After location, the most important thing you need to look at when buying property is the price.
As the other famous saying goes – “There’s no such thing as bad real estate, only bad pricing”.
You may be buying the worst piece of real estate in the lousiest location ever, but if you’re getting it at an unbelievable price, it may still turn out to be a great investment.
So… how do you determine the right price to pay for a property?
This is Part II of the FH Property Series, where I’ll be sharing everything I know on buying property in Singapore.
Check out Part I on how to pick a property here.
Theory – How to calculate Price when buying Property in Singapore?
If you go to real estate school, they’ll teach you that the 3 ways to determine price are:
- Sales Comparison
- Replacement Cost Approach
- Income Capitalization
Let’s touch on each of them briefly.
The most basic form of valuation.
You find a similar property of similar size and age, and you see the last transacted price (on a psf basis).
That’s the market value of your property.
Everyone knows how to do sales comparison, and intuitively it’s the first method we will use.
I’ve extracted a screengrab from Property Lim Brothers below that gives you an idea of how sales comparison is done.
Replacement Cost Approach
Sometimes the property you’re buying is unique, and you just can’t find anything similar in the area.
Maybe it’s a small development, maybe the age is unique, or some other reason that makes it hard to find a similar property to compare.
In such cases you fall back to the cost approach – How much does it cost to build an equivalent property.
You calculate (1) the value to buy the empty land, (2) add on building and development costs, and (3) subtract a bit for depreciation and old age.
This is the main method that I use, so we’ll go in depth into the numbers and method of calculation later.
Income Capitalization (Cap Rate)
The core concept with income capitalisation is that you calculate the rental income, less off expenses, and apply a multiplier known as the “capitalisation rate” (also known as cap rate).
So let’s say the rental income per year after deducting expenses is $50,000.
If you apply a 3% capitalisation rate, the value of the real estate is $50,000 / 0.03 = $1.67 million.
For stocks investors who are familiar with Price to Earnings, Income Capitalization is basically P/E valuation.
Only difference is that you replace earnings with rental income, and replace the P/E Multiple with the cap rate.
How do I do it? Calculate Price for a Residential Property in Singapore?
Okay so that’s the theory.
How do I do it in practice, for Singapore residential properties?
Income Capitalization I’ve found to be most useful for commercial properties.
If you’re buying a shopping mall or an office building or an industrial property – absolutely use income capitalization. Use Income Capitalization and cross check against a mix of Sales Comparison / Cost Approach.
But income capitalisation I find less effective for Singapore residential properties.
For Residential Property in Singapore, the way I like to do it is to use the Replacement Cost Approach – it’s to find the replacement price. And crosscheck against sales comparison.
Don’t forget to sign up for our free weekly newsletter too!
What Price does the Property Developer need to sell at to break even?
To understand replacement price, you first need to understand how a property developer prices a property when they bid for land.
Let’s say GuocoLand is bidding for the white site in Lentor.
What is the price they need to sell to break even?
The way you do it, is to add:
- $300 – 400 psf for construction cost (used to be $200 – $300 pre-COVID but the price has gone up since due to inflation in labour and raw materials)
- 15% for Sales Expenses (property agent fee, marketing and advertising expenses etc)
- 10% for developer profit
So GuocoLand paid $1204 psf ppr for the land (per square foot per plot ratio – basically the cost per square foot of buildable area).
The cost of the land + building is $1204 + $400 (we’ll take the higher end of the range) = $1600 psf (round up for the sake of discussion).
The cost of land + building + Sales Expenses is $1600 X 115% = $1840 psf.
This means that Guocoland will need to sell at about $1840 just to break even.
But of course Guocoland needs to make a profit too, so you add in 10% profit.
Realistically, you’re looking at $2000 average selling prices across the board.
These are Average PSF numbers
Now of course these are average PSF figures for the entire development. The price you actually pay will depend on the size of the unit you buy.
If you buy a 1200 sf 3 bedroom, you may pay below the average $2000 psf (PSF goes down the bigger you buy).
If you buy a 400 sf studio, you’ll probably pay above the $2000 psf.
