By Gerald Tay (guest contributor)

Suppose you intend to buy a leasehold property with 30 years or less remaining on its lease – how would you know whether it is worth the price you are paying? Or put in another way, what price justifies your making the purchase?

This is the thrust of this final article on Property Valuation.

Valuing leasehold properties is more complex

Previously, we’ve covered critical financial ratios to measure the worth of a property. This is straightforward for freehold properties. But for leasehold properties, the answer is more complicated due to their limited ‘shelf-life’.

The following is the typical tenures for different types of leasehold property:

  • Residential – 99-year
  • Commercial – 99-year
  • Industrial – 60- or even 30-year

However, we need to know that the real tenure does not equal the leasehold period remaining. Leasehold properties seldom maximise their entire lease tenures. After 35 to 40 years, the vast majority of leasehold properties are demolished and rebuilt with their leases topped up.

Therefore, when valuing property, we need to be more aware of the ‘Real’ or ‘Practical’ tenure of the property. For our valuation purposes, here’s a general rule for the ‘Practical’ or ‘Real’ tenure of different kinds of properties:

  • Residential – 40 years
  • Commercial – 60 years or remaining tenure, whichever is lesser
  • Industrial – Remaining tenure

Never bank on ‘en-bloc’ as a profit strategy

We should remember that there’s no certainty a property will be granted an extension on the lease (top-up) by the Singapore Land Authority (SLA).

Thus, we should never bank on collective sales or ‘en-bloc’ as a profit strategy. There’re many instances where forced ‘en-bloc’ sales are unprofitable for some people.

Example: Comparing different leasehold properties

Mr Lim has short-listed three properties with different leasehold tenures for consideration, as illustrated in Table 1 below.

I’ve simplified and removed the financial calculations (which need a financial calculator to be derived) to aid in your understanding.

141208 Table 1

Table 1: Comparison of three properties

The learning points from Table 1 can be summarised as follows:

  • Compared with Properties A and B, Property C has a lower Net Operating Income (NOI) and a lower tenure with only 20 years left on the lease. We can thus derive that Property C is the best value for money, with the highest ROE of 251.82%
  • It’s important to derive the actual Present Value/Worth of the property using the Time Value of Money – money now is more valuable than money later on.
  • Property C’s asking price is closest to the actual Present Value/Worth – its POV is the lowest.

Based on our calculations in Table 1:

  • We can negotiate for a lower price. We don’t ask for the sake of asking and neither do we become ‘cheap’ in our offer and lose the deal.
  • We’ve a clear target price to work on – if the asking price is far from our target price or if we don’t get it, we simply walk away from the deal.

Example: Long Term Rental Increments

Let’s inject more realism into our valuation by adding some rent increases rather than keeping it fixed for the entire lease tenure.

Do be prudent and realistic on the rent increases, even though rents do go up in general over time.

141208 Table 2

Table 2: Comparison of three properties including rent increases

The learning points from Table 2 can be summarised as follows:

  • We use dollar value for rental increments for simplicity.
  • A percentage rate increase may suffer from a compounding/cumulative effect and cause unrealistic projections 30-40 years into the future.
  • We’ve to compare at least 2 or more properties to effectively make an objective buying decision.
  • Property C is still the best value for money with the highest ROE return, even with periodic rent increments.

Conclusion

As a conclusion for the entire Property Valuation series, I would like to emphasize how using critical financial metrics and ratios provides clarity for owners, buyers, sellers or investors in the form of:

  • Conceptual clarity: A number of different yield metrics exist on the market – it is important to be clear about how the specific terms are defined.
  • Operational clarity: To have a clear overview of rental incomes, operating costs and property values for the ordinary buyer/seller.

Finally, do remember that:

  • Reported yields can be “manipulated” by choosing metrics and massaging estimates of uncertain factors that are favourable to the people with vested interests.
  • We should be clear about the purpose for which each yield metric is used. The most important distinction is between using yields/income/price returns for ownership purposes and using yields as benchmarks or bubble indicators for investors.
  • Always have a clear view of the property’s price-income-yield ratio. For example, how it relates to the real return on other investments, inflation levels, risks and expectations for both buyers and sellers.

By guest contributor Gerald Tay, who is the founder and coach at CREI Academy Group Pte Ltd, an organization dedicated to empowering retail property investors with smarter investing philosophy and strategies. He is a full-time investor with over 13 years of solid experience in building his wealth through Property Investment and is financially wealthy today.

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