Building a Passive Income? Annuities VS Property Investment

I’m sure that many of us have always regarded property as a premium investment, much more so in Singapore where it is viewed as a representation of personal success. From the booming property market in the 1980s to the 2000s, it is undeniable that you could have made a fortune through smart property investments.

Due to Singapore’s limited land, property investment has always created investor confidence, further with the state’s pro-home ownership policies to create a sense of belonging, there are always compelling arguments for property investment.

However, as we have already experienced Singapore’s exponential growth to become a global city, it seems that property investments have already started to lose its punch.

Research has also shown that as property prices continue to remain subdued compared to the rest of the world, gross rental yield (not counting taxes, maintenance costs etc.) however, remains poor, standing around 3%. (globalpropertyguide.com)

Looking into property investment, I’m sure we’ve all thought of the same two strategies, rental income and capital appreciation. Of course, for arguments sake, both strategies can be used concurrently and favorable returns are not impossible.

Figure 1
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However, for the purpose of this article, I’m seeking to address how viable property investment is when used for rental income as many of us have dreamed of. Should you be amongst the many that have considered Property Investment at the start, or even as an end goal, I encourage you to read on!

Understanding property as an Investment

First thing to note is that property used for investment is not the property you would be living in yourself. In general, property investment is used to generate either a form of income, or a lump sum profit as mentioned above. But, we’re mainly talking about the use of property for their rental income. This means to rent out your property to a tenant, and they in turn, pay you monthly (in the Singaporean context, mostly to foreigners and expats).

More importantly, we need to understand the costs of property investments, which could actually cause your rental yield to dip down further than expected (aka net yield).

Understanding the cost of Property Investment

1. High Outlay of capital + Incurring debts from Loans

Whenever we think about property investments, the first step always starts off with financing the property through a bank loan (aka Mortgage Loan)

Figure 2
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This high outlay of capital however, typically becomes a milestone that most try to achieve just to acquire that second property for investments. Unfortunately, many don’t see that there are other ways to actually achieve a passive income without such a huge single outlay of capital.

The reality of property investment is that we can’t do this in phases. Unlike other financial instrument or products, property investment is one that doesn’t allow you the flexibility of spreading out your investment.

To put it in perspective, you can’t buy the bathroom first, then the bedroom, then the living room… you have to buy property as a whole.

This brings about another problem that comes with taking a loan; you incur in this case, quite a massive debt. This debt brings about a repayment plan that if you are unable to follow through, can lead to the bank repossessing the property.

As shown above in figure 2, this massive loan includes a repayment with interest. The bank typically gives you an attractive rate (e.g. 1.8% – 1.9%) that may seem worthwhile at the start.

While many have their minds fixated on a fixed-rate mortgage, many also don’t realize that the interest rate for your repayment of the loan is fixed only for the first 2-3 years! After which, the interest rate then fluctuates and it tends to be higher than the initially offered interest rate.

  • A 0.5% difference in Interest Rate on a $450,000 loan = a $2,250 difference!
  • Over the course of the usual 30-year loan repayment period, that amounts to $67,500!

The repayment of this loan alone already starts to dig into the rental income that you get from the tenant.

2. Maintenance Cost + Tax on Income

To add fuel to the fire, there are other costs that need to be considered in any property investment.

As with owning any property, there are always maintenance costs to be considered in ensuring your property is “good for rent”.

This maintenance cost although small in retrospect, carries a risk of biting back when we least expect it. I’ve heard stories of unfavorable tenants that could push up on-going maintenance costs.

Again, another piece of the pie is taken away.

3. Additional Costs to Consider

Firstly, ABSD, is an additional tax that is imposed on the SECOND property bought. This would thus apply mostly to property that is bought with an investment in mind.

It already starts off at a rate of 12% that is tagged to the purchase price or market value of the property. Generally, the more expensive the property, the higher the ABSD. This can erode any potential profits you make from the investment.

Secondly, there is also an income tax on rental income that again, takes a further bite away from your currently beaten down rental income. The same tax rate applies based on your income and again, this can further reduce the return you can receive from renting out the property.

