During the National Day Rally this year, Singapore Prime Minister Lee Hsien Loong spoke at length about the Voluntary Early Redevelopment Scheme (VERS) which will allow home owners to vote on whether to sell their Housing Development Board (HDB) flats to the Government once the lease nears its end.
VERS provides owners of older HDB flats peace of mind, as it helps to boost liquidity for the older flats nearing the end of the lease. As long as the Government continues to invest in HDB flats through Home Improvement Programmes (HIP and HIP II) and VERS, home owners can be assured that their aged flats still hold value. In the case of VERS, the Government is willing to step in when free-market economics do not work out.
There are lingering concerns over VERS in terms of payout and its execution, given voting is required as compared to Selective En bloc Redevelopment Scheme (SERS), which is compulsory and meant for selected HDB blocks or precincts with high redevelopment value. The Government has not announced the details of VERS.
In my view, VERS still has some drawbacks as uncertainties remain over its compensation amount. It is possible that the compensation is largely dependent on the site’s redevelopment potential. In other words, since VERS sites are not deemed to have very high redevelopment potential, the payout for VERS could be based just on current market value. This implies that flat owners of VERS should not expect a ‘windfall’, unlike in the case of SERS or even private en bloc market.
The Response to VERS
Initial reaction to VERS has been mixed. Some amongst the elderly community would like the Government to bring forward VERS so that they can cash out their flats before they pass on. Others have been calling on the Government to consider 100 per cent vote threshold for VERS to protect all home owners. Such consensus level will make it too prohibitive for VERS to take place, given the large number of residents in any HDB precinct, which consists of hundreds if not thousands of households. The frustration of flat owners will remain if the consensus requirement is not met. However, if the consensus requirement is below 100 per cent, it could create a social divide between the majority and minority owners like in the case of private en bloc market.
At this juncture, VERS is probably still the best stop-gap option to preserve the market value for existing 99-year leasehold flats, but I believe that we can have a more permanent solution for future Build-To-Order (BTO) flats to avoid all the pitfalls of VERS.
During National Day Rally, PM Lee spoke against the idea of selling HDB on freehold tenure. As he reasoned, it will be bequeathed to home owner’s descendants in perpetuity. Over time, our society will split into property owners and those who cannot afford a property. The Government will also have limited option to take back the freehold flats for redevelopment and Singapore will run out of land for future generations.
An Alternative Approach
Freehold HDB flat is a no-go, but what about selling a freehold HDB flat with strings attached? For example, the Government could launch a new scheme to sell freehold HDB flats with an Embedded Call Option (FECO) to allow a buyback clause at the end of 99 years?
Let me elaborate.
FECO flats will replace all BTO flats in future. This gives the Government the right, but not the obligation to acquire the flats back any time after 99 years by paying freehold market value.
In practice, the Government will always acquire FECO flats at the end of the 99th year. This will serve the same purpose as the current 99-year BTO flats, where leases run out and flats are returned to the Government at the end of the lease term.
FECO flats will also be priced slightly higher to account for the freehold tenure. Using Singapore Land Authority (SLA)’s leasehold table as a guide, the freehold value will be roughly about 4.2% higher than the current BTO flats sold under a 99-year leasehold tenure. FECO flats will still be highly-subsidised as that has always been the Government’s intent to make public housing affordable for the masses.
The Government will then inject the full sum received from FECO sales into GIC to be invested. After a holding period of 99 years, GIC will have accumulated enough reserve for the Government to pay for the acquisition of the flats (see chart below). This scheme is like how our Central Provident Fund has worked for our retirement needs.
The 99 Year Opportunity
Historically, HDB annual price appreciation averages 2.8 per cent based on various holding periods ranging from 5 to 25 years. GIC on the other hand, has annualised returns ranging between 4.3 and 5.7 per cent based on holding periods ranging from 5 to 20 years.
Let us assume a new FECO flat with a market value of $500,000 is sold today at a subsidised rate of $250,000. Based on an assumption of a 3 per cent historical appreciation of the HDB flat and a 4 per cent annualised return on GIC investment portfolio, at the end of 99 years, the initial investment quantum of $250,000 would have ballooned to $12.1 million. This will exceed the freehold market value of the flat at $9.3 million. The financials are made feasible due to the extremely long investment horizon of 99 years.
4 per cent is not excessive given the current floor interest rate for CPF Special Account is also 4 per cent.
How does this scheme compare to the 99-year leasehold BTO flats?
FECO flats will have the benefit of preserving the re-salability and market value of older flats since they are still deemed freehold. This is very much in line with Government’s asset enhancement policy.
The call option will allow Government to acquire HDB flats to make way for future generations’ housing needs if the Singapore population continues to grow. It is also self-funded from the return from the sovereign wealth fund, which eliminates strain on the Government’s budget.
Most importantly, it minimises the risk of having social divisiveness due to voting.
Some may question whether there would be a funding gap arising from this scheme, as currently the land sales of BTO flats will also go back to the reserve. The impact may be rather limited, as only a tiny proportion of the investment returns of the total reserve (also known as net investment returns contribution or NIRC) supplements the Government’s spending, which is roughly about 17% of the budget in the last two financial years.
Over the last 10 years, Singapore’s NIRC has more than doubled from $7 billion in FY2009 to an estimated $15.9 billion in FY2018. On top of that, HDB has also incurred a budget deficit for home ownership subsidies. The figure was $1.4 billion in FY 2017/18.
For the FECO scheme to work, GIC’s annualised return must exceed the HDB’s annual price appreciation in the long run. This can be achieved as the Government has much control over the price appreciation of the HDB flats through supply and demand side measures to ensure the sustainability of the property market. Additional stress tests may be needed to ensure the scheme can withstand external shocks during tough times.
Chart: Freehold HDB with Embedded Call Option Flats VERSus GIC Investment over 99 Years
Source: Cushman & Wakefield Research
Note: Initial free market value and initial GIC investment quantum is $500,000 and $250,000 respectively.
This article first appeared on 20th January, 2019 in the Straits Times under the headline “Is there a more permanent solution than Vers for HDB flats?”