I was always curious about whether it make sense to downgrade to smaller flat, a same size flat in another location or apply for a BTO flat.

I guess I was triggered by **Kevin @ Turtle Investor** talking about his first pot of gold, where if he sells his HDB flat in Punggol, he could net a conservative cash in flow of $161,000. **Frugal Daddy** at his blog also talked about how downgrading to a 3 room flat from his 4 room flat, or getting a 4 room BTO flat could allow a swifter route to financial independence.

I just like the different perspectives this small financial space is able to drum out.

What I would like to find out is roughly how much we could stand to gain** if we were to sell one HDB flat and downgrade to a smaller flat**.

Is it worth the hassle at all? How high of a value do we consider high value?

Today we will run though some of these numbers and see everyone thinks this is a good idea.

### What we want to find out

Let us be clear about what I am investigating today.

I can be exhaustive and look at this from a lot of angles but I am not going to do that. I will also explain why I decide to narrow down to these parameters.

Here are some of our constrains:

- If there are
**benefits from selling a good value HDB flat**and purchasing**another resale HDB flat** - The family would need a place to stay, and they won’t be staying with siblings or parents
- We will also investigate whether
**there is a difference paying off the second flat in full, or taking a 50% and 80% mortgage** - There will not be any discussion on whether we are using CPF or using our liquid net worth. We will be looking at our CPF and liquid net worth as a whole
- There will be no discussion on upgrading instead of downgrading
- This decision is taken after the mandatory 5 years MOP (minimum occupation period)
- The areas of downgrading will be some of the relatively cheaper areas in Singapore
- There will be
**an outstanding mortgage**on the HDB flat we are selling - HDB Loans at 25 years tenure are used
- We assume the net cash in flow from selling can be invested in wealth machines at 4% or 5% rate of return

#### Why downgrade their place?

Different people downgrade for different reasons.

Some downgrade because circumstances such as when family faced **financial difficulties**, in servicing mortgage, or that they got into heavy debt and have loan shark chasing them.

Like what Frugal Daddy think, we can also see folks in their mid 40s exploring whether monetizing the HDB flat would** increase their speed towards financial independence**.

There will be a large group that would like to sell a high value flat and take a second bite of the subsidized BTO, so that **the value of the high value HDB flat can pay off the BTO flat fully**.

Indeed, even if we are not talking about BTO but buying a smaller resale flat, many would think the price appreciation of the first HDB flat will pay off the second HDB flat in full.

#### The unique thing about your home as an ‘investment’

Many considered their HDB as an investment, and took the route of upgrading the place they live, to another HDB or a condominium.

The difference between your dwelling as an investment compared to other things is that when you liquidate this ‘investment asset’ you will need to find another dwelling because you need a roof over your head.

This is not like buying a $250,000 corporate bond where you can roll into a portfolio of exchange trade funds (ETF) and not worried about having no place to live.

#### “How much you make” needs to be view differently

You find out how much you make by taking the current value minus

- the mortgage outstanding at the time of sale,
- the down payment paid,
- the closing costs of the HDB flat when purchase,
- the renovation,
- the interest expense paid over the length of stay
- and any more maintenance expense on the home.

What you get is the cash equity.

Due to the many items above, your cash equity left might be smaller than you think.

Unfortunately, in this comparison, you **always need to find a place to stay**.

Your current HDB flat appreciate in price. The **place you move into in this period of time also appreciate in price**.

#### CPF will be used to fund the second home purchase

My assumption is that there is no difference whether you are getting in cash or CPF, such as what Kevin at Turtle Investor alludes to.

This is because more so than likely, after the sale, those amount you have used by CPF to pay the principal and interest as well as the accrual interest that this amount can earned will be used to pay off the new resale flat as much as possible.

There will be differences, if you decide not to do that, and decide to use cash to pay for the new resale.

In that case, you may not be able to put all your CPF money into wealth machines that earn you a rate of return of 4% or 5%.

#### The Net Equity Cash you get needs to be Invested

The purpose we are doing a downgrade in HDB flat **is to free up cash flow**. This cash flow needs to be invested for capital appreciation or cash flow. Either way, there is a rate of return tied to it.

Of course, a family could have other purpose, such as using the cash for some emergency, donation or to pay off some debt.

But if you are thinking of living off the net cash without it being invested, you need to think clearly if it will last as long as you need it.

