Singaporeans love expensive, tiny apartments. Why?

 

 

Property. Every Singaporean’s dream.

 

 

Recently, I attended a housewarming party and a friend of mine commented that it was crazy that Singaporeans are buying one to two-bedroom apartments as an asset. Of course, we didn’t have this discussion in the presence of the homeowner who had invited us. The homeowner had bought a two-bedroom apartment (about 700 square feet) in a 1000 unit condominium for more than S$800,000.

Of course, the homeowner wasn’t the only one. The entire project was basically sold out which is why my friend thought it was ridiculous that they would pay a higher per-square-foot (PSF) price compared to larger apartments. In essence, the lower you pay for PSF, the more space you get for each dollar that you pay.

That’s not all. There’s a second problem with owning property.

It’s not liquid

The problem with property is that it takes time to sell it. You can ask any property agent but I don’t think you’ll be able to raise cash from selling your property if you need the cash in a matter of days.

In the event you are forced to sell due to a market downturn, guess what? A fair number of people are looking to exit too. This increases the probability of making a profitable exit from investing in property.

However, I believe that re-mortgage options are available which somewhat mitigates the problem of liquidity.

Property prices always go up over time

This is perhaps the biggest motivation for the average property investor or an investor of any asset class for that matter. The question is whether this idea holds true in perpetuity.

On one hand, property prices move in tandem with inflation over the long-run. On the other, buildings get older and require maintenance over time. The older an apartment is, the less appealing it becomes for new buyers and renters as well. One of the few things a good piece of property has would be its location. A case in point would be how badly maintained Far East Plaza and Far East Shopping Centre are relative to the malls at Orchard Road, yet owners who bought those units years ago would make many times their money if they were to sell today.

If buyers bought the smaller apartment to stay, they may eventually find that the increase in price may not be enough to help finance the purchase of a larger property unless they turn to the public housing market.

Other than the issue of liquidity coinciding with a fall in property prices, smaller apartments tend to have the largest number of buyers and these buyers, being the middle-class in Singapore, tend to be the most economically sensitive ones as well.

Furthermore, Minister for National Development has thrown a spanner in the works by indirectly hinting that even HDB apartments may not hold their value in the very long-run. And the repercussions are real with some flat owners finding it difficult to sell older flats. The same probably holds for private apartments with a similar land lease structure.

So why is it that Singaporeans still love such tiny apartments?

Affordability

The first obvious point is whether the property buyer can afford the mortgage. Property prices in Singapore are some of the highest in the world. Naturally, this means that almost everyone takes out a mortgage in order to buy property.

Although the PSF may be higher for smaller apartments, the total price, or what we call quantum, is lower. For example, a 700 square feet apartment with a PSF of $1,300 would cost $910,000 whereas a 1000 square foot apartment with a PSF of $1,100 would cost $1,100,000. An apartment with a higher quantum would naturally require a greater amount out of pocket for the downpayment as well as a larger mortgage to service each month.

The best example of this is how some years back, a few property developers launched projects with shoebox apartments (less than 550 square feet) with prices around the $500,000-$650,000. The draw of these apartments was the low quantum but they commanded PSFs of anywhere from a $1500-2000.

No matter the size, most people who bought 1-2 bedroom units were looking to rent these apartments out. Presumably, the game plan is to have renters pay for the unit (including mortgage) over 25-30 years and at the end, cash out by selling the unit or continue to rent the unit and have an additional stream of income.

Leverage

The attraction that most Singaporean property buyers don’t admit to is that buying property allows them access to leverage. What is leverage? This is simply the ability to control more assets with a much smaller capital base.

Banks are in the business of lending and are happy to make loans which have collateral. This is the reason why banks are quite happy to make loans on property given that the buyer passes the required checks on their credit standing.

When buying a property, a buyer typically only puts 20% of his own money in the transaction. This means that you could control an asset worth a $1 million with just $200,000. $1 million may seem impossible to most Singaporeans while $200,000 is much more realistic.

Therefore, why not trade $200,000 today in order to control an asset worth $1 million? Sure, I have to take a mortgage which brings the total amount I have to pay for it more than $1 million but if my renter’s paying for it, then why not? Furthermore, interest rates are low which means the interest cost is low. Leaving that $200,000 in the bank also means that I’m getting next to nothing on it.

For buyers who buy to rent, leverage also makes the rental yield look more attractive. A 4% rental yield on an apartment becomes a 14% if you only have to put 20% down and the interest rate you have to pay is 2%. Sure, interest rates are going up but rents may not remain stagnant either. Leaving that money in the bank or their CPF account* which pays 2.5% is nothing when compared to a 12% return. Read more here if you’re interested in the calculations. Of course, the return would be lower after accounting for taxes, and expenses related to upkeep and rental of the property. Factor in the opportunity cost of investing in another asset and the real return could very well be near zero.

Conclusion

In sum, my view is that Singaporeans love tiny apartments because of the lower quantum which makes them more affordable. Furthermore, as a property investor, the leveraged return is quite hard to beat.

In exchange, property buyers take on the burden of a 25-30 year mortgage and the risk that property prices may drop. Also, if their only investment asset is that single piece of property, I shudder to think of what might happen if there are asset-specific risks. Most people aren’t engineers or property managers so there’s no telling what kind of issues that particular property could have in the long-run. Property investors take on the added risk and expenses related to rental of the property. On top of all this, property buyers forgo what is essentially a risk-free yield of (currently) 2.5-3.5%.**

Oh yes, there is also the additional risk of not being able to service the mortgage in the event the property price is near the maximum the bank was allowed to loan you.

By now, you probably can tell that I’m not so big a fan of property as an asset class but given how most Singaporeans don’t see or understand other alternatives, I’m not surprised at how popular tiny apartments are with Singaporean buyers.

Notes:

*CPF is a pension scheme that every working Singaporean is enrolled in.

**Most people pay for their mortgages from their CPF OA account so I’m factoring in the extra 1% that CPF pays on balances up to $60,000.