Real estate is a popular investment asset in Singapore.
Especially New Launch Condos.
With multiple projects all over the island, buyers today have a buffet of choices.
Why new launches though?
You may have heard it before…
New Launch Effect, TOP-Spike, TOP-effect…
Same thing, different names.
They all refer to a sharp increase in capital values of the property when it completes, giving the first owner a ‘quick flip’.
It’s touted as one of the best ways to make money from Real Estate investing in Singapore.
However, do you really know how much return you’re getting?
And whether it’s really worth the money and risk?
It’s common that depending on who you speak to, you get a different answer.
So in this article, I’m going to go through some of the different formulas of calculating your real estate return on investment for new launches.
Keep reading!
First, the parameters that we’ll be using.
It’d be best if you try the example as well so you can check your answer with mine.
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Type of property – New Launch Under Construction
Purchase Price – $1 mil
Down payment – $250k
Acquisition costs – est. $27k (Buyer Stamp Duty + Legal Fees + Misc. Costs)
Holding period – 3 years
Mortgage repayments – $18k total over the period
Selling price (nett) – $1.1 mil
O/S Loan – $700k
What’s your answer?
Method 1: Return On Investment (ROI)
The easiest method.
Your answer: 1.1mil/1mil = 110%.
Or, a 10% return over 3 years.
This method is often used from a 3rd party perspective when details of the purchase are not available.
In the past, this method was more commonly used.
However, it understates the actual investment return because it does not take into account any loans for the property, and assumes full settlement for the purchase.
Correspondingly it is now rarely used by salespeople to pitch returns on real estate investment.
Method 2: Return on Equity (ROE)
Then came ROE, which sought to more accurately account for the amount of leverage used in the investment.
This is done by eliminating the loan amount from the calculations and considering only the income earned and cash outlay.
Or, in layman terms, your return for each dollar you put in.
In this case,
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Net Income = Profit – Expenses = ( $1.1 mil – $1mil ) – $45k = $55k
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Equity = Down payment + All Other Costs = $250k + $27k + $18k = $295k |
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ROE = Net Income/Equity = $55/$295 ≈19% |
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I do an explanation on the above 2 methods in the video below.
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Now things were starting to look better for the investor.
Method 3: Return on Expenses
Here, is a twist on the Return of Equity.
Those who suggest this method say that the Principal amount i.e. the Down Payment of 250k is money that is put into your property at purchase, which you then get back when selling.
The argument is that it isn’t a cost item and hence shouldn’t be used in calculating return.
Taking the same numbers from method 2, you’ll get:
$55/($295 -$250)
= $55/$45
≈1.22
Or, a 22% return over 3 years.
The numbers look even rosier now! But there’s more.
Method 4: Cash on Cash Return
Using only the money out vs the money in, this method removes all the financial jargon and focuses only on the dollars.
For our example, that’s
Or, a 36% return after 3 years.
Certainly looks pretty decent doesn’t it?
Watch a visual explanation on these 2 methods in the video below.
Do you find it interesting that for the same question on calculating your real estate return on investment there can be so many different answers?
Ranging from 10% to 36%?
Is there truly a right answer or best way to calculate?
The tricky thing about evaluating real estate investment returns from new launches is the lack of rental data.
Rental yield, which is a common measurement tool is therefore not applicable here.
The beauty of rental yield is because it reflects a return on a per annum basis.
Something which we are unable to do for the 4 methods above as there is no income during the 3-year holding period.
Still, there is a method to convert the one-off gain after 3 years into an annual rate of return.
Method 5: Internal Rate of Return (IRR)
The internal rate of return (IRR) is a metric used by finance and investment professionals to estimate the profitability of potential investments.
The formula for IRR is
Looks daunting, doesn’t it?
Especially in comparison to the previous methods.
Don’t worry, you can calculate it easily using excel.
This is best explained with an example.
Watch the video below where I run through the method using excel, as well as an actual case study.
A simpler way to think of IRR, is to consider it as the annual growth rate.
It is useful to annualise the return in this manner for comparison with other potential investments…
Just like how the professionals use it.
Commonly in Singapore, it can help to answer the questions:
- Is it better to place my money in my CPF or use it for property?
- Should I place my money in Fixed Deposits or property?
Conclusion
Ultimately, there isn’t a one-size-fits-all approach to calculating your return on any particular real estate investment.
And if the complexity of IRR isn’t your thing, any of the simpler 4 methods would be suitable as well.
Just make sure you’re consistent and understand that if anyone gives you a different value, it’s likely because they’re using a different method.
It doesn’t matter which you use, but you can only compare returns when they’re both derived from the same method!
Jeremy Ow summed it up nicely in his comment on my YouTube video:
I find that when calculating investment returns, it is choosing a method which balances between ease of calculation and accuracy of determining the rate of return. If one really desires to be most accurate, the method of calculation will tend towards tediousness and one of complexity. Because there are so many variables to consider such as mortgage payments over a 3 year period could fluctuate in any single year due to either a fixed interest rate or floating interest rate. Also, we can consider the time weighted manner of calculation since every mortgage payment is also a cash outlay incurred over different sub-periods of time over the entire overall duration of say 3 years that the property was held before sold. Also, what about any home improvements (renovation cost) and repair costs done on the house?
Thus, my take is that we can seek to be as accurate as possible in such investment return calculations. However, it can get too tedious in the end. So I will go for a balance between ease of calculation and accuracy of the calculation. As long as it is a fair reasonable estimate of the investment return, there is no need to fret over that the calculation must give the best 100% most accurate answer to the investment return.
What is the main aim of this exercise of calculating investment return for most investors? Isn’t it to meet someone’s financial and life objective in life? As long as the particular property investment makes sense over a period of time to meet one’s financial or life objective in the end, who cares whether that few % difference in my choice of calculation methods will show me? It may turn out to be just a numbers game to make me feel happy. But so long one’s financial and life objectives were met by making a sensible choice on a particular property investment is what matters for the investor at the end of the period of holding the property.
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Well said, my friend.
A real estate investment is a huge sum of money and is never easy.
Even if you calculate your return on investment right, there are still many more things to think about.
Final Words
I want to thank you for watching my videos and coming to the end of my article.
Here’s the EXCEL file which you can use to calculate IRR.
Now I’d like to hear your thoughts.
What’s your #1 takeaway from these methods?
Did you learn something new?
Which is your go-to method?
Or maybe you have a question.
Either way, leave me a comment below right now.
Ask Jim 