Value of a Leasehold vs. Freehold Property (Part 1)
Questions that I commonly get to address regarding leasehold and freehold properties are — What is the value of my Leasehold property? What is the value of a leasehold condominium compared to a freehold condominium? Would there be a significant impact on the value we can get should our condominium be slated for a collective sale? To address these questions more accurately, we need to first understand Bala’s Table.
Who is Bala And What is Bala’s Table?
Back when Singapore was part of the British colony, the British Land Office wanted to work out a way to charge the renting of state land to private entities for long periods. That was when Bala designed a table that served as a guideline for charging state land being leased out. Today, SLA uses this table to determine the value of leasehold land.
Let us begin by understanding how to read this table. Theoretically speaking, if a Freehold land is valued at $100, a fresh 99-year leasehold land would be valued at $96. Since the Singapore Land Authority (SLA) owns almost 90% of state land, this is how a 99-year leasehold land is priced when it is released to the public for bidding. If any developer were to enbloc a 99-year leasehold land, they would have to top up the lease term back to 99 years. Assuming the land has a remaining lease of 50 years. The developer will have to top up from the valuation of $74.70 to $96 before they can redevelop and start selling.
But what is the basis of Bala’s Table and how are these figures even computed? This is where it starts to get a little tricky.
For simplicity, we will use a 2% interest rate (long term yield on government bonds).
Bala’s Table is based on the Net Present Value of the future rent that the land can stand to gain. Assuming that we know the annual rent for the property (D) and that it appreciates at the rate g every year, we can deduce the value of Freehold land. For leasehold land, we need to account for the value of the rent after T years.
How accurate is Bala’s Table?
Considering that Bala invented this table in 1947, it is expected that the percentages is largely based on approximations and interpolations since technology weren’t so advance then. Today, with advancements in technology (and some experimentation), we conclude that a 2.94% discount rate best matches Bala’s Table.
Since Bala’s Table is based on the Net Present Value of the future rent that the land stands to gain, Bala’s Table is accurate as long as the discount rate is 2.94% higher than rental growth. Hence, if we expect property rent to grow by x%, we will need to use a discount rate of (2.94+x)% to deduce a leasehold curve.
Is Bala’s Table the only mean to calculate Leasehold & Freehold value?
Now that we can safely conclude that Bala’s Table uses a 2.94% discount rate higher than rental growth, we wonder whether the discount rate of 2.94% is the most ideal and accurate. In recent years, there has been proposals to increase the discount rate to 3.5% or 6%.
What this means is that an increase in the discount rate increases the value of leasehold properties relative to freehold properties at the initial phase of the lease. Looking at the 6% discount rate, we notice that for the first 40 years (give and take), the value of leasehold properties is identical to that of freehold properties. If that is the case, developers looking to enbloc leasehold land that is less than 40 years old essentially do not need to pay the top-up premium to renew the lease — which simply doesn’t make sense.
Does that mean Bala’s Table is the most accurate representation of Leasehold against Freehold Land?
Considering that Bala came up with this table back in 1947, it is certainly a remarkable attempt. However, in an article published in the Quarterly Journal of Economics in 2015, Giglio, Maggiori and Stroebel used a mixture of private residential transactions in Singapore, England and Wales to deduce long term discount rates. For Singapore, location, age and size of the properties were used as controlling factors for transactions between 1995 to 2013. The results? Leasehold properties with 95–99 years remaining lease were transacted at approximately 88% of freehold properties (compare this to 96% according to Bala’s Table). This led them to a discovery of a 2% discount rate for the leasehold curve.
In hindsight, it does seem that that a brand new leasehold development being priced at 88% of a comparable freehold development resembles how properties in Singapore are priced.
Is this really applicable in Singapore’s context?
After all, Singapore has regulations limiting the use of CPF monies for older leasehold developments and banks in Singapore have bank loan restrictions for these older properties as well.
If you are buying a private property with a remaining lease of less than 60 years, your current age plus your remaining lease must be at least 80 years. You will not be eligible to use any CPF monies for private properties with less than 30 years remaining lease.
Banks will also be less susceptible to lending the higher Loan-To-Value limit if the loan period extends beyond the borrower’s age of 65.
As such, a local real estate consultant, Ku Swee Yong, proposed a Leasehold curve that considers Singapore’s constraints.
With these restrictions in play, we notice that leasehold properties depreciate in value at a faster rate when it reaches the 64 year mark. At this point, it is safe to say that it will be a tall order for the leasehold property to find a suitable buyer.
This first part aims to give you an insight on how the value of leasehold land compares to freehold land and roughly how the top-up premium is determined for developers looking to enbloc leasehold land. It does seem that a 2% discount rate (as with the research conducted by Giglio, Maggiori and Stroebel) is most realistic. Perhaps, we might see a revision on how leasehold land value is determined compared to freehold land, but for now, SLA is still sticking to Bala’s Table.
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!