#### Defining the value of the home to be sold

We assume 2 different value. The first one is **$750,000** and the second i**s $550,000**.

I use $750,000 as a prevalent figure of some HDB flats in good location that can fetch around that price. We do know that areas like Toa Payoh, Bukit Merah and Duxton fetch much higher than that.

In any case, if your flat value is more than that, it means you have slightly $100,000 or $150,000 more in cash equity after deducting all the closing costs.

The second figure of $550,000 is a step down but still offer enough premium if your BTO purchase is cheaper as the area you stayed at is not well located. $550,000 is a figure some would consider selling to monetize $200,000.

#### The value of the resale flats that are available to purchase

After selling, the family can choose to buy a resale 5 room, 4 room or 3 room flat.

If we assume that the profile of the adults in the family to be in their 40s, they would still require a particular size of home so that quality of life is not downgraded too badly. This will eliminate 2 Room Flexi from this equation.

I manage to ask my friends on some of the ‘slums’ and ‘shanty towns’ of Singapore and we have the list above, with the latest transacted resale value of different specification of HDB flat.

We will use the average figures for each category of HDB specification.

### How much does Selling a $750,000 HDB Flat Net you?

To obtain how much cash equity we have left from selling the flat, we have to deduct the outstanding mortgage loan on existing flat, in this case it is $100,000.

Then we need to deduct the closing costs for selling the HDB. Typical commission for the agent fees to selling a home come up to 2% of the home value.

The cash equity left after all the costs is $635,000.

We then would need to purchase a resale flat.

We will simulate three options to purchase the resale flat:

- Attempting to pay without a mortgage. This is what many would find ideal
- Purchasing with a 50% down payment
- Purchasing with a 80% down payment

#### Buying a Resale Flat Fully paid in Cash

The table below lists:

- the average cost of each 5 room, 4 room and 3 room that can be purchase more cheaper in Singapore
- the closing costs of buying the resale unit
- how much down payment is put in and the mortgage amount
- the cash out flow at the start from this purchase
- the net cash equity left from #1 that we can utilize as our cash flow

Some how the total closing costs for different sizes comes close to 10% of the value of the HDB flat purchased. Our mileage may vary due to the level of renovation we do.

While we have a net cash equity of $635,000 at the start, purchasing different size of property would left us with $163,000, $251,000, and $328,000.

No surprise that if you downgrade to the smallest HDB size, your net cash equity left is the highest.

Since we are trying to pay with cash, there is zero mortgage amount.

The table below focus on:

- Annual Mortgage Payment for Servicing the Mortgage of the Home
- Annual Cash In Flow from investing at different rate of return
- Annual Free Cash Flow after deducting the Annual Mortgage Payment

In this simulation, we fully pay off all the homes, and thus there are no annual mortgage payment in #4.

If you are able to invest the net cash equity of $163k, $251k and $328k at 4% rate of return, your Annual Cash Inflow is $6.5k, $10k, and $13k respectively. If the rate of return is 5%, your Annual Cash In Flow gets bumped up to $8.1k, $12.5k, $16.4k.

Because we do not have mortgage payments annually, the Free Cash Flow is the same as the Cash In Flow.

Here we see that downgrading to a cheaper area with a 4 room and 3 room, could provide $800/mth to $1,300/mth. This is almost similar to a **CPF Life annuity payout if you pledge the full retirement sum**.

If Frugal Daddy have a similar situation, and I know he has worked out his expenses,

This situation left him:

- with no more mortgage payment
- a free cash flow to pay for a sizable of his survival expenses (what is survival expense?)
- possibly a lower appreciating asset

#### Buying a Resale Flat Taking a 50% Mortgage

In this simulation, the parameters are the same as previous, except:

- The down payment is 50%
- There is a mortgage

Because there is less down payment, the Cash Equity left after paying for the costs and down payment is more than previous.

This sum in itself looks rather useful.

In the table above we have an annual mortgage payment #4.

If you are able to invest the net cash equity of $378k, $426k and $468k at 4% rate of return, your Annual Cash Inflow is $15.1k, $17k, and $18.7k respectively. If the rate of return is 5%, your Annual Cash In Flow gets bumped up to $18.9k, $21.3k, $23.4k.

However, we will have to deduct the annual mortgage.

The Monthly Free Cash Flow after the Mortgage Payment works out to be between $600/mth to $1,300/mth for a downgrade to 4 room and 3 room.

