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Stop the Wealth Transfer by Deferring Land Cost Payment
By paying only the construction costs at the point of BTO, homeowners need only a smaller downpayment and a much smaller HDB loan. They can not only repay the loan within 15 years instead of the current 25 but also use a smaller monthly mortgage payment. In the end, the smaller loan amount and shorter loan term translate into lower interest payments. The shorter loan term also means that homeowners can clear two housing loans possibly even before they hit 50 years old, assuming they buy two new BTO flats during their lifetime. This greatly reduces households’ financial risks.
18 September 2019
As aforementioned, the high housing cost issue is not just about affordability but also about homeowners’ retirement funding and financial resilience. These long term risks cannot be mitigated by dispensing more grants to enhance affordability in the short term. Unless the pricing model is fundamentally changed, the issue of public housing will become a ticking time-bomb for the future governments.
So, what can Singapore do?
Switching from ‘Affordability’ to ‘Deferred Land Cost’ Approach
One simple solution is to announce land cost at the point of BTO sale but defer its collection from homeowners till the point of resale. Government still collects the land costs to build reserves but the money comes from not homeowner’s CPF but the resale proceeds. Any shortfall (e.g. due to weak resale prices) resulting in the land cost not fully recovered will be borne by the Government. In this way, if the government makes an overly optimistic projection on land costs at the point of BTO sale but cannot fully recover it at the point of resale, the households will not be penalized by the Government’s misguided optimism.
Moreover, because homeowners now need to pay for only the construction costs, they need a smaller downpayment and a smaller HDB loan. They can not only repay the loan within 15 years instead of the current 25 but also use a smaller monthly mortgage payment. In the end, the smaller loan amount and shorter loan term translate into lower interest payments. The shorter loan term also means that homeowners can clear two housing loans possibly even before they hit 50 years old, assuming they buy two new BTO flats during their lifetime. This greatly reduces households’ financial risks.
In total, homeowners enjoy CPF savings from the lower interests incurred and the land costs not paid using homeowners’ CPF money. Conceptually, the proposed cost-based pricing thus works on the principle that public housing is first and foremost a consumption good and a homeowner pays only the costs of consuming it. However, if he sells the apartment, then the house becomes an investment asset and any gains from the land dividend must rightfully be shared with the State which has not only provided the land but also enhanced its value by developing it. If however resale prices soften and the land cost is overstated, then the paper loss should rightfully be borne by the Government and not the homeowners.
Homeowners therefore get the best of both worlds. They bear limited downside risk, with public housing as a consumption good, while still enjoy potential capital gain with public housing switching to an investment asset at the point of resale.
Illustration of the Proposed Approach Using a Four-Room BTO Flat
Let’s look at the proposed cost-based pricing model using the earlier example of a four-room BTO flat costing $562k in matured estate or $309k in non-matured estate in May 2019.
Assuming that land cost is 50% of the BTO price, a homeowner in a matured estate pays $281k for construction, $281k for land, and another $182k for interests over a 25-year loan period, under the current ‘Affordability’ pricing approach. The final total price he pays from his CPF savings is $781k, of which $500k or 64% of what he actually pays to the State for land, interests and resale levy (net of grant), is basically profit (i.e. wealth transferred) to the State.
Under the proposed ‘Deferred Land Cost’ pricing approach, which defers the payment of land costs (i.e. 50% of $562k or $281k) till the point of resale, a homeowner only pays construction costs of $281k. Because of the low BTO price, he needs only a small housing loan of $253k that can be repaid not only within a shorter period of 15 years but also with lower monthly mortgage payments. His total outlay will add up to be $334k comprising of 281k for construction costs and only $53k for interests. Compared to the current affordability pricing model, he immediately gets an interest savings of $129k (i.e. $182k – $53k) because of the smaller loan and shorter repayment period.
Comparison of the Two Approaches Using a 4-Room BTO Apartment in 2019.
a. The proposed pricing model is different from the current one in three ways
(i) Land cost, assumed at 50% of the BTO price, is payable only at the point of resale.
(ii) Loan term is reduced from 25 to 15 years.
(iii) Under the proposed pricing model, homeowners receive no grant but pay no resale levy either.
b. Homeowners need only a much smaller downpayment to book a BTO flat.
c. Because land cost is not paid at the point of BTO sales, a substantially smaller loan is needed under the proposed approach. The smaller loan and short loan period translate into very much lower interests payable to HDB.
d. Homeowners who purchase a new BTO flat in non-matured estate will have $226k more in his CPF account for retirement under the proposed approach. It comprises savings of $155k from land costs not paid using CPF; $62k from lower interest payment and $10k from resale levy (net of grants) not paid.
e. Homeowners who purchase a new BTO flat in matured estate will have $448k more in his CPF account for retirement under the proposed approach. It comprises saving of $281k from land costs not paid using CPF; $129k from lower interest payment and $37k from resale levy (net of grants) not paid.
f. In effect, homeowners who receive grant under the current scheme pay back the grant in the form of resale levy at the point of resale. Under the proposed pricing model, since no grant is dispensed, homeowner pays no resale levy.