So you adjust the price / market value accordingly for what you buy.
How to calculate Replacement Cost (or market value)?
Using the example above, replacement price is basically land value + construction cost.
So back to the lentor example – land value + building cost is about $1600.
That’s the cost price / replacement cost / market of a brand new building in that area, before you add in things like sales expenses or developer profit.
So if you’re buying a 20 year old freehold, you subtract a bit for the condition of the property.
Say 100 – 150 psf because it’s a bit old and dirty.
And your fair value is about $1450 – $1500 psf.
If it’s brand new of course (or 2 – 3 years old), then you can pay up to $1600 and still be close to fair value.
How to calculate Land Value?
The trickiest part with the replacement cost valuation method is to calculate land price.
There are two main ways to do it, ranked from easiest to hardest:
- Government Land Sale (GLS)
- En Bloc
- Take recent property sales in the area and work backwards
Easy – Government Land Sale (GLS)
The easiest way to calculate land value is if there is a recent Government Land Sale (GLS).
If there is, you just check the psf ppr the property developer paid for the land tender, and that should give you a very close approximation of the land value.
Medium – En Bloc
En Blocs are also very easy – you can use the value that the property developer paid for the land.
The only thing to take note of is that if the En Bloc is for leasehold land, then you need to add back the land premium to calculate the value of a full 99 year lease.
So let’s say the developer paid $1200 psf ppr to the homeowners, for a development with 60 years left on the lease.
The developer then pays another $200 land premium to URA to “top up” the lease back to a fresh 99 year lease.
The land cost here is $1400.
Don’t forget this step, otherwise your number will be meaningless.
Hard – Take recent property sales in the area and work backwards
Sometimes though, there’s just no recent en bloc or GLS.
Which makes your life a lot harder.
In such cases the next best thing is to approximate based on recent land sales in the area. In other words, you use the Sales Comparison approach to calculate land value.
Eg. A 30 year old leasehold property in the area was sold at $1600 psf last week.
Based on the condition of that property, you think about $150 – $200 psf of repair / reno work is required.
So you add this back into the sale price, to get the replacement cost.
That would give you $1600 + $200 = a rough valuation of $1800 psf for the replacement cost of the land.
And then you repeat this for a few properties in the area, varying the age / location / floor each time.
If you do a few of this, that should allow you to triangulate the average land price for the area.
It’s basically using what we learnt about the developer pricing methodology, and working backwards to find the replacement cost of the land.
But FH, the Pros use “Gut Feel” when it comes to valuation
Okay I know that the 20 year veteran property investors will tell you that they can just “tikam tikam” the valuation.
But their “Gut Feel”, more often than not, is usually a variation of one of these 3 valuation methods above.
So get your basics right first, and understand the theory behind each of these 3 valuations methods, and their strengths and weaknesses.
Once you’re familiar with them, you can very easily apply all 3 of them on the go to give you a gut feel valuation. And then you can laugh at others when they whip out a calculator. 😉
How to use the Replacement Cost Valuation?
Now that you have your replacement cost, how do you use it to guide your buying decision?
The broad idea is that as long as you pay close to replacement cost, you won’t lose too much money.
But there are some nuances that we’ll discuss below.
Fair Valuation is a Range
The biggest one to remember, is that valuation is both an art and a science.
There are a lot of numbers and mathematics above, but DON’T fool yourself into thinking that this is the 100% correct valuation of your property.
Just like with stocks – fair value for property is always a range.
So if your fair value is $1400 – $1500 psf, that is your fair value range.
Don’t be so stubborn that you can only buy / sell property within that range.
Just like if your fair valuation of DBS is $25, the share price can still trade at $30 for years.
The Property Market can move very quickly
This one is especially relevant right now, when the Singapore residential property market is red hot.
The replacement cost methodology is fundamentally backward looking.
You’re looking at past transacted prices from a few months ago, and trying to calculate price today.
Prices could legitimately have moved 2% – 3% in the time since.
So you need to be aware of market sentiment as well, and you may need to make adjustments to your fair valuation range accordingly.