The Monthly Free Cash Flow is much smaller for a downgrade to 5 room in another area of Singapore.

This situation left the family with a similar situation to the previous scenario **except that there is a mortgage payment, which is fully covered by the cash flow, provided the family invests well**.

#### Buying a Resale Flat Taking a 80% Mortgage

How would the situation differ if a bigger mortgage is taken?

Your #2 Cash Out Flow will be much smaller, leaving you with a bigger amount (#3) to be invested.

As we put a smaller down payment, our Annual Mortgage Payment is much larger, betweek $12k to $18k.

If you are able to invest the net cash equity of $507k, $531k and $552k at 4% rate of return, your Annual Cash Inflow is $20.2k, $21.25k, and $22k respectively. If the rate of return is 5%, your Annual Cash In Flow gets bumped up to $25.3k, $26.5k, $27.62k.

After deducting the annual mortgage, the free cash flow left (#6) for 3 room and 4 room is between $500/mth to $1,285/mth.

We see a similar pattern. **No matter** whether we make a **big down payment or a smaller one , no paying in cash**, the cash flow for different HDB size, **in the grand scheme of things do not deviate much**.

#### Summary

Here is the summary if your home value is $750,000:

The conclusion we get from going through these 3 simulations of selling and buying a resale flat is that there are definitely some cash flow advantages if you have a high value HDB flat and downgrading.

The bigger the downgrade the bigger the annual free cash flow.

The free cash flow is greater without mortgage, but if you would like a lump sum, perhaps to purchase more property assets after this HDB purchase, you might need to take on more mortgage.

### How much does Selling a $550,000 HDB Flat Net you?

We repeat the 3 simulation as before, only this time, we reduced the value of the HDB flat we are selling from $750,000 to $550,000.

Not everyone can have a luxury to own a HDB flat worth $750,000.

So if you owned one that is $550,000 does it make sense to downgrade?

To obtain how much cash equity we have left from selling the flat, we have to deduct the outstanding mortgage loan on existing flat, in this case it is $100,000.

Then we need to deduct the closing costs for selling the HDB. Typical commission for the agent fees to selling a home come up to 2% of the home value.

The cash equity left after all the costs is $439,000.

#### Buying a Resale Flat Fully paid in Cash

The table below lists:

- the average cost of each 5 room, 4 room and 3 room that can be purchase more cheaper in Singapore
- the closing costs of buying the resale unit
- how much down payment is put in and the mortgage amount
- the cash out flow at the start from this purchase
- the net cash equity left from #1 that we can utilize as our cash flow

One very **distinct difference** we observe here is that, with the $200,000 reduction in value of the home we sold, if we move to the average cheap 5 room HDB flat, we would **need to fork out an additional of $32,800 for the geographical arbitrage**.

The #3 Cash Equity Left for **4 room flat** is also** much much smaller at $55,300** versus $251,300 in the $750,000 simulation. It makes you wonder if doing this downgrade makes any sense.

In the case of 3 room, some would feel the $132,400 freed up is still worth the trouble.

There will be no additional cash flow for the 5 room flat ‘down grade’. This is really a lifestyle downgrade.

In the case of 4 room flat, the Monthly Free Cash Flow is $184/mth if the rate of return is 4% and $230/mth if the rate of return is 5%. Perhaps, working harder to gain a $300/mth increment might be less of a hassle.

In the case of the 3 room flat, the Monthly Free Cash Flow is larger at $441/mth and $551/mth.

In the case of both 3 room and 4 room flat, it should be noted that **while free cash flow is small**, but the family **eliminated the $100,000 in outstanding mortgage of the first flat**.

#### Buying a Resale Flat Taking a 50% Mortgage

If the family takes a 50% mortgage, the distinct difference lies with a downgrade to the 4 room flat. The annual and monthly free cash flow is smaller than that of not taking any mortgage, from what we learned in the $750,000 simulation.

With less cash flow, if the rate of return of the net cash equity (#3) is lower, say 4%, the free cash flow is negative. If its 5%, the free cash flow is positive ($1988/yr or $165.67/mth)

#### Buying a Resale Flat Taking a 80% Mortgage

We see a similar trend when we bumped the mortgage to 80%.

#### Summary

Here is the summary if your home value is $550,000:

By observing the summary, one conclusion is that this helps the family eliminate the $100,000 in outstanding mortgage.