In short, by simply deferring the payment of land cost to the point of resale, a 4-room homeowner will have $226k (for BTO in non-matured estate) to $448k (in matured-estate) more in his CPF for his retirement, depending on the location of his new flat. This is not inclusive of opportunity costs (i.e. interests his CPF savings could have earned if not paid out under the current pricing approach) and potential capital gain when he sells his BTO flat.
More Room for Capital Gain because of Lower Interest Cost
Assuming that resale price has appreciated 30% from the BTO price he paid when a homeowner decides to sell his flat some years later.
Regardless of whether his flat is in matured or non-matured estate, the homeowner suffers a loss under the current pricing approach despite the 30% appreciation of the flat value.
In contrast, under the proposed ‘Deferred Land Cost’ approach, the homeowner makes a profit of $64k or $116k, depending on the location of his flat, after paying the deferred land cost. This is because the lower interest cost left more room for capital gain.
Current Pricing Approach
Proposed Pricing Approach
The capital gain can be credited to a special ‘Nation building Bonus’ CPF account in recognition for the homeowner’s contributions to nation building. If the household decides to migrate, the bonus can be seized by the State as a punitive measure. Alternatively, the capital gain can be shared with the State based on a pre-defined formula.
Reverting CPF and HDB to Fulfilling their Original Roles
The savings from the proposed pricing scheme may vary depending on the various assumptions made. Notwithstanding, the benefits from the lower loan amounts and shorter loan periods are obvious regardless of the figures used.
Notably, the savings will be even greater if the actual land cost is higher than the 50% assumed. They are also sure deals compared to the current model which promises contingent capital gain that may not materialize depending on future market conditions.
More importantly, the savings are not subsidies or grants provided by the Government. In effect, the proposed BTO pricing approach merely protects the CPF savings of homeowners accumulated from their own hard work by stopping the wealth transfer from the homeowners to the State through the high land cost as well as the high interests incurred for the HDB housing loan.
The proposed pricing approach thus simultaneously achieves the seemingly conflicting or mutually exclusive objectives of
promoting homeownership without draining the State’s fiscal resources
preventing wealth transfer from the households to the State to ensure that their CPF savings are protected to fund their retirement;
allowing households to still enjoy the bonus of a capital gain when the flat is converted from a consumption good to an investment asset at the point of resale; and
allowing the land costs to be collected by the State, albeit only later at the point of resale.
In the end, both HDB and CPF will revert to doing what they were first created to do: providing genuinely affordable and high quality public housing and helping households to save for their retirement.
Using Public Housing to Raise the Total Fertility Rate
Because HDB flats are now genuinely affordable, a problem that may arise is that all couples choose to go for the biggest flat available at every sales launch. One simple solution is to link the size of flats to the number of children in the households.
Doing so also helps Singapore to achieve the pressing objective to raise total fertility rate (TFR) and reduce the dependence on immigrants to address the issue of ageing population. At the same time, it also genuinely lightens the financial burden of couples who want to have more children. Instead of investing in a house, they can now invest in what makes the house a home.
There is already precedence of linking the size of flat to the size of household. Currently, for example, singles are allowed to buy only 2-room BTO flats. This policy of promoting family as a basic unit can be extended so that bigger apartments are reserved only for families with children.
With that restriction in place, the likely scenario will see young childless couples in their 20s starting with a 3-room apartment. They then sell and upgrade to a 4 room or 5-room flat when they are in their 30s depending on the number of children they have at that point. The housing loan for the second BTO flat will be fully repaid by the time they are in their 50s. They can stay in the second flat after their retirement or downgrade to a smaller flexi-lease apartment if they choose to.
At any time, couples who want a bigger apartment than they are entitled to can buy one from the resale market paying the full resale price from which the Government can recover the land costs. Doing so also helps to create demand and price support for the HDB resale market. Hopefully, by not punishing couples having more children, the restriction may over time lead to higher TFR.
Over the past few decades, Singapore’s demographic dividend contributed immensely to the growth of not only the economy (income generation) but also land dividend (wealth generation). With the proposed pricing model, the process can now be reversed so that land dividend can be used to replenish Singapore’s demographic dividend for a more sustainable future.