If the URA Price Index tells you house prices have moved 3% quarter on quarter, and the numbers you’re using are from 6 months back, you probably need to add 3% – 5% to get the fair market value.
Don’t Forget Subjective Value
A massive factor to consider, especially if you’re buying for own stay, is subjective value.
If you love the property because of its arched pillars, you may be willing to pay slightly more for the property.
Or if you hate it because of the disgusting layout (to you at least), that subjectively the property is worth less to you, and you may not want to pay anything more than the low end of the valuation range.
The important thing to note is that replacement cost just tells you what the fair value of the land is, approximately.
It doesn’t tell you the price that you should actually pay for it.
That is your decision, and yours only.
If you decide that buying real estate in Lentor at $1450 psf is stupid, then it’s your decision to walk away and buy in another area, or to put all that money into stocks and rent a house instead.
This isn’t the 1990s – Lowball offers don’t work anymore
What you shouldn’t be doing though, is that if you know fair value is $1450, but you insist on only buying at $1350.
That to me – is a fool’s errand.
This isn’t the 1990s anymore.
Today, anyone can go onto the URA website or Property Guru and pull up 10 years worth of transactions with a single click.
Everybody out there, including your competing buyers and the seller himself, knows the fair valuation range of the property.
With the internet, there is no information arbitrage anymore.
In other words – this isn’t your grandfather’s generation where you can lowball an offer and get accepted.
Can you buy Singapore Property at an undervalue?
That said, there are exceptions to this.
The only reason why a seller would sell at an undervalue today is because (1) he is desperate for cash, or (2) illiquidity.
In this low interest rate environment that is flush with liquidity, almost no investor is desperate for cash. There is always the option to rent it out, and even if they want to sell, there’s a long list of buyers waiting.
During COVID the government even gave homeowners the opportunity to defer mortgage payments – when have we ever had that in Singapore’s history?
Fire sales are much less common today.
Which leave illiquidity – basically a house where nobody wants to buy.
But be objective with this one.
If you’re buying a $1.5 million condo in a great location, chances are there will be 5 other bidders competing with you in this market.
If you’re buying a $10 million penthouse in the CBD, or a leasehold landed with 30 years left on the lease in Sembawang, then ok maybe you’re the only bidder and you may have more room to negotiate if you put in a serious offer.
How to negotiate a real estate transaction is a whole other story in itself, which we will cover with a full article.
Buy Great Real Estate at a Fair Price
My advice is this – Think of it like stocks.
Instead of obsessing over trying to get the perfect price, focus on the bigger picture.
Accept that whatever real estate you want to buy, you have to pay the fair market value for it at the time you are buying.
Spend your time more productively by picking great real estate that will appreciate in value over time.
In other words – buy Great Real Estate, at a Fair Price.
And earn the long term gains.
Love to hear what you think!
If you enjoyed this article, do support Financial Horse as a Patreon to get exclusive early access to the FH Property series, as well as other premium content.
Check out Part I on how to pick a property here.
Looking to buy Bitcoin, Ethereum, or Crypto?
Check out our guide to the best Crypto Exchange here.
Looking for a low cost broker to buy US, China or Singapore stocks?
Get a Free Apple stock (worth S$200) when you open a new account with Tiger Brokers and fund $2000.
Get 1 free Apple share (worth $200) you’re new to MooMoo and fund $2700.
Or Interactive Brokers for competitive FX and commissions.
Do like and follow our Facebook and Instagram, or join the Telegram Channel. Never miss another post from Financial Horse!
Looking for a comprehensive guide to investing that covers stocks, REITs, bonds, CPF and asset allocation? Check out the FH Complete Guide to Investing.
Or if you’re a more advanced investor, check out the REITs Investing Masterclass, which goes in-depth into REITs investing – everything from how much REITs to own, which economic conditions to buy REITs, how to pick REITs etc.
Want to learn everything there is to know about stocks? Check out our Stocks Masterclass – learn how to pick growth and dividend stocks, how to position size, when to buy stocks, how to use options to supercharge returns, and more!
All are THE best quality investment courses available to Singapore investors out there!