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Should you choose a freehold or a leasehold condo? Weighing the pros and cons

Which one is better for rental yields? Which one fetches a better price during en bloc? What's better if you're looking to stay for a long time? We compare the two options.

When considering what kind of condo to get, it’s best to start by defining the terms. A freehold property can be held by the owner indefinitely. A 99-year leasehold property reverts back to the state, upon the expiry of its lease. 

Meanwhile, a holdover from the Colonial era are properties with 999 year leases. But this is, for all intents and purposes, similar to freehold.

Note that in any case, there are provisions that allow the government to reclaim the land for vital infrastructure or security purposes. If your house is in the way of a major highway, the fact that it’s freehold is not going to save it. 

There is also the possibility of en bloc redevelopment. If a developer makes an en bloc attempt for your freehold condo, and the other residents agree to it, you’re still going to be moving out.

As a (very loose) rule of thumb, the initial sale price of a freehold unit (new sale) tends to be 10 to 15 per cent higher compared to a leasehold unit in the same area.

Now that’s out of the way, let’s look at the never-ending dispute of prices: Which is worth more, 99 years or freehold?

This question is not easy to answer, as it is difficult to isolate individual causes of property value. For example, a unit with 70 years left on its lease, but is located in the Central Business District (CBD), will probably still be worth more than a freehold unit on the outskirts of Punggol.

Likewise, if a freehold property is situated closer to a MRT station, it can be hard to tell how much of the higher valuation is due its freehold nature, and how much is related to its accessibility.

So it should come as no surprise that, for the past two to three decades, analysts and investors have been arguing about the price effects of leasehold versus freehold. There are a few common conclusions that we can arrive.

1. PRICE DIFFERENCES OCCUR AT THE 21- AND 40- YEAR MARK

As a rule of thumb, a new freehold unit will be priced at about 10 per cent higher than a leasehold counterpart. However, leasehold units tend to show greater depreciation than leasehold properties at 21 years of age, and then 40 years of age. Before that point, it’s even possible that some leasehold properties will depreciate slower than their freehold counterparts.

2. IN THEORY, FREEHOLD FETCHES A BETTER PRICE DURING EN BLOC

The en bloc value of a freehold development should be higher, as the owners are giving up more. A leasehold unit near the end of its lease should be priced lower, since in a few decades the owners could end up getting nothing from it; or so goes the theory.

But if it worked that neatly, we could just compare the en bloc price of a freehold unit and a leasehold unit, and declare “Development X is cheaper because it is leasehold”. In reality, that would be a misleading comparison.

En bloc offers are affected by a range of factors, such as the state of the market, the zoning laws, and the amenities that have been built up. For example, if zoning laws dictate that a freehold development cannot be replaced by a condo of the same height, then the en-bloc price may be lower despite the condo being freehold.

Likewise, it is nearby amenities – such as construction of train stations, malls, and schools – that developers factor into their en bloc bid. If the amenities around a freehold condo don’t improve substantially, that can still translate to a lower en bloc price.

3. LEASEHOLD IS BETTER FOR RENTAL YIELDS

Leasehold units can be better for rental yields, by dint of simple mathematics: The rental yield is the annual rental income, divided by the total cost of the property. Lower cost, higher yield.

Also, bear in mind that rental income is unaffected by whether a condo is freehold or leasehold. A tenant will not pay any less just because a condo is on a 99-year lease.

For example, say you buy a leasehold condo that is S$1 million, and generates S$3,000 a month in rent. This is a rental yield of 3.6 per cent.

Now say you buy a freehold counterpart, in the same area, and it costs 15 per cent more. That’s $1,150,000. Now will your rental income increase? Unlikely, as it does not matter to the tenant whether you have a 99 year leasehold or a freehold. You will probably still get $3,000 in rental income.

The total rental yield is thus 3.1 per cent, making it less attractive to a landlord.

This is one of the reasons landlords like to look for older leasehold properties, which may lead to lower capital to purchase, and higher yields.

4. THE ADVANTAGE OF FREEHOLD IS MORE THEORETICAL THAN PRACTICAL

When it comes to property as an investment, the difference between freehold and leasehold could be the equivalent of navel-gazing. It’s not a dispute that can be settled because most of it is hypothetical, and whatever you come up with, there are a thousand examples in the real world that will prove otherwise.

An investor would do better to focus on the key principles. That is, what are the prices of surrounding properties? What amenities do the URA master plan suggest, and what do the transaction records show? These issues take precedence over whether a unit is freehold or leasehold.

For home owners looking at long-term stay, don’t assume freehold is necessary. Family structures and places change. Family members migrate, children move out, and you may want a change of scene 20 years from now.

There are situations where home buyers opt for freehold, and then end up moving out after 40 years anyway, as the children have left and they want to downgrade. In such a situation, they could have saved considerably more for retirement with a leasehold property.

This article first appeared in 99.co.

Source: CNA/mm

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