Understanding how to calculate your real estate ROI (return on investment) will help you determine if property investment is the right vehicle for you.
“Don’t wait to buy real estate, buy real estate and wait.
– T. Harv Eker
Real estate has been a predominant asset of investment. Question is if Singapore’s property market is still worth investing? More importantly, what is the real estate ROI (Return On Investment)?
Question From The Explorer:
Real estate investment has historically been a favorite class of investment asset, given its favorable risk-return profile. But why exactly so?
Question From The Skeptic:
With the many regulation and cooling measures in Singapore, is it still a good place to park your funds and build your wealth?
Question From The Engineer:
Are we buying properties just because that has been what wealthy individuals have been doing or do we know exactly what returns we are getting?
Let the numbers tell.
In order for us to answer these questions, we need to find out what is the exact real estate (ROI)% that we are expecting from investing in Singapore’s real estate.
The following example does not aim to give a complete account of the computation that will be applicable for all real estate investment. The key takeaway is to know the estimated ROI in % and absolute terms mainly from rental income so that you can have a better idea if this particular asset class is suitable for you. Hence, we will not discuss about capital appreciation to simplify the calculation.
Figures To Be Used (average or per regulatory requirement).
Rental yield: 3% (average we are looking at for the residential market today)
Loan-To-Value: 75% (per current regulation, for first residential property loan, assuming you can take up to 75% of the property value)
Loan Tenure: 30 years (how long you can loan depends on your age as well)
Interest Rate: 2.2% (average banks’ rate currently)
Property Value: $800,000 (arbitrary)
Computed Rental Income & Mortgage Payment:
Monthly Rental Income = 3% x $800,000 / 12 months = $2,000 / month.
Monthly Mortgage is estimated to be $2,278.21 / month.
In addition to above computed figures, take note of the breakdown below:
Out of $2,278.21 monthly mortgage, $1,178.21 goes to the payment of the principal, while $1,100 goes to the payment of interest for the 1st month.
However, for simplicity sake, we will not dwell into the slight shortfall that the investor need to top up using his/her CPF or cash as part of the computation of the eventual ROI.
Relationship Of Principal/Interest Payment With Time:
As time progresses, the portion of the monthly mortgage that goes to paying the interest decreases, while that of principal increases.
Now that we understand the main revenue (rental income)and cost (bank’s interest), we can proceed to calculate the estimated ROI.
In order to appreciate the real estate ROI we are expecting, below are 2 simple methods to estimate the returns we are getting.
Real Estate ROI Method 1: Year 1 ROI vs Year 30 ROI.
Year 1 ROI
= (Rental Income – Interest Cost) / Initial Captial
= ($2,000 x 12 – $1,100 x 12) / $200,000 x 100% = 5.4%
Year 30 ROI (Assuming last year interest = $0)
= ($2,000 x 12 – $0 x 12) / $200,000 x 100% = 12%
Hence, we will be expecting a ROI of 5.4% – 12% over the 30 years period.
Real Estate ROI Method 2: Culmulative Average
= (Cumulative Rental For 30 years – Cumulative Interest For 30 years) / Initial Capital
= [($2,000 x 12 x 30 – $220,153.82) / $200,000] / 30 years x 100% = 8.33%
Therefore, we can expect an average ROI of 8.33% over the long term.
*Note: Sum of total interest over 30 years can be computed using financial calculator.
What happens 30 years later?
Fully paid property that you can liquidate
OR continue to collect the rental as a passive income while the underlying asset preserves the wealth for you.
OR wait for the windfall from en-bloc by developers. ;P
Above all, they are just some simple computations to help you get started and understand what you are signing up for. If the risk and return numbers work for you, then it’s time to put it into plan and start saving for the capital outlay 🙂
Other Factors To Consider
Finally, there’s other elements that can increase/decrease your ROI and that includes but not restricted to below:
(-) Property tax
(-) Maintenace/repair cost
(-) Stamp duty.
(+) Capital Appreciation
Investment Strategies To Boost Your Real Estate ROI (For Next Time…)
Similarly, some strategies that can increase your real estate ROI are:
Take advantage of market cycle
Identifying undervalued properties
Take advantage of progressive payment
Take advantage of deferred payment scheme
Exit and reinvestment strategy to harness maximum return
Therefore, the long term risk-return profile is still favorable, especially if the right investment strategies are adopted – which we will leave the discussion for the future. If you currently own a home, you can start tracking your property value here, know what you have to prepare for your next investment property.
Last but not least, for those who are purchasing your first home, do check out the article here on whether you should consider HDB or Private as your first property.
Keep learning and happy investing!
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