At some point, Singaporeans got the idea that the whole “landlord” thing is easy. All you need to do is buy a house, rent it out, and eventually sell it. That’s like saying all a heart surgeon has to do is open your chest, massage your heart, and sew it back. It sounds way easier on paper than it actually is. If you’re about to join the whole property scene, take a minute to digest some hard truths:
Unless you are super rich, vacancies hurt way more than you imagine
You’ve heard the usual babble about holding power, so you (hopefully) know the grief behind vacancies. In order to prepare you psychologically, let’s give you a real world example of what happens when your property goes vacant.
Let’s say you buy a property to rent out, and the loan is $960,000. Assuming an interest rate of 1.8 percent per annum over 25 years, one month’s repayment is around $3,977.
(And if you’re in the fourth year or so, the rate will probably be over two percent, making the monthly repayment anywhere between $4,200 to $4,500).
Now, a vacancy can happen for a huge number of reasons: the tenant got retrenched and is going back home, or if they’ve been here long enough to buy their own flat, and so on. That poses the risk that your property is vacant for a month or two, and you will have to bear that mortgage without the rental income.
Have you given a thought – real careful thought – to what it takes to make up that amount? Here’s what often happens:
- Never eat out again: save $200 a month
- Use the bus instead of the car or cab: save $350 a month
- Skip family days in the park and mope at home: save $200 a month
- Skip repairing the broken fridge door: save $200
- Skip buying new clothes: save $150
- Don’t go out with friends: save $150
I can go on with a long list of deprivations. And you’ll notice everything up there, by the way, barely makes up a quarter of $3,977. So you’ll have to give up a lot more than that, and you’ll find your quality of life sinking faster than a fat man’s conviction in a candy store.
When you do find a new tenant, say through a property agent, you’ll have to pay one month’s rent as commission. So whatever your period of vacancy, it’s effectively plus one. Two months of vacancy is as good as three, after you pay the agent.
This isn’t to say no one survives vacancies. Landlords struggle through them all the time. This is just a warning to a new landlord to brace him/herself. Take it from someone with experience: on the pain scale, two to three months of unexpected vacancy ranks between “fork in the eyeball” and “getting run over a bus, repeatedly “.
Maintenance and renovation costs constantly tempt you to become a slum landlord
When people see hovels in post-apocalyptic movies, they’re struck by how grim it is. But as a landlord, you’ll actually find it uplifting that a half demolished brick wall is all people need. Maybe that means you can skip on some renovating costs.
Air-conditioners are the bane of most landlords. After about two years in this business, you’ll come to see air-conditioning as the natural enemy of your money. It is the most common thing for to go wrong.
Equally, floors get scuffed, and the ones near the toilet often rot if they’re wood. Cupboards crack and peel. Faucets get choked. And while you may put up some wear and tear in your own home, your tenant (or prospective future tenants) generally won’t.
The point is, maintenance costs tend to spike whenever a tenant leaves, and you need to nice up the place for the next one. Every seven or eight years, you’ll probably have to do some renovations (or “asset enhancement”). This can raise your costs by magnitudes of thousands.
Again speaking from experience: buffing the floors, replacing the air-conditioners, fixing the faucets, repainting the walls, replacing the furniture, redoing the lights, etc. can result in a bill of anywhere from $7,000 to $12,000. In some cases much more.
Oh, and have we mentioned that sometimes, you can’t rent out the unit until all that work is done? If your contractor takes a month, see point 1.
Refinancing is more unpleasant than you think
If you’re considering becoming a landlord, you already know what refinancing is*.
This is another one of those things in which the theory is much less unpleasant than the reality. Conventional wisdom is to consider refinancing options every fourth year – even if you decide not to do it, you have to be alert to when cheaper rates crop up. Refinancing keeps monthly repayments down. More importantly, it helps with capital gains: the more interest you pay on a house, the less your ultimate profit when you resell it (see below).
Refinancing is not free. It’s amazing how many first time landlords are still surprised at this. There are conveyancing fees, in which lawyers need to charge you a lot of money for the difficult task of filling in a Microsoft Word template. This can range between $2,000 and $3,000. Then on top of that, there are valuation fees. That’s about another $500 to $600.
