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CONDITIONS back in 2011 could not have been better for developers of industrial space. The fever took hold as investors piled into the non-residential property sector after many rounds of government cooling measures imposed on the residential market.
Some of the changes in policies during this period include an increase in the seller's stamp duty (SSD) in January 2011 and the introduction of additional buyer's stamp duty (ABSD) in December 2011.
Yet, the good times did not last long. The cooling Chinese economy coupled with the nearly muted year-end manufacturing activity at home are weighing on the Singapore industrial property market, prompting both industrialists and investors to tweak their competitive strategies.
Against such a backdrop of slower growth and weaker sentiment, many have debated the issue of whether to invest in 30-year, 60-year leasehold or freehold industrial properties.
Among industrial properties with different remaining tenures, 30-year leaseholds have been hit the hardest. The price index of sites with 30-year leases and below started to fall in Q2 2015, dropping from 108.2 in Q1 2015 to 105.6 in Q2 2015. This translates into a 2.4 per cent quarter-on-quarter contraction.
Since then, the price has slipped continuously. Up to Q4 2015, the cumulative drop was at an all-time high of 9.9 per cent. This is the highest level of total contraction recorded since the time series started in Q1 2010.
The situation was slightly better for industrial properties whose remaining tenure is between 31 and 60 years. Although the price index also suffered quarters of consecutive decline, the rate of contraction was relatively mild. As at Q4 2015, the cumulative decrease of the price index was only 2.2 per cent.
Meanwhile, leasehold industrial properties with 60-year leases and above fared the best. The price index held up its momentum despite market uncertainties and low investor sentiment. Even though the index dropped slightly in Q4 2015 by 1.1 per cent quarter on quarter, this was after having gained 3.1 per cent over the past three quarters.
Yields of 30-year leasehold properties outperformed
Data based on industrial properties that are marketed by SLP Business Space reflects the clear division in terms of yields among properties with different remaining tenures.
The minimum rental yield is calculated by taking the minimum monthly rent divided by the maximum price that investors have to pay to acquire the property. Similarly, the maximum rental yield is equal to the maximum monthly rent divided by the minimum asking price.
At first glance, 30-year leasehold industrial space appears to beat their 60-year leasehold and freehold counterparts hands down. Both new and old 30-year leasehold properties yield much higher rental returns, fluctuating between 4.15 per cent and 9.77 per cent for newer space and between 4.39 per cent and 9.38 per cent for relatively more mature estates. This is partly caused by the discounted price of such properties compared to similar freehold space.
Therefore, the empirical evidence seems to support the hypothesis that 30-year leasehold industrial space is a much better bargain than freeholds or 60-year leaseholds.
However, it should be noted that for every investment, there are two aspects of returns, namely the return of capital and the return on capital. Return on capital is the amount of income generated from the initial investment. This indicates how efficiently the capital is being utilised. Hence, from this perspective, a 30-year leasehold does indeed outperform its counterparts.
The return of capital is the time it takes for an investor to recoup the original financial outlay over the life of the project. Since a leasehold property has a limited lifespan, it is theoretically expected that the return of capital for a leasehold site should be greater than that of a comparable freehold estate.
The premium return for a leasehold, which refers to the excess yield of a leasehold over that of a freehold, is to compensate for the decaying nature of these properties.
Nevertheless, given the market turmoil and declining investor confidence, it is understandable why many investors are jumping on the shorter leasehold bandwagon. After all, such properties promise higher immediate returns, which are preferred to the delayed future returns and inherent uncertainties associated with longer leaseholds amid current market conditions.
Why invest in longer leasehold industrial space?
It is noted that many people are still attracted to longer leasehold industrial properties despite the relatively lower returns. The reasons revolve around concepts of ownership and inheritability. For freehold properties, investors may view it not as an investment opportunity but an asset to be passed down to the next generation.
That being the case, this group of investors are less sensitive to the market conditions or the current offering returns and hence, more willing to forgo the aforementioned yield premiums in return for longevity and ownership.
In conclusion, the argument over which industrial properties are superior should not focus only on the nature of remaining tenures.
Each type of leasehold has its own advantages and drawbacks as presented.
Instead, investors should focus on what they are looking for from the investment - be it immediate cash flow, stable income or ownership.
At the same time, it is equally important to keep in mind the impact of other factors that can also play a significant role in influencing the rate of return.
These include potential changes in government policies, land zonings, opening of new MRT stations and other non-tenure factors.
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