Leveraged Yield of Return for your Property

Property rental is a passive income dream for a lot of people, which is why you see many people flocking to condo launches these few years.

And the main attraction why property is better than bonds, equities or other asset class is that it is the easiest for average folks like you and me to leverage up.

Recently, the Singapore Government have been trying to stem this property speculation wave, which have seen property prices climbing like mad.

So how much return can you make nowadays if you try to rent out?

Leveraged Yield Formula

The formula to calculate how much leverage yield as an investor you can garner when you rent out your property can be represented by this generic formula

L = (R – (1-N)*C)/N

where

  • L = Leveraged Return
  • R = Yield on asset e.g. rental yield, yield on bond
  • C = Cost of borrowing e.g. interest from bank
  • N = % owner have to put down

You can use this formula for other leverage strategy as well such as borrowing to buy bonds or REITs

REITS, Business Trust, Infrastructure Stocks

The unleveraged yield on asset (R ) on such assets typically range around 6-8% for REITs, infrastructures, utilities.

The leverage rates vary from 30%-50%.

Leveraged Yield of Return for your Property vunPdHP

In the case of an average asset, say Industrial buildings in REITs, or utilities their returns typically ranges from 6-7%.

The leverage can go up to 40% or 50%. The boost usually is rather significant as shown above.

It is why REITs are attractive since majority are rather leverage.

Leveraged Yield of Return for your Property 0bQlY3O

For the more conservative assets such as preferred shares, blue chip REITs the yield is lower, but the borrowing costs are lower as well. They may be more conservative.

But if you put down more of your money, the boost to yield is going to be less

Commercial Properties in Singapore

RENTALS have kept pace with the rise in private home prices, but not across the board.

"Rental yields remain at 3.7 per cent islandwide," Maybank Kim Eng said in a report that compared 2011 and 2012 rentals at projects with more than 10 rental contracts.

The minimal change in the figure indicates condominium rental rates have generally kept up with the increase in prices last year.

However, not all districts fared equally. The worst showings were in Newton and Sentosa, with yields compressing to just 2.2 per cent last year.

Leveraged Yield of Return for your Property NpXgvsv

What used to be the situation before the cooling measure is that you can probably put down only 20% of your money.

Even with a lower yield on asset at 4% and a cheap borrowing cost of 1.5%, the leverage return is an astounding 14%

Leveraged Yield of Return for your Property g25g5kN

Leveraged Yield of Return for your Property NnR0BBM

If the leverage is drastically constrain, your returns look rather close to what you get as the returns on REITs, business trusts.

That is to say you put $400k in a condo downpayment versus $400k in a basket of stocks yielding 7.5%

Conclusion

At the end of the day, people buy property not so much for the rental but for the leverage appreciation.

The different asset classes grow at different rates and they have different depreciation levels as well

  1. Property 99 years lease?
  2. Commercial property 999 years lease?
  3. Ships 25 years?
  4. Roads 15 years?

From the looks of it, my figures are even conservative since in the quote above the yields can be near 3.8%.

Property, stocks or bonds, at the end you have to determine the cost of purchase and the value you get.

Buy something that is dear and you do not have much safety.

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  • Marti

    The problem here is that the mortgage loans are variable rates – which means over the course of a typical mortgage (say 30 years) it is very likely that interests will go up by a lot. These calculations don’t take into account that risk. What happens when they reach 4% or higher? What happens when suddenly a lot of cashflow-negative investors all try to dump their property at the same time?

    The property market is a game of musical chairs: it looks like easy money when rates are this low, but when the music stops…

  • Drizzt

    hi Marti.

    Do you truly believe that? Because a lot don’t see it. I thought the asset rental yield is much higher like 4.5% and was astonished they announced some as low as 2.2%!

    What are you experience with rental yields from friends?

  • Marti

    Sorry I maybe wasn’t very clear – I was referring to interest rates.

    Most mortgages in Singapore are something like “3-month SIBOR plus 1%”. Right now that puts mortgage rates at slightly above 1%, which makes even a yield of 2.2% sustainable with leverage.

    But over the course of 30 years this SIBOR rate will fluctuate. Looking back to the past 30 years, it has gone as high as 8% and on average been about 3%. What happens when all the property investors, leveraged to their eyeball, have to pay 9% interest on their mortgage when they only pocket 2.2% of yield?

    Making leverage computations based on current mortgage rates is fundamentally flawed because these rates won’t last, and they are an historical abnormality. Property investment is a long term game.

    When the US rates went up a few years ago, a lot of Americans realized they couldn’t afford their mortgage, and the rest is history…

  • Drizzt

    hmm. i wonder whether that will happen. rates usually go up when the situation picks up to control inflation. i would think rental lease will increase as well.

  • Marti

    The problem is rentals are tied to household income (ie: people can only dedicate a portion of their salary for rent) so their increase potential is limited and always slow. Much slower than the fluctuation of interests rates which could easily double or triple in a year’s time (since they are close to zero now)

    Property works a bit like bonds : when rates go up, it’s not the generated income that increase but the price of the asset that goes down to reflect the changing yield.