If you are downgrading to 5 room it may not be worth the hassle. It may make sense for a **downgrade to 4 room, if you can achieve a higher rate of return**.

A downgrade to 3 room looks the most viable. However, be prepared that the $132,400 equity cash may not generate a high free cash flow for you to use, perhaps only offset some of your small expenses.

### Getting more Equity Cash with a BTO Application?

What is on some of your mind is what if its not a resale purchase but a BTO purchase.

Here are some of the recent prices of new BTO without grants:

Compare then against the average of $430,000. $350,000 and $280,000 for 5 room, 4 room and 3 room flats.

Applying for the BTO is at least** $110,000 cheaper** on average.

However, do note that you may need to pay a resale levy:

The amount of levy is as follows:

- 5 room: $45,000
- 4 room: $40,000
- 3 room: $30,000

This would reduce your additional cash flow should you choose the BTO route to:

- 5 room: $65,000
- 4 room: $70,000
- 3 room: $80,000

It looks like 3 room and 4 room BTO can still be worth it. You would have to bear with waiting for your flat again.

### Downgrade and then Purchase another Investment Condo

One alternative that you might be considering is that, can I downgrade to a 3 room HDB flat, free up ample net cash equity, and then purchase an investment property?

I think it is possible, but the rules are no different from my simulation of investing the net cash equity at 4% and 5% rate of return.

You are expecting your investment property to grow at this rate of return if not more than these rates.

Suppose you are targeting a 2 BR Condo for $1 million, and would like to sell your HDB valued at $750,000 for a 3 room HDB and then purchase this 2 BR condo. If you fully paid up for your 3 room HDB, you would need to down pay at least 20% of the condo price, which is $200,000. You will also need to pay Buyer’s stamp duty and additional buyer’s stamp duty of 7%, since this condo will be your second property. These stamp duty would set you back another $94,000.

Your net cash equity of $328,400 is enough to pay for the downpayment and closing costs.

Since most Singapore properties after expenses and mortgage payments are negative in terms of cash on cash returns, this means that you likely need to top up the shortfall in monthly cash flow from your annual household disposable income.

In this case, since you are not getting any cash flow from renting out your 2 BR, what you are looking for are capital appreciation over time.

It might make sense to buy a condo to live in and wait for it to appreciation, rather than purchase a HDB and a condo.

### Conclusion

Downgrading from one flat to another with a certain objective is not an easy decision. However, through my simulation I was able to draw some conclusions:

- The bigger the downgrade, the more net cash equity you will be able to free up
- In general, the free cash flow generated is higher by taking no mortgage than taking mortgage
- Downgrading to a smaller flat allows the family to enjoy greater government subsidies
- While 4 room HDB flat gives you the flexibility to rent out 2 rooms instead of 1 versus 3 room HDB flat, the rental you gain from the additional room ($6000) may or may not offset the lower free cash flow of a 4 room HDB flat. This would depend on the location and popularity of the new HDB flat you purchase
- If your home value is not having an exceptional premium, and are closer to the average, factoring the closing cost, the free cash flow generated might not be worth the trouble
- What may be of note is that a downgrade would eliminate mortgage payment, or reduce it, freeing up cash flow from your disposable income at work

What do you guys think? Did I missed out any crucial numbers or factors I did not considered?

Have you guys carried out such a shift and would you like to share your experience?

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TZL

Wednesday 17th of August 2016

Hi Kyith, if the Rate of Return of Wealth Machine (4%) > HDB mortgage interest rate (2.6%), I do not understand why the free cash flow generated is higher by taking no mortgage than taking mortgage.

Does that mean, as a first time home owner I should pay off my downpayment as much as possible with my excess cash?

I always hold the understanding that it's better to hold a long loan tenure (minimal loan mortgage to pay) and invest the rest in own Wealth Machine (Rate of Return of 4% or higher).

Kyith

Thursday 18th of August 2016

hi TZL, i held the same idea before this, which is why i did the simulation with 2 different mortgage. the result is a bit of a surprise. but do note there is some difference. this is not an apple to apple comparison. the mortgage payment is also partly an accumulation of equity, so its not a total loss. it is a loss because you need a place to live and its not possible to forgo this equity ever, unless you live with your parents. if you look at my workings,i dont think its wrong. you get more initial cash flow but you have to pay off your mortgage. Also part of the deduction in cash flow is also your principal payment. its not exactly interest only.frankly i hope someone points out that i may be wrong

AL

Monday 15th of August 2016

Hi,

For the portion on funding the downgrade with 100/50/20% of downpayment, perhaps you can include the calculation of CPF monies, as that is also part of the portfolio when the silver years arrive.

