Value of a Freehold vs. Leasehold Property (Part 2) Which is better?

In Part 1, we attempted to break down how the value of a leasehold property is calculated relative to a comparable freehold one. In short, Singapore Land Authority (SLA) uses Bala’s Table to determine the value of a leasehold land. However, a study by Giglio, Maggiori and Stroebel in 2015 discovered a more robust leasehold curve (based on actual transactions) that more accurately depicts the difference in value between a leasehold and freehold property.

Now that we have got the technicalities out of the way, let’s start addressing the age-old question on whether Freehold or Leasehold is better.

Will the Value of my Leasehold Property Drop to Zero Eventually?

In short, yes. According to Bala’s Table, the value of a leasehold property is relative to that of a freehold property. Suppose the value of a freehold property remains unchanged, a comparative leasehold property will start depreciating in value almost immediately and eventually hit zero at the end of the lease term.

However, realistically speaking, the value of properties in Singapore increases with demand. Demand for property and rental acts as a catalyst for property growth. Suppose demand increases by 2% yearly, the value of freehold properties will also increase by 2% per annum. Since leasehold properties are a fraction of the value of freehold properties, its value will also increase.

Price of Leasehold if Freehold rises by 2% per annum

Freehold properties are always priced at a premium as compared to leasehold properties. In the beginning, the value of freehold and leasehold properties will both rise, although not in tandem. Eventually, the value of leasehold properties will start to experience a dip — also known as the lease decay.

Hence, the peak for leasehold properties in general occurs between 65 to 72 years into the lease if property prices grows at a rate of 2% per annum. But what if property prices does not grow at a rate of 2% per annum?

Price of Leasehold if Freehold rises by 1% per annum

To be more conservative, we impose a property growth of 1% per annum and find that prices of leasehold properties peak between 45–62 years into the lease. These results, in theory, serves as a guide as to why prices for leasehold properties continue to increase even though its lease is decreasing.

Bearing in mind that in Singapore’s context, with restrictions on loan amount and CPF usage for older properties, the lease decay for older properties can be much faster.

For CPF Usage:

1. your age plus the remaining lease of the property must be at least 80 years at the time of purchase.
2. if the property is less than 30 years at the time of purchase, no CPF can be usable.

For Bank Loans:

1. lower LTV limit applies if the loan period extends beyond the borrower’s age of 65 years.

Based on this, an individual looking to buy a private property must be at least 35 years old to obtain the full 75% loan amount and the property must have at least 45 years remaining to utilize their CPF savings.

How Fair is Leasehold Prices as Compared to Freehold Prices: A Look at Real Data

Bala’s Table vs. GMS Leasehold Curve

Looking at both Bala’s Table and GMS Leasehold curve, the GMS curve is derived from past transactions from 1995–2013 and hence, captures buyer‘s sentiments more accurately. For this reason, we will use the GMS curve to determine the prices of leasehold land as a percentage of freehold land.

According to the GMS curve,

1. leasehold properties that are 10-years-old should be priced at 86% of a comparable freehold property; and
2. leasehold properties that are 20-years-old should be priced at 82% of a comparable freehold property

For our first case study, we will look at the Tanjong Rhu area which has a good mix of both 99-year leasehold and freehold properties.

Tanjong Ria (LH), Casuarina Cove (LH), Parkshore (FH)

Tanjong Ria — 99 years from 1993; Average $psf = $1263psf

Casuarina Cove — 99 years from 1993; Average $psf = $1365 psf

Parkshore — completed in 1995; Average $psf = $1690 psf

As per the date of writing this article, the most recent 6 transactions reflects a 19-25% discount for leasehold projects — which is in accordance to GMS curve.

For our second case study, we analyse the Bayshore area.

The Bayshore (LH), Landbay Condominium(FH)

The Bayshore — 99 years from 1993; Average $psf = $1119psf

Landbay Condominium — completed in 1996; Average $psf = $1448psf

As per the date of writing this article, the most recent 6 transactions reflects a 22.7% discount for leasehold projects — which is in accordance to GMS curve.

Conclusion

The 2 case studies further strengthens our conclusion that the GMS leasehold curve is a good enough model to compare leasehold prices against freehold prices. Most investors would be of the notion that freehold is better than leasehold simply because of the lease decay for leasehold properties.

Now that we know that leasehold properties appreciate in value together with freehold properties, it is worth noting that leasehold properties make good investment options as well. That being said, more analysis and due diligence is required for leasehold properties since we need to be wary of the lease decay that can potentially affect our exit strategy and profit margin.

As a rule of thumb, the lease decay for leasehold properties is more pertinent once it is 45–60 years into the lease.

I hope this article serves purposeful in helping you make a more well-informed decision, regardless of whether you’re purchasing a property for own-stay or investment. As always, feel free to share your opinion in the comment section and I will take time to address them when I can. Till next time!