Owning a property is a huge milestone in many of our lives. This is partly because it signifies reaching a certain level of independence, but it also comes from property ownership being viewed as a big financial achievement.
Why do we view property ownership as a significant financial goal? There are both good and bad reasons for this. A good reason might be that it shows you have reached a point in your career where you now have the financial means to do so. A not-so-good reason is that people also think of their home as a major investment asset.
While understandable, it is not always the best mindset to have as a homeowner.
Homeowner or Property Investor? (Why They are Not the Same)
Homeowners and property investors both buy property. So, from that aspect, they can appear to be equivalent. And it is true that property is a substantial asset. According to the Department of Statistics, residential property comprised 41.6% of the average household’s total assets as of mid-2020. Keep in mind that this figure also includes CPF, which is why it might be a bit lower than you expected.
Further, as an asset, Singaporean residential property – both private and HDB – has indeed demonstrated a long-term uptrend. This doesn’t mean they have appreciated every year. But over the long term, the upward trend is clear.
This trend has understandably fuelled the mindset that people’s homes are also appreciating investment assets. After all, your home will likely – or already has – appreciated in price. And there is no doubt that it is an asset.
There’s just one problem – this is a risky way of thinking. Here are three big reasons why your mindset as a homeowner should not be the same as that of a property investor.
1. Returns on Investment are Extremely Difficult to Realise
As your home appreciates in value, you build what is known as equity in your home – the difference between the current market value and your outstanding home loan amount. The theoretical capital gains you could realise if you sold your home is part of this home equity figure.
But here’s the difference between a home and an investment property. It is extremely difficult to realise these gains as a homeowner. The only way is to sell your home, which would then require you to buy a new one. And if your property price had increased, that means it’s likely this new home would be similar in price too – unless you are choosing to downsize. On the other hand, a property investor does not live in their unit and has no problem selling it when the price is right.
The same applies for rental cashflow. Unless you are renting out a room, your home cannot generate cashflow, whereas a property investor can rent out the whole unit.
In short, property investors can easily realise their returns from their investment, either in the form of capital gains or rental cashflow. The same does not hold true for homeowners.
2. The Carrying Costs of Your Home are Likely Too High for it to be a Worthwhile Investment
Property is one of the few forms of investment that require cash outflows for upkeep. These are costs that must be factored in when calculating the return on investment (ROI) of a property. If an investor is not careful with how they manage this, their ROI would be negatively impacted. In other words, they must be strict in how much they spend on the property.
While there are no in-depth surveys on this, we would be willing to bet that few, if any, homeowners are analysing how much money they have put into their home and how it is affecting their ROI. In fact, we doubt most homeowners even bother calculating their ROI at all.
And if they do, it is usually only when they sell it, whereupon they do the most simplistic calculation. For example, they might say they bought their home for $500,000 and sold it 10 years later for $1,000,000 – that’s a 100% gain! But this disregards the interest costs, taxes, maintenance and others.
Of course, this is understandable. Homeowners need not drill down into ROI calculations for their home. If they did, they might find that their home isn’t really as a good an investment as they thought (especially since you would spend more on your home than a rental property). But investors must do so – and therein lies the key difference.
3. Investments are Unemotional, Choosing a Home is Anything But
The perfectly rational investor does not exist. But still, the investment process is supposed to be as rational as possible. When assessing potential properties, a property investor would be studying factors such as rentability, expected cash flows, valuations, and transaction history. On top of that, they would also be studying the interest rate environment to determine the type of mortgage to choose and potential future repricing or refinancing.
While there is some overlap, these are not the criteria that people use when choosing a home. Instead, they are looking at more “emotional” aspects such as:
- How would I feel about living here for the next five years or more?
- How close is it to my friends, family, and workplace?
- Would my children and family enjoy living here? Are there good schools nearby?
Because these emotional factors are often more prominent when buying a home, the home people end up choosing may not be the most ideal investment property. That’s perfectly normal – and also why you cannot think of your home as an investment asset.
So how should you think about it instead?
The Homeowner Mindset – A Day-to-Day Expense with Longer-Term Potential
Here’s a practical suggestion for how to think about your home – as a day-to-day expense with longer-term potential. That can sound confusing, so let’s break it down.
On a day-to-day basis, you want to think of your home as an expense – no different than rent. You must pay for the mortgage, property taxes, and maintenance. This will not only make you more careful in your regular budgeting, but also make you think about other investment opportunities, such as stocks.
However, you also want to recognise that over the longer term, your home equity is indeed valuable. It is wise to keep track of it and understand that you can eventually convert it to cash if you so choose. And if you don’t sell, but move to a new property, you can turn it into a source of rental income. But this should not be the primary “lens” in which you view your home, but something you can keep in the back of your mind for the longer term.
How Does This Translate to Home Financing?
If homeowners and investors have different mindsets, then they must also have different approaches to home financing. Since homeowners should think of their home as a monthly expense, the most important thing they should pay attention to is affordability. Because you are not expecting a return on your home, your focus should be on not biting off more than you can chew.
Here, tools like our Mortgage Affordability Calculator will prove useful. By using a higher interest rate than prevailing market rates, it automatically builds in a buffer to minimise your chances of choosing a loan that is too big for you to handle.
For investors, on the other hand, affordability is likely not their priority. Instead, it is the degree to which the property can cover their mortgage, the yield, and their ultimate return on investment. There are many more factors to consider, and it is overall a more complex situation. This also reiterates why homeowners and investors should not think of their properties in the same way.
Everybody’s situation is unique, which means that sometimes the lines between homeowner and property investors can be blurry. As such, you should always do your research before committing to a purchase. If you can need personalised advice and guidance, we can provide that through our expert Home Finance Advisors.
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This article was written by Ian Lee, an ex-banker turned financial writer who hopes to use his financial background and writing skills to help raise people’s financial literacy levels – a necessity in our modern world.