I did a calculation using the current allocation, contribution and interest rates and found that making 100% payment for my upcoming BTO would leave me with more CPF to withdraw at age 65 than had i made a 20% or 50% downpayment. i guess having max monthly contribution to the OA draws more interest than having a larger principal but zero monthly contribution.

Kyith

Monday 15th of August 2016

hi, i am taking it that cash and cpf are the same, that whether we use cpf or cash it is the same.

Frugal Daddy

Monday 15th of August 2016

Hi Kyith

Thanks for the research!

Like what SI memtioned, lease affects the value. Especially for those 30 years left because of the loan you can take. Buying bto involved a lot of luck factors, like it or not. Time can increase your luck factors but still limiting due to forever uncleared waiting list (don't know from where). Getting a high value flat at undervalued flat is like finding undervalued small cap equity during a red hot ipo with tiny public offering.

150k to 200k in bank is a better choice than everyday experience, if you love your first flat that much?

Residential flat is hardly an investment. I hope most people understand. Unless yours is like duxton bought at 400k n sold at 1m. Congratulations.

Kyith

Monday 15th of August 2016

Hi Frugal Daddy,

> Time can increase your luck factors but still limiting due to forever uncleared waiting list (don’t know from where). Getting a high value flat at undervalued flat is like finding undervalued small cap equity during a red hot ipo with tiny public offering.

This is true, and a lot told me they should have waited for the high value BTO

> 150k to 200k in bank is a better choice than everyday experience, if you love your first flat that much?

I wonder if this is a question. Sometimes the feeling is important, because without feeling attached to a place, perhaps we are out of touch with the idea of feeling things anymore.

> Residential flat is hardly an investment. I hope most people understand. Unless yours is like duxton bought at 400k n sold at 1m. Congratulations.

Everyone thinks their flats are a duxton

Jared - SMOL

Monday 15th of August 2016

Kyith,

The examples you gave are more for older Singaporeans who are tapping the HDB Silver Housing Bonus:

hdb.gov.sg/cs/infoweb/residential/living-in-an-hdb-flat/for-our-seniors/right-size-with-silver-housing-bonus

The upgrade downgrade game is usually played this way:

1. 2 bites of the cherry. Buy HDB 3 or 4 room first. You just starting out - not enough cash to pay deposit for 5 room flat :(

5 years later sell in open market and upgrade to 5 room BTO (2nd bite)- now can afford the deposit, and with promotions and pay raises, you feel comfortable having a bigger HDB loan.

2. Wait another 5 years and sell HDB 5 room. Rinse and wash. Buy private condo now! Without the sale and profit from selling your HDB 5 room, how to afford the 20% cash deposit for condo?

Still in debt, and bigger bank loan some more! But career doing well and property keep on rising in a bull market. Hit metal when its hot!

3. Repeat process with landed townhouse or terrace property - especially if landed property is your dream. Not everyone can say they are landowner in Singapore ;)

4. Now is the hard part. Pray to Lady Luck that you have the wisdom or luck to sell your private property and DOWNGRADE back to HDB resale BEFORE a property bear market!!!

Now you are debt free and the reverse of what most retirees face - cash rich and asset light.

Remember Mdm Lark from Wallstraits days?

She moved from landed property to a HDB 5 room flat in Queenstown ;)

See? Who says must invest in equities to be financially free? But must hope for a 20+ year bull run in properties - and that did happen in the past ;)

As for the next 20 years???

Don't look at me!

Kyith

Monday 15th of August 2016

Hi SMOL,

thanks for visiting. yes we don't need to invest in equities with its higher volatility and scams when there is a property market with better historical returns with lower volatility. How is Lark doing nowdays? i didnt know Lark is a Mdm!

Createwealth8888

Sunday 14th of August 2016

When we are in 20s, 30s or 40s we may like to think our residential home is great asset; but are we so sure when we are in our 60s, 70s or 80s we still think that way.

Why not check with our grandparents whether they are happy to shift out from their home or they prefer to die at their long, long place called Home?

Kyith

Sunday 14th of August 2016

hi uncle cw, most would prefer to stay put. a good ponder because most do not have the retirement monetization plan when the most common is to downgrade.