So if your refinancing shaves a little off your interest rate (say $200 a month), it can take you about one and a half years just to break even on your refinancing costs. You haven’t saved a single cent in that entire time. This is why sometimes, a mortgage broker will suggest you don’t refinance even if you can.
On top of that, refinancing means going through the whole mess of qualifying for a loan again. It really is possible to have qualified for a loan the first time, but not the second time around. For example:
Say you were making $10,000 a month on a paycheck before, but switched to a job that makes you $12,000 a month through sales commissions. Suddenly, it’s harder to qualify. That’s because variable income gets a 30 percent haircut, and your $12,000 a month now counts as $8,400 a month.
(*If you don’t, please look it up before buying a house. A landlord who doesn’t understand property loans is like a vet who’s allergic to pets; theoretically possible, but there will be a lot of tears.)
After taxes, maintenance, and interest, capital gains are seldom as high as you imagine
More seasoned landlords won’t have this issue. But among new landlords, overestimations are common. What we’re about to describe is actually common sense, but an alarming number of people lose sight of it:
Say you buy a house for $1.5 million, and sell it at $1.8 million after 25 years. You have also rented it out for $5,000 a month throughout the whole time. How much do you make?
Some people will just total up the rental income ($1.5 million) and the difference ($200,000), and conclude they’ll make $1.7 million. But it’s not quite that much.
Say you buy a house for $1.5 million. You borrow $1.2 million for it (you have to put at least 20 percent down). You take a 25 year loan, for which we’ll use an interest rate of 1.8 percent throughout (let’s say you refinance to keep it low).
Your total repayments on the loan, at the end of 25 years, will be around $1.49 million. The total interest repayments on the house alone is around $291,000. That shaves your capital gains from $1.7 million to $1.4 million.
Now refinancing isn’t free (see point 3). So assume you kept costs low by refinancing every fourth year, and the price is around $3,000 each time. That’s about six times over the course of 25 years, or about $18,000. Now your gain is around $1.39 million.
Then there’s the property tax. Assuming you can rent out the property for $5,000 a month, that’s an Annual Valuation (AV) of $60,000. For non owner-occupied properties, that’s a tax of about $6,900 per annum. Over 25 years, that’s $172,500. Now your gain is $1.2 million.
Over 25 years, let’s say the maintenance fee (to the management committee) is about $200 a month. On top of that, you need to do major maintenance work / renovations at least once every seven years. Say that costs about $5,000 each time, and you do it three times. That’s $75,000 in maintenance over 25 years.
Now your gain is close to around $1.14 million, over 25 years. That’s still something to be excited about of course, but note that (1) well over half a million dollars can disappear into the various costs, (2) we are assuming you can sell at a $200,000 profit, and (3) we are being super generous with the costs.
Most landlords do not see 100 percent occupation over 25 years. Most landlords will not see an interest rate of 1.8 percent over all 25 years (the historic interest rate in Singapore is close to four percent, and it probably will go back there one day). And we are being conservative with the maintenance costs – it is entirely possible for major renovations to cross the $50,000 mark.
We’re not trying to dissuade you from being a landlord, or to invest in property in general – it is a proven asset class, and making over a million in 25 years is quite a feat. Just be aware that the potential payoffs are sometimes stretched.
Above all, be prepared for the stress it adds
Property is supposedly less stressful than stocks or Forex. Experience from being a landlord says that’s not always true.
The first time you open your bills and see you owe $3,000 on your own mortgage, and $4,000 on another house, it’s hard not to freak out a little. $7,000 in loan repayments, without factoring in taxes and maintenance, is enough to make many people break into a sweat.
It can cause you to worry more about financial stability. If you get retrenched and can only rely on the rental income to service the loan, for example, the fear is palpable. What happens if the tenant pays late? What happens if there is a vacancy now?
If you decide to heed no other advice as a new landlord, then stick to just one:
Keep six months of mortgage payments in an emergency fund. If you don’t have it all now, then build the fund over time. This will give you sufficient time to find a buyer in worst case scenarios, or to deal with the occasional rogue tenant. Above all, it helps you feel safe.