Understanding Lease Decay: How It Affects You as a Property Owner

When it comes to property ownership in Singapore, the term "lease decay" is one that often crops up, especially when dealing with leasehold properties. Understanding lease decay and its implications is crucial for any property owner or investor, as it directly impacts the value of your asset over time. A key tool used to visualize this concept is the Bala Curve, which we'll explore in this article.

What is Lease Decay?

Lease decay refers to the diminishing value of a leasehold property as the lease approaches its expiry date. In Singapore, properties can be classified into two main categories: freehold and leasehold. Freehold properties provide indefinite ownership, while leasehold properties are typically held for a fixed period, such as 99 or 999 years.

As the lease on a property shortens, the value of the property generally decreases. This reduction in value becomes more pronounced as the lease term falls below certain key thresholds—often at the 60-year, 30-year, and 20-year marks. This phenomenon is what is commonly referred to as "lease decay."

Introducing the Bala Curve

The Bala Curve is a concept widely used in Singapore to illustrate how a property's value diminishes over time as the lease decays. Named after Mr. S. Bala, a former chief valuer at the Inland Revenue Authority of Singapore (IRAS), the curve provides a visual representation of the relationship between the remaining lease term and the property's value.

Credit: Juan Velasco, Centre for Liveable Cities

How the Bala Curve Works

The Bala Curve is typically represented as a downward-sloping graph, where the x-axis represents the remaining lease term, and the y-axis represents the property's value as a percentage of its original value. The curve shows that the value of a leasehold property remains relatively stable for the first 60 to 70 years of the lease. However, as the lease term drops below these critical points, the property’s value begins to decline more steeply.

Simplified Explanation:

• Start of Lease: A 99-year leasehold property starts at around 96% of its freehold value.

• 60 Years Remaining: The value decreases to about 80% of the freehold value.

• 30 Years Remaining: The value further drops to around 60% of the freehold value.

The Bala Curve's shape is non-linear, meaning the value does not decrease evenly over time. Instead, the decline in value accelerates as the lease gets shorter, particularly beyond the 30-year mark.

Why Does Lease Decay Happen?

Several factors contribute to lease decay:

1. Reduced Market Demand: Buyers are generally less inclined to purchase properties with shorter leases due to concerns about future resale value, financing difficulties, and the prospect of the lease eventually expiring.

2. Financing Challenges: Banks and financial institutions are more reluctant to provide financing for properties with shorter remaining leases. When they do, the loan-to-value (LTV) ratio is often lower, meaning buyers may need to pay a larger upfront sum.

3. HDB Restrictions: For HDB flats, there are additional rules regarding lease decay. For instance, if a flat has less than 60 years left on its lease, the buyer’s ability to use their CPF to finance the purchase is restricted, which further limits the pool of potential buyers.

4. Depreciating Asset Value: As the lease runs down, the property is worth less, affecting both resale and rental yields.

How Does Lease Decay Affect You?

1. Impact on Property Value

The most direct impact of lease decay is on the property's market value. As the lease shortens, potential buyers may perceive the property as a less attractive investment, leading to a decrease in market value. This can be especially concerning if you're looking to sell your property or use it as a form of retirement savings.

The Bala Curve visually emphasizes how this value erosion accelerates as the lease shortens, particularly as it approaches the 30-year mark.

2. Challenges in Selling

Lease decay can make it more difficult to sell your property. Buyers are often hesitant to purchase leasehold properties with shorter leases because of the potential issues with resale and financing. As a result, your property may stay on the market longer, and you may need to lower the asking price to attract buyers.

3. Loan and Financing Issues

If you’re considering refinancing your mortgage, the remaining lease period on your property will be a critical factor. Banks may offer less favorable terms, such as a lower loan quantum or higher interest rates, for properties with short leases. Additionally, if you plan to buy another property, the proceeds from selling your current property may be less than expected due to lease decay.

4. Limitations on Using CPF

For HDB flats, CPF usage is limited when the lease falls below 60 years. If the remaining lease doesn’