What’s the Value of my Leasehold HDB (3)? Dealing with HDB Lease Decay
The Housing and Development Board (HDB) is one of the keystones of Singapore’s success. Since 1960, it has built more than 1.2 million flats and housed more than 80% of the population. While most of us have only seen HDB flat prices rise in our lifetimes, more recently, the concern has been about HDB lease decay. Put differently, this is about how the prices of the 99-year leasehold HDB flats will fall to zero as the lease runs out.
What is HDB Lease Decay?
All HDB flats built have a 99-year or shorter leasehold. Between 1960 and 1990, the HDB built a total of more than 665,000 flats in Singapore. Some of these HDB flats have been sold, at prices higher than they were purchased from the HDB, thanks to the relentless rise in HDB resale prices.
HDB resale price index
But the rapid pace of building in the early years means that over the next 5 years to 2025, there will be more than 665,000 HDB flats aged 35 years or more. n other words, they will have less than 65 years left on their lease. From our analysis here, we can project that HDB flats on a 99-year leasehold may see their values start falling as early as from the 45th year onwards, or when there is 54 years of the lease remaining.
99-year Leasehold Decay assuming 1% growth in Freehold prices
99-year Leasehold Decay assuming 2% growth in Freehold prices
Others have speculated that the value of the HDB flats may decay even faster than what the theoretical models predict. An example of a projected lease decay model is the one by local property expert Ku Swee Yong.
Market forecast of HDB lease decay
Regardless of the model used, the prices of leasehold HDB flats are unlikely to continue rising after about 50 years. And from about 65 years, they will drop sharply towards zero.
Why is HDB Lease Decay a Problem?
You don’t need to be a mathematician to know that 99-year leasehold HDB flats are worth zero after 99 years. And all HDB homeowners know that too. So what is the issue?
The concern arises because the rise in HDB flat prices over the years has outstripped the growth in wages by a long way. The result of this is that the average Singaporean has 50% of his/her net worth on average tied up in the HDB flat. For lower income Singaporeans, this can be as high as 90% of their net worth. As many Singaporeans use their Central Provident Fund (CPF) savings to pay for their flats, much of their retirement savings are also locked up in the HDB flat. Hence, HDB lease decay implies a huge loss of these Singaporean’s savings and retirement funds as the lease runs down.
Using the chart of the market forecast of HDB lease decay as a guide, suppose a couple aged 40 bought a 40-year old HDB flat for $860,000 in 2017 to raise their family. They may continue living in the HDB flat after they retire and the children have grown up and moved away. By the time they pass on, say at the age of 75, or 35 years after the purchase of the HDB flat, the HDB flat might only be worth $300,000! Hence, of the $860,000 they put into the purchase of their HDB flat, $560,000 has been lost through lease decay. And this is just the nominal amount. $860,000 put in fixed deposits at a lowly 2% interest a year will compound to $1,720,000 after 35 years!
So HDB lease decay has a double whammy. Not only are Singaporeans putting a lot of their savings into their HDB flats, which cannot be easily monetised to pay for their expenses in retirement, but the savings put into the HDB flat also dwindles away over time, leaving little for their children to inherit. Hardly the characteristics of a good investment asset!
What can we do about HDB lease decay?
Ever since the Minister for National Development reiterated in Parliament that the Government will not offer the Selective Enbloc Redevelopment Scheme (SERS) to all HDB flat owners, much ink has been spilt on the issue of HDB lease decay.
At one extreme, some have argued that HDB homeowners have known all along that the flats would be returned to the HDB after the 99-year lease is up. Others have argued that the tremendous impact of this on retirement adequacy and social mobility requires a national solution. Some proposals include allowing homeowners to renew their lease after 99-years in return for a “ground rent”. This is much like the practice in the UK and Hong Kong for leasehold properties. Other proposals include mandatory redevelopment of the HDB flats and renewing the lease every 50 years.
Even the Government has felt the need to act, proposing a Voluntary Early Redevelopment Scheme (VERS). The one common thread and potential shortcoming of these schemes is that the State and the taxpayer will foot a large part of the bill, but they still fail to address the problem of what if not every resident in the block or estate agrees to take up these plans? You cannot renew the lease for half the flats in a block, or demolish half a block of flats.
A solution for HDB lease decay
But what is most surprising is that a solution for the problem of HDB lease decay already exists. And it ensures that HDB flat owners don’t lose any of the money they have put into their flats! Too good to be true?
The solution is none other than the HDB’s Lease Buyback Scheme (LBS). Rather than to put down in writing how it works, let me just show HDB’s graphic to explain it.
