Tuesday, April 17, 2018

Recognize the consumption component in property ownership

The government has the perception that a short term lease is consumption and a longer term lease is investment. They set a minimum of 60 years lease for the unrestricted use of CPF.

This perception is wrong. All properties have a part for consumption and another part for investment.

For example, if someone buys a property with a lease of 30 years, the purchase price will be consumed within 30 years.

If this person buys a 60 year lease property, he will have to pay a higher price. At the end of 30 years, the value of his property would have dropped, due to the consumption of the property for 30 years.

Suppose the price for a 30 year lease is \$180,000 and a 60 year lease is \$240,000. The difference is \$60,000.

At the end of 30 years, the value of a 30 year lease would have dropped to \$0 and for the 30 year lease, it would have dropped to \$180,000 for the remaining lease of 30 years would be \$180,000. We ignore appreciation in the property values in this calculation.

If he had invested his \$60,000 to earn 4% per annum, it accumulate to \$194,000.
Hence, in both cases, the property is being consumed at the same rate.

The same argument would apply for a 99 year lease and for a freehold property.

The property with a longer lease or a freehold property cost more than a short lease property.The difference in the purchase price represents the "investment". The underlying amount is the "consumption".

If we assume an average appreciation in property of 2% p.a. he need to earn 6% p.a in alternative investment to be as good as property. This is possible by investing in equities.

If the government recognises this point, there is no need to restrict the use of CPF savings for property with a remaining lease of 60 years or to apply a complicated formula for shorter leases.

They can allow the unrestricted use of CPF with a lease of at least 30 years or even shorter.

Alternatively, the government can reduce the compulsory contribution to CPF and allow the people to use the money in any way that they wish, for example, to rent a property or to buy a short lease.

This is the standard practice in most or all cuontries around the world. There are few countries that have a CPF system that forces the savings to be used to buy properties.

Tan Kin Lian

Note: the figures of \$180,000 and \$240,000 are quite realistic. They are taken from this table.
https://www.sla.gov.sg/Portals/0/Services/Land%20Lease%20Conditions/DP%20policy%20wef%2031%20Jul%202000.pdf