Of course, it is entirely possible that you could get a favorable interest rate, low maintenance costs or even split the cost of investing with a trusted friend or even your Spouse. However, the one thing that this is entirely reliant on is whether or not you find a tenant to supply that rental income.

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Rental income as a whole, scales down to a binary risk in whether you find a tenant or not, aside from every other consideration. Singapore thrives as a global hub, attracting expats and foreigners far and wide. However we can never dismiss the possibility of something like the Corona Virus (Covid-19) that has effectively limited the number of possible tenants coming into Singapore to be candidates for your rental income.

A point I got from the book “Rich Dad, Poor Dad”, talked about property investments in which sometimes we tend to acquire liabilities thinking they are assets. In some property investments, that could have been the case in which although it can be an income generating asset, it may however, costs you more to keep it.

Ultimately, there are tons of costs that have to be factored in when considering the net (actual) rental yield. This is not to say that property investments are horrible, but there are factors that beg the question “is rental income truly the most appropriate source of passive income for YOU?”

What else can you do for a passive Income?

The idea of being a landlord, renting out your property and generating an income stream, can be achieved through other alternatives that takes away the need for a huge amount of capital and the need for a loan.

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Everything we’re about to do with regards to our money, chances are it is with the end goal of achieving that elusive income stream that grants us our financial independence.

Aside from the pains and obstacles as mentioned above, another consideration here would be an Annuity.

What is an annuity?

An annuity is a financial product from insurance companies that targets a singular purpose: Providing the insured with a regular income stream (normally during retirement). Many people thus have the impression that Annuities are purely used for a retirement income. While that is true, there are tons of other uses in which an annuity serves as a passive income.

  • Allowances for children/parents, holiday fund for the end of the year, even paying off insurance premiums

The same argument then should be applied, how financially painful would it be to own an annuity since it gives you an income that outlives you?

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Let’s use the same arguments to pit an annuity against rental income.

1. Is the income stream guaranteed?

Annuities unlike Rental Income, does not face the binary risk of a tenant existing or not. Annuities provide that consistent guaranteed income stream for our lifetime. Yes, till we die.

2. Is there a need for a huge outlay of capital?

As illustrated above, there is of course a premium (investment) paid for such a financial product. As with any investment, a lump sum, one time premium is available. But what makes it affordable and sustainable?
It is the feature that allows for flexibility in premium term. Think about it like the above example, unlike buying property, an annuity figuratively allows you to buy the toilet, then the bedroom, then the kitchen!

The flexibility that is allowed in your annuity removes the need for a huge outlay of capital, and more so, the need for a loan!

This is because of the absence of the need for a FULL purchase at once. An annuity allows you to break up your investment into bite-size digestible bits that doesn’t break your bank account.

3. Tax on passive income?

Generally, annuity payouts are not taxable. To further the argument, when annuities are paid for through SRS for example, it even reduces your taxable income.

These small financial advantages, compounded over time may well add significant returns.

What should you do now?

It should be noted that this article is not saying that property investments are a waste of time. It is entirely possible for you to possibly make a profit and even sustain a good rental income. However, there are, and should be different conditions that should be met when considering investments through property.

As mentioned, there are tons of factors that actually eat into your profits and rental income. One of the biggest considerations would be the loan that you need to take to finance the investment.

Of course if you’re in a fantastic financial position, a loan might not even be needed to go into property investments. Should the repayment of the loan no pose as a potential problem where a tenant existing is crucial, property investment could be justified.

However, assuming not everyone has a few million in the bank waiting for the next investment, we do need to be practical about the investment decisions we make. We don’t want to be caught in the position where we risk such a big investment for a coin flip when you have worked so hard for your money.

If this article manages to speak to you in ways to consider other options, or maybe you’ve been considering investments to build a passive income, download the guide below to explore the different types of annuities that could be customized to better fit your financial situation.

(NOTE: Get our Guide to Building A Passive Income Through Annuities to explore the different types of annuities that could be customized to better fit your financial situation. Get your guide Here)

Article by Leon Lee
Email: leon.lee@gen.com.sg

The writer is a Financial Services Consultant representing GEN Financial Advisory

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Leon Lee
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Bachelor’s Degree in Economics

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2020-06-02T08:03:58+08:00