Industrial strata units as an alternative investment?

February 17, 2012

The recently imposed Additional Buyer’s Stamp Duty (ABSD) on certain categories of residential properties had some analysts predicting a spillover of demand to non-residential properties like industrial, retail or office strata units, but the situation might not be as straightforward as it seems.

Industrial strata units have always been an alternative investment to residential properties given its relatively affordable quantum.

The pick-up in industrial strata transactions since 2009 is in part due to the number of Government Land Sales (GLS) sites which led to more industrial strata project launches as well as the spike in residential prices since 2Q09.

Increases in industrial rents and the low interest rate environment also prompted more ownership/investment so that rental cost is controlled for companies while investors get to enjoy better returns. The remarkable economic and manufacturing growth in 2010 injected confidence into the industrial market and boosted demand for such properties.

This led to the Government releasing more sites for industrial development last year. Another 11 industrial GLS sites were sold last year and most of them are expected to be launched for sale this year.

Buyers of strata industrial units

If interest in industrial strata units has picked up since early 2009, who are actually the buyers of such units?

According to caveats logged with the Urban Redevelopment Authority (URA), slightly more than 70 per cent of buyers of industrial strata units are companies, with Singaporeans making up around 25 per cent and foreigners the remainder.

While the number of Singaporeans buying industrial strata units have increased in absolute terms over the past 11 quarters, their proportion in percentage terms have actually dipped to 21.8 per cent in 3Q11 from 35 per cent in 2Q09.

Why aren’t more Singaporeans buying?

Shorter Tenure

Industrial strata developments are built on lands with tenure varying from 30/60/99/999-year leasehold or freehold. But the most common tenure for industrial developments is either 30- or 60-year leasehold as they are built on lands sold under the GLS Programme. Comparatively most residential, office and retail strata developments sit on lands with a 99-year lease. This means that investors in industrial strata units face higher risk as the tenure is shorter.

Unfamiliarity with the product

Singaporeans are more familiar with residential developments as it is a part of their life but not industrial developments, and not many understand the technical requirements of tenants of industrial developments.

Cannot be used for personal enjoyment

If the investor is unable to rent out his industrial strata unit, the unit will be left vacant. It is unlike a residential unit where he can move in to stay for a while looking for a tenant.

CPF cannot be used

With effect from July 1, 2006, CPF monies cannot be used to purchase non-residential properties. This means that if the property is not tenanted, the investor has to use their monthly income to service the monthly mortgage payments.

GST is payable

As this is a non-residential property purchase, investors have to pay Goods and Services Tax (GST) on their purchase of an industrial strata unit.

Higher interest rate

Interest rate on loans for non-residential property is higher than that charged by banks for loans on residential property.

Non-Residential Strata Properties Worth Considering?

Because of the higher risk involved in a non-residential property purchase, investors are compensated in the form of higher rental returns for such properties. Typically for a leasehold non-residential property, the gross yield is between 4 and 6 per cent, higher than the 2 to 4 per cent for a residential property.

Instead of comparing the two investment products by location or unit size (sq ft), a better comparison would be the price quantum since investors will have an investment amount in their mind when they want to invest and we are looking at the financial aspects in terms of downpayment, stamp duty and ABSD.

Generally, a studio or one-bedroom private residential unit can cost between S$500,000 and S$600,000, while an industrial strata unit can cost around S$500,000.

Based on upfront cash alone, investors would be better off investing in an industrial strata unit rather than a private residential unit. But it should be noted that the tenure for the two types of properties are different. The price difference between a 99-year leasehold and a 60-year leasehold property can be as much as 25 per cent.

After accounting for the difference in tenure, investors would be better off buying a private residential unit. But if tenure is not an issue, investors can consider buying an industrial strata unit since it offers better rental returns in exchange for the risks involved.

In short, there might not be spillover demand to the strata non-residential market. By imposing the ABSD, the Government is simply trying to balance out the demand in both the residential and non-residential market, letting investors decide if the difference is sufficient to cover the risks.

The ABSD quantum of 3 per cent or 10 per cent depending on the residential status and number of properties owned is probably derived from studying the upfront cash difference between investing in a residential unit and a non-residential unit.

The recent policy on a minimum size for an industrial strata unit means that investors have to fork out a higher quantum upfront thereby increasing their risk exposure.

By Lee Sze Teck – senior manager for research and consultancy at DWG.