(Article contributed by Ku Swee Yong, CEO of International Property Advisor Pte Ltd.)
In May 2019, the government relaxed rules for older people looking to buy old flats using more money from their CPF accounts. The aim of amending the rules was primarily to improve the demand for older flats, so that the value of older flats may be maintained for longer. (Source: MOM Press Release: More Flexibility to Buy a Home for Life While Safeguarding Retirement Adequacy)
One of the examples quoted in the Ministry of Manpower’s press release described a couple, John (age 48) and Jane (age 45), who is buying an old 4-room flat with 50 years left on the lease. The age of Jane, the youngest buyer, and the remaining lease equals to 95 years in total, satisfying the new criteria for using CPF to fund their purchase in full. The price of the flat is $430,000. Under the new rules, all $430,000 may be paid from the couple’s CPF accounts. Under the previous rules, CPF usage was capped at 80% of the value of the old flat, i.e. $344,000. Thus, the new rules allow the buyers an increase of $86,000 CPF usage.
Market watchers were quick to highlight the benefits of the change of rules, pointing out that the new rules will “help unlock values of older houses that were artificially depressed by the previous CPF rules.” (Source: “A CPF key to unlocking values of older homes”, TODAY, 11 August 2019)
The values of older flats will be unlocked. Really? What gives?
(Note: For the purpose of our discussion, we define ‘old’ or ‘older’ flats to be over 40 years age, which means that these flats have less than 59 years of lease remaining. That is when financing restrictions begin, such that the number of buyers taper down, adding downward pressure on the resale value.)
Let us review if John and Jane’s purchase of the 49-year-old 4-room flat with $430,000 of CPF fund was a prudent one.
What if things don’t go as planned?
Firstly, did John and Jane consider that their plans may go awry and exigencies might pop up during their retirement years? What if they desperately needed to sell their flat 15 years down the road, will there be many families willing, and able, to buy the remaining lease of 35 years on this flat?
a. Potential buyers who would like to make full use of their CPF would have to be 60 years old and above.
b. Buyers below 60 years age will need to supplement their purchase with cash.
c. Any buyers above 55 years of age are likely to have cashed out their CPF down to the Full Retirement Sum (FRS) or for those who are richer, the Enhanced Retirement Sum (ERS). They would only be able to use money in excess of the Basic Retirement Sum (BRS).
d. Based on current CPF rules, pledging a property allows a buyer of age 55 and above to draw down on the CPF retirement account to pay for the house, down to the minimum sum or BRS of $88,000. Drawing down CPF from the FRS to BRS level means $88,000 may be used to purchase the flat. Drawing down from the ERS to the BRS level means $176,000 may be used to purchase the flat. But these comes at the expense of the monthly retirement income the buyer can receive from age 65 onwards.
e. For a 60-year-old couple who wished to pay in full with CPF monies, assuming both have maximum ERS, they can afford to pay $176,000 x 2 = $352,000. At this selling price, John and Jane will incur a loss in value of $430,000 – $352,000 = $78,000. A $78,000 depreciation in 15 years (or $5,200 a year), not bad if the old flat is seen as a consumption. But for the 60-year old couple buying at $352,000 for 35 years of use, they lose about $10,000 of their CPF monies per year.
f. How many old couples are able to fork out such a large sum from their CPF, and sacrifice their monthly income after they crossed 65 years of age?
g. How many younger couples are willing to purchase the flat? Prospective buyers below 60 years old would only be able to use a pro-rated amount of CPF depending on their age. These buyers would be cognizant that they might outlive the remaining 35 years of the flat’s lease.
h. Therefore, John and Jane will have to find buyers who are willing to fund their purchase with cash and CPF.
Which begs the question: how much would buyers be willing to pay John and Jane for a flat with 35 years left on the lease which will certainly depreciate to zero value? Even if VERS (Voluntary Early Redevelopment Scheme) were to take place, what is the compensation that the buyers will receive? Will the compensation also cover relocation costs? What if the vote for VERS did not go through?
Have John and Jane considered carefully?
Secondly, we wish that John and Jane consider carefully whether they should apply $430,000 of their CPF monies to live in this flat for the next 50 years.
a. In the immediate next 20 years of their lives, as John (68) and Jane (65), retire from full-time work and lose their income stream, they have also lost 20 years of interest payment from 2.5% per annum of interest from CPF Ordinary Account (OA) and 4.0% per annum of interest from CPF Retirement Account (RA). Depending on their income and how much was in their CPF OA when they turned 55, John and Jane would lose at least $274,000 of interest income in the next 20 years.
b. By then, the flat’s lease would be left with 30 years and a residual value that may be well below half of the $430,000 purchase price. Unless they have a lot of cash for their retirement years, the depreciation of the flat over the next 20 years added to the loss of CPF interest of at least $274,000 would significantly impact their retirement. They have little option to monetise their flat’s value except leasing out spare bedrooms.
c. If John and Jane were to live to the ripe old ages of 98 and 95, their HDB flat would have zero value and they would be without a roof over their heads at a time when they are most in need.
d. At their current age of 48 and 45, while they are still healthy and earning a steady income, they should consider using less CPF fund and taking a 15-year loan to afford a younger flat even if it is more expensive.
What’s our conclusion?
Early data collected from the first 2 months after the relaxation of the rules seem to indicate that the transactions of old HDB flats have increased. However the authors of the research might have overlooked that the stock of old flats has increased substantially over the past year. (Source: “CPF, loan rule changes reinvigorate demand for older HDB flats: OrangeTee”, The Business Times, 6 August 2019)
While there may be a greater number of middle-aged buyers below 55 who will be eligible to buy old flats fully funded by CPF, the increase in the age-sum from 80 to 95 years also means fewer younger people are able to pay in full for the old flats using CPF, which means demand from younger buyers will be reduced.
We also doubt that the relaxation of the rules would appeal to people who are above the age of 55 and have their savings inside their retirement account (RA). Leaving their CPF inside their RA earns them a minimum of 4% per annum, a steep interest to give up in exchange for buying a property which will continuously depreciate.
Therefore, it is tough to argue for the case that the overall demand for old flats will increase and that the prices of old flats will be uplifted.
We urge older buyers to carefully consider their full options, including long-term renting, to reduce the risks of being unable to monetize their flats and have their hands tied during retirement years.
Ku Swee Yong is an Adjunct Faculty at the Singapore Management University and the CEO of International Property Advisor Pte Ltd. Joel Kam is a future graduate of the Cass Business School, London, UK.