In short, the 65-year old HDB homeowners can sell the last 35 years of the lease back to the HDB. They also get to live in their own HDB flat for the next 30 years without rent. In the example, assuming that their 34-year old HDB flat is worth $520,00 today, they get a payment of $219,300 plus other bonuses which can amount to $5,000.
Not so fast, you might say. The HDB homeowners are only getting $219,300, which is way below the current valuation of $520,000! Yes, but the sum of $219,300 is paid today, for the sale of the flat in 30 years’ time. And since the money will be first paid into the HDB homeowners’ CPF Retirement Account, which pays interest of 4% to 6%, this means that the amount is really worth $759,000 in 30 years’ time!
Under LBS, HDB buys back your flat in the future at a higher price than what it is today!
How is this possible? Is the HDB knowingly overpaying for old HDB flats, i.e. wasting taxpayers’ money? Well, no. As noted earlier, the Singapore Land Authority (SLA) uses Bala’s Table to determine the value of leasehold property relative to freehold. Using the values in Bala’s Table, and assuming freehold property increases in value at a rate of 2.1% a year (which is the historical average), we see below that a 34-year old HDB flat worth $520,000 will be valued at $759,000 when it is 64-years old.
While we may have our own opinions whether the value assigned to the old HDB flats by the SLA and HDB are accurate, they are entirely consistent with the official valuation of land in Singapore.
But where will the money to pay for all these old HDB flats come from? Nobody knows for sure, but it can come from the Singapore’s Reserves, part of which are accumulated from the Government Land Sales to the HDB for building HDB flats. Since a large part of the price we pay for new HDB flats is for the cost of the land, it is not surprising if the value of the reserves far exceed the purchasing price of the HDB flat under LBS. As an example, suppose a new Built-To-Order (BTO) HDB flat costs $250,000, of which $100,000 is the cost of the land it stands on. Investing $100,000 at a 5% return over 34 years amounts to more than $525,000. So paying the HDB homeowner $219,300 for his/her HDB flat is less than half of this amount.
But isn’t this raiding the Reserves? Actually, no. The Reserves cannot be used for spending or consumption, for sure. However, the Government can use them to acquire an asset, i.e. converting it from financial assets to real estate assets. It is not 100% logical though, since the SLA actually owns the freehold land underlying the 99-year leasehold HDB. So, in effect the Government is buying back something it already owns. But the legal basis is sound.
Why aren’t people jumping on the Lease Buyback Scheme?
This is possibly the most illogical part of all. Ten years after its introduction, only 3,100 households have taken up the Lease Buyback Scheme. Out of around 550,000 eligible HDB flats which are 35 years or older. Perhaps:
- The amount offered by the HDB appears low. (But that is what the power of compounding and discounting is about)
- There are restrictions on how the proceeds can be used. (The proceeds are used to top up CPF Retirement Accounts and enroll in CPF Life)
- Homeowners worry they will live past the age of 95, and will have no place to stay. (Unlikely, but since the HDB needs to utilise the old HDB flats acquired, they can rent it back to you)
- The communication of the benefits of the LBS has been poor
Regardless, much of the agonising over the HDB lease decay issue is unwarranted, as there are already solutions to it.
Can the Government afford the Lease Buyback Scheme?
A final concern may be the total bill to the Government of the Lease Buyback Scheme. Can we really afford it? As discussed above, it is certainly feasible on an individual HDB flat basis.
Suppose over the next 5 years, the owners of 100,000 eligible HDB flats per year sell their flats to the HDB under the LBS, with an average payout of $200,000 per flat. This amounts to $20 billion a year. By comparison, Government expenditure in the 2019 Budget was $22.7 billion.
But this is still small compared to the Reserves which have been accumulated over the years from land sales. However, if there is any doubt about whether the LBS will continue in its present form, then there is all the more reason for HDB homeowners to act fast!
Ever since the revelation that only 5% of all HDB flats undergo SERS, there has been concern about HDB lease decay. Part of this is because HDB, unlike private 99-year leasehold condominiums, cannot undergo an enbloc sale. For private leasehold condominiums, an enbloc sale allows homeowners to exit a lease which is running down. However, part of the concern about HDB lease decay has been due to a lack of understanding about what tools are available to deal with it.
The Lease Buyback Scheme is currently the best, and perhaps only, realistic solution for the issue of HDB lease decay
Unfortunately, the lack of understanding and communication, and possibly also the overly restrictive conditions on the LBS has resulted in this solution being underused. In fact the LBS allows HDB owners much more flexibility in terms of how they can use the cash value of their HDB flat, e.g. for retirement spending, or for a bequest. Perhaps it is time to go back to the HDB to better understand how they can help!