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Saturday, December 5, 2009

Watch your cashflow

Choices to make on a vacant property

PRIOR to 2005, I stayed in a walk-up apartment located on the fourth floor. It was my bachelor pad and of course walking up four-storeys was not a problem. That apartment served me, a care-free single, very well.

All of us go through different life-stages. For me, the impetus for a life-stage change five years ago was to start a family and for my ageing parents to stay with me instead of being on their own. My bachelor pad could no longer serve these “new” needs and I decided to move out. At that time, I had two options:

(1) Sell my apartment and move into a bigger semi-detached house. This option is attractive as it allows me to manage my cashflow better since I would only service one mortgage. However, I have to be mindful of the property cycle. In a best-case scenario, I would make a profit if I were to sell when the property market cycle is up. But timing was not in my favour then and if I were to sell it, I would have made a loss.

(2) Keep the apartment, rent it out and move into a slightly smaller terrace house. For this option, I would be servicing two mortgages concurrently.

It would also mean that I have to manage the risks of not being able to rent out the apartment or have a low rent returns.

But it would provide me with an opportunity to wait till the market improves further before I sell the apartment.

To reduce the mortgage burden, I would not be able to afford the bigger semi-detached house.

Since I was not inclined to sell my apartment at a loss, I eventually chose the second option. As there are also relevant cashflow considerations when investing in a property, the factors I reviewed before making a decision were as follows:

·Cashflow – Rental versus on-going expense. Simply put, this refers to the assessment between inflow and outflow of cash in relation to the property. For first-time investors, you may not be fully aware of the operating expense. Some of these costs are high, since tenants usually do not take good care of the house, its fixtures and appliances.

This means that ongoing repair and replacement costs are higher and more frequent.

Mortgage payment. The bulk of the outflow or expense is the monthly mortgage payment. This is the most obvious cost. In the event that I am not able to find a tenant to rent out my apartment, I must be able to keep up with both mortgage repayments.

Monthly maintenance fee / conservancy fees / sinking fund. Most condominiums have such fees which can cost up to a few hundred dollars a month. This can add up over time.

Fully / Partially furnished. Units that are furnished naturally fetch a better price, but some tenants have difficult demands. Though most of these are one-off expenditure, there can be ad-hoc expenses for repair due to wear and tear.

The same is also true for fixtures and appliances for the apartment. One must be prepared for such contingency expenditures as they do happen from time to time.

·One-Off Costs.

Agent fee. While this is once-off, whenever tenants change, you end up paying another round of agent fee to look for another tenant. It is good to get expatriates given their deeper pockets, but they can terminate their tenancy whenever their employment changes.

You may incur additional agent fees when you have to look for new tenants. It usually requires only a two-month termination notice. If your tenant stays for three years, you would have effectively “saved” on such fees compared to having tenants who stay for one year at a time.

·Risk of an empty house. When times are uncertain and economic growth is weak, the risk of not having a tenant or having a tenant who pays low rent is very real. When this happens, you must have other sources of income to pay for the shortfall.

Otherwise, you may be faced with an unattractive option of selling the property at a low price or worse, creditors might foreclose the property due to defaults on loans.

In my case, I was cautious. I wanted to make sure that even without a tenant for six months, I would have sufficient savings and income to comfortably service my two mortgages.

This will ensure that I would not run into a tight cashflow situation. Perhaps I have the advantage of being in the financial services profession, and I’m able to assess the risks to ensure that I can manage them before I embarked on buying my choice of home and investing in a property.

I cannot emphasise enough the importance of cashflow considerations in managing personal finance.

Besides, banks giving out loans do take into account the client’s ability to service their loans which, in principle, is an assessment of the client’s cashflow position.

So as the idiom goes, cut your coat according to your cloth.

·Tay is senior vice-president and senior head of UOB’s personal financial services division.

By The Star (by TAY HAN CHONG)

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