How To Avoid A HDB Negative Sale Scenario
One of the most debated topics in the HDB resale market has got to be CPF accrued interest. Specifically, how using CPF to fund your property purchase can potentially result in a negative sale, where proceeds from your property's sale all go back into your CPF account.
The best cases of these scenarios would leave sellers without any cash proceeds from the sales. In the worst of circumstances, it could mean sellers have to top up the shortage of the amount owed to CPF using their cash savings. If they cannot or choose not to top up, they can apply to CPF to write it off.
They are choosing to write off the profits from the sale of their property! In simpler terms, they are throwing their hard earn money out the window.
Out the Window!
But if we follow some professionals who advise against using CPF monies to fund a property purchase, how then should a young couple in their early 30's or even late 20's pay for their first home?
Personally, I would not be able to afford my HDB flat if it was not for my CPF monies.
Realistically speaking, how many of us have that much cash savings saved aside for property purchase when we were at that age?
The biggest question here will be, how do you avoid a potential negative sales scenario when it comes time for you to sell.
The real problem causing negative sales scenarios in the HDB resale market
The real culprit for the negative sales scenarios is not CPF accrued interest.
The money used for your property is treated by the CPF board as if it never left. CPF accrued interest is the interest it should have accumulated if it is still in the account.
We have to understand that CPF monies are for us to use in our retirement. It is money for our future when we are old.
So who is the real culprit?
Are you ready?
The buyers.
You mean me?
More accurately, their lack of financial knowledge when purchasing their property.
How a lack of financial knowledge causes a negative sale scenario
In more than 80% of the cases, a negative sale scenario happens not at the sale. It occurs at the purchase.
Negative sales scenarios are getting more common these days as young couples eager to get married do not want to wait for the time it takes for a BTO flat to build.
They will then look into the option of buying a resale flat from the resale market. With the amount of grant they are getting, many of them had no problems getting a good-sized HDB flat.
In their considerations when buying their first home, most will consider the size of the flat, the location, the amenities, and whether there is any morning or afternoon sun into the house.
They will then consider what kind of renovation styles they should do and how much they should allocate.
Only a handful of them truly understands that buying a property requires careful financial planning. The majority of the new home buyers does not consider the following:
Are the property's gains in the first 5 years really gains?
The age of the property and its stage of growth
Exit strategy for the property
Looking for a place where you can call home with your partner can be an exciting and emotional process.
Most people are focused on the present and do not consider what happens years later. When they find a place that they feel wonderful about, rationality goes out the window.
While you should feel good about your potential home, you should also feel good about the home's financials.
By simply understanding the 3 points stated above, you would have reduced the potential of a negative sale in the future by 99%.
Understanding the financials of the property
Are the property's gains in the first 5 years really gains?
At its 5th year mark, when a property reaches its MOP and is up for sale, sellers usually see a massive gain from the price that they paid for it.
However, many people mistook the huge profits from the first 5 years and thought that their property would continue to grow at a rate of 6-10% per year.
In truth, the gains from the first 5 years are not a genuine appreciation of the property. It is simply the property's actual value given by the market. The price difference from what we paid for is the government's subsidy amount when we first purchased it.
That is why it is called subsidised housing in the first place.
That would mean that the actual appreciation of a HDB flat starts from its MOP year.
CPF accrued interest is compounded based on the amount used for the property. The longer you hold on to it, the more CPF would have been used for it, increasing the amount of CPF accrued interest at an alarming rate.
It is the main reason why most HDB owners see their cash proceeds dwindle the longer they hold on to their HDB after MOP. The actual growth is simply not enough to cover the gains required to offset the CPF accrued interest.
Therefore, cash proceeds are needed to compensate for the shortage.
As long as you understand this, you will know that the accrued interest will creep up onto the cash proceeds a lot faster than you think, especially if you have used a significant CPF sum to fund your purchase.
Age of the property and its stage of growth
All HDB flats fall into the general growth cycle. Their growth years are usually between the 5th to 20th year, peaking around the 10th - 15th year.
During the growth years, you can expect a steady appreciation of your property.
After that, growth slows, and the stagnation stage begins. This stage begins after the property hits the 20th year mark. Growth will slow to less than 1% per annum as the property ages.
After the 30th year mark, the property starts its steady decline.
Let's take, for example, a young couple who bought a 20-year-old resale HDB as their first home. The purchase price is $460,000 for a typical 5 room HDB in a non-mature estate.
They placed $150,000 CPF as a deposit on a HDB loan, which they can afford with the CPF housing grant that they are receiving. Their monthly mortgage works out to be $1,406, paid entirely using their CPF accounts.
In this instance, their CPF accrued interest will be base on $150,000 plus $1,406 x 12, $16,782, which works out to be $4171.80 for the first year.
That would work out to be 0.9% of the property's value. While accrued interest is effectively 0.9%, growth is only a meagre 0.57%.
In this scenario, this couple would essentially be having a negative sale from the first year of ownership! And they would still need to hold on to the property for another 4 years before they could sell it!
Exit Strategy for The Property
Are you going to stay in this property for the rest of your life, or would you intend to upgrade 5-10 years down the road?
Different goals require different planning and exit strategies for your property.
If your goal is to sell off right after MOP and possibly fund your upgrade to private property, it is vital to be in a property that will potentially give you the proceeds, in cash and CPF, to fund the purchase.
If you require cash proceeds from the sale to fund the next purchase, the timing of the sale is even more critical to avoid funds being channelled back into your CPF via accrued interest.
Start by projecting your payments 5 years into the future and extending your property's current growth rate by the same period.
Take into account the CPF accrued interest and find out how much cash proceeds you will have at the time of sale. As private properties require a minimum of 5% cash, it is good to know that your current property will have the ability to contribute to that.
The True Value of Using CPF to Fund Your Property
With all that's said, we have to remember that CPF monies are still our money! It is money that we can use to fund our next property purchase.
The true value of our CPF money is its ability to allow us to tap into otherwise untouchable funds for our retirement while enabling us to build our cash reserves.
A prepared investor will know to build his cash savings from his income source in preparation for the next property purchase. It will not matter if the proceeds are CPF proceeds or cash proceeds, as he knows that these proceeds go into the next property purchase.
He is clear about his financial goals, and he understands how the property fits into the overall plan.
He can concentrate on finding the best property that gives the best returns instead of fretting whether he has cash proceeds from selling his property.
Conclusion
A negative sale scenario happens at the purchase, not at the sale of the property.
In the case of a HDB or a leasehold private property, prices are unlikely to go up after it reaches a certain age.
Before you commit to buying your first home or your next home, consider the finances and not make a move based purely on your emotions. This will potentially make the difference between a wealth-generating decision or a big setback to your financial goals.
Take the time to consider the 3 factors stated above and see how your next property purchase fits into your overall financial plans.