10 Oct Difference Between ROE and ROA for Property Investments
When it comes to property investments, one of the first things you have to understand is the difference between ROA (Returns on Assets) and ROE (Returns on Equity). That’s because property investments allow you to borrow money from the bank which increases your returns dramatically.
Often, when we hear about investors talking about Singapore properties’ rental returns such as 3%, 4% rental yield, what they are referring to is the ROA. Return on Assets basically takes into account the value of the property rather than the cash you actually put in.
Sam bought a $2m condominium which gives him a monthly rental of $6K. The formula (Rental x 12 months / $2,000,000) shows us an rental return of 3.6% annually.
Today, banks pay less than 1% per year on savings deposits. Longer term fixed deposits pay 1.5%. Properties in M’sia and Philippines may pay rental yields of 5-8% but they come with risks and more work in managing the leases. Thus, investors may say that Singapore properties are less attractive today. Is that true?
Well, yes and no. With prices climbing throughout the past 4 years, it is without a doubt that yields will be compressed. Any market in the world has similar patterns. When prices increase, yields drop. That is simple economics.
However, take a look at the bigger (Or Actual) picture – which is ROE.
Return On Equity for properties are extremely attractive and more accurately paint a picture of your returns.
Sam buys a $2m condominium as an investment with 20% downpayment and 80% bank loan. His actual cash downpayment is only $400k while the bank lends him $1.6m (OPM – Other people’s money).
With a monthly rental of $6k, he is in fact getting a rental return on equity of 18%! ($6,000 x 12 / $400,000). There is no other investment vehicle that can give you this extent of leverage, yield, loan tenure and the flexibility of enjoying the condominium facilities at the same time! Only a physical property can.
If we nett off the expenses that come with owning the property ($400/mth maintenance fees, $600/mth property tax, Commission $250/mth, Misc repairs, $100/mth), the nett rental return on equity after expenses is still 13.95%!
Of course, there are costs associate with loan as well. Based on 1% interest, monthly interest costs is roughly $1,300, based on 2% interest, monthly cost is roughly $2,600. Since the loan is amortizing in nature, the interest costs do go down over time. Based on returns after interests, it will be approximately 10% for 1% interest and 6% for 2% interest net yield, which is still decent.
Yes, there is no doubt that Singapore’s market is at an all-time historical high! However, there are still undervalued condos out there that have not appreciated as much as the market and still provide great Returns on Equity! If the client keeps his funds in the bank, inflation at 4% an annum is eroding his savings. Even if he were to invest in equities/derivatives/Gold etc.. banks will NOT give loans of up to 80% or 30 years repayment periods at 1+% interest rates.
It is impossible to find such support with other investment vehicles! If one were to invest abroad, it will still be difficult to get such favorable loan repayment/interest rates/loan to value limits!
Opportunities are still present for those who know how to fully grasp and apply the concept of Wealth Creation through Property Investments for themselves.
Do not assume that just because the Singapore market cycle is at its peak, there are no undervalued buys out there. Savvy investors know that they need to be on a constant lookout to make their money work harder for them and property investments will still be the safest bet out there.