Sunday, August 16, 2015

SMARTER financial planning beyond 50: Property Downsizing?!

In the Invest section in today's newspaper, Lorna Tan talked about 8 issues that people approaching retirement should be looking at.

I really like the bucket approach and I think it is the most prudent way for someone with zero prior financial planning to start preparing for retirement. For people that have already started their financial preparations way in advance, the only takeaway is that it would be optimum to have such investments be matured or ready for withdrawal over a period of time to maximize their returns, rather than to have them en masse mature at the same time - retirement age.

However, I have a big beef with her point of #7, which is property. Her suggestion is to downsize the house. The next suggestion is to do the HDB Lease buyback scheme. I am not very sure about the HDB buyback scheme, so I shan't comment.

I think that for a retiring couple, a 3 room flat is ideal space-wise. While the extra bedroom may no longer serve its purpose as a bedroom for a child or a guest bedroom, it could be retro-fitted to be a hobby room or more likely - storage space. After living on earth for that many years, most people would have accumulated a fair amount of trinkets and possessions.

First, let's look at downsizing. 

Looking at the resale prices of HDB flats, if you choose to downsize, you would get on average between $60,000 to $140,000 depending on the flat you have and what you end up with.

Surfing around property guru, the listings for room rentals vary vastly. Rooms that rent under $300pm are almost definitely actually part of a room shared with multiple other people. Rooms can go as low as $500pm with just the bare bone basics and might not come with a fan and definitely without aircon. Proper functional rooms without psycho landlords seem to rent at around $700pm (confirmed by my Malaysian friend) and goes up based on location. Do take note that for the rest of the example I am going to use this number of $700pm, which in reality would differ from estate to estate and could be much higher for people living in better estates or at very good flat locations.

Thinking about it, collecting $700pm translates to $8400 a year, which is actually 13.6% of $61,765 (the amount "got back" from downsizing from a 5rm "study" to a 4rm)! It is common knowledge that the rental yield of rooms are much much higher than the rental yield of entire flats. Even from a 4rm to a 3rm, the yield is a very decent 6%. You tell me if it's possible to get 6% gross in the rental market today from an entire unit, even from shoeboxes.

If you're downsizing from a 5rm to a 3rm flat, you would get back $201,547, but you would be giving up a rental income of $1400 a month (1 rooms and 1 "study"), which translates to $16,800 a year or in other words, an investment that gives about 8.3% gross yield. Net? Probably easy over 7%.

Do you think it is better to downsize and collect back a big lump sum? What would the future returns of that lump sum be? Can the retiring couple resist the urge to "spend a bit for a treat"?

Would it not be better to hold onto a currently valued $201,547 real estate asset that produces 8.3% gross annual yield? Even if the rental market is in the doldrums and market rate falls by HALF, you would still be getting returns of 4%. Net returns still ought to be over 3% in that sort of doomsday scenario. If the property market is red hot, rental rates could rise and there is also a good opportunity for further capital appreciation.

Living in a bigger HDB and playing landlord for the first 10-20 years into retirement and then finally considering downsizing when it is too tiring to manage the tenants seems to me like the much more prudent and conservative strategy that actually produces very good returns as well.

The downsides? Lack of privacy and security, which can be mitigated by carefully selecting tenants and having a CCTV system. Repair and maintenance would likely be marginally more tiring, since upkeep is still required for the rest of the apartment that the tenants are not living in.

Retirees shouldn't be thinking about how they can invest and earn more money. Instead, they should be focused on smartly using their accumulated assets, which in this case might mean managing their real estate asset to produce supernormal returns and then only disposing of it much later.

NB: I don't think that people should buy bigger homes with the purpose to rent out existing unused rooms, unless they can reasonable foresee that they will expand their family and make full use of those rooms in the future. It would make more sense to just right-size your home to begin with. As appealing as all the intangibles sound and the ring of being a multiple homeowner, I have thought about it and I think it would make a lot more sense to invest the difference in REITs compared to another private property. However I can understand how people might be in this situation of having "unused" space in their homes when they are nearing or at retirement. In such a scenario, it makes sense to me to handle it in the way above.

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