, these websites show seller’s asking price, NOT transacted prices. These sky-high figures are properly just the wishful thinking of greedy sellers hoping to hit the jackpot. Remember, in property investment, the seller’s asking price is not relevant. It is the operational performance of the property that determines the property value which becomes your offer price. In good deals, the numbers work. In bad deals, they don’t.
Hence, a more realistic selling price of Adam’s home will be about $1.1m. His projected capital gains are thus likely to be lower, about $500k. He can’t be putting in $500k for his new home now isn’t it? A lower downpayment now (assuming it to be $400k) equates to higher bank loan of $1.3m. At the age of 48, Adam should not bear a much higher bank loan.
- Adam’s ‘investment home’?
Purchase of an ‘investment home’ for $850k? Is it necessary to purchase a 2nd property just because ‘I don’t have any other investments’ ? Remember, only invest when the numbers work. Do not invest for the sake of investing.
Under the low-interest climate today, Adam is likely to rent out his 2 bed room unit for about $3k thus able to cover his monthly mortgage loan. But my question is, how long is the low-interest climate going to last? When interest rate goes up, will his rental be able to cover his monthly mortgage? Adam has overlooked the operating performance of his property. He assumes that the up-and-coming MRT station will secure his rent for many years to come. But with the influx of at least 5 new developments in that area, what kind of rental premium can Adam’s unit call for? As of today, there are at least 12 condominiums in the area that Adam is looking at. An important factor to consider is the future supply of properties. Future supply indicates how properties will perform in the long term. In general, if supply is greater than demand, you may want to stay away or at least keep looking for a better area.
Adam’s gut feeling that the area’s investment value will not depreciate is dangerous. Too many people purchase investment real estate on a hunch. Indeed, it is important to have such instincts but do remember, such gut feelings are the products of experience, not a right of birth. Hence, it is impossible for a person who has never done a single investment deal (I don’t consider your home an investment) to have an instinctive knowledge that one deal will be better than another. It’s not that simple. In fact, this type of ‘instinct’ gets investors off the wrong track. So save your gut feelings for at least 10 years down the road after gaining enough experience. The MRT is not everything that decides on the value of a property.
- “..Years later, when my children grow up, I will sell away the bigger home, take the proceeds upon capital appreciation and move into the smaller unit for retirement.”
Unfortunately, I can’t say for sure if this plan can be fulfilled. God knows what will happen to the economy 15 or 20 years later when his children grow up. This is pure speculation. What if Adam retire in an economy that is just starting to begin into a financial crisis like Japan, Europe or USA today? He may even suffer a loss then. Don’t forget, today’s price is peak price, or HIGH price.
I would advise Adam to stay put for now. Finish up his current $300k loan while ‘waiting’ for the next property downturn. He may consider taking up an equity loan to purchase his 4 bed room unit then. He can rent out his current home (which will likely be paid off in full then) to enjoy infinite passive income.
While waiting for the downturn to come, educate yourself financially. Don’t wait till then to do it, because it will be too late.
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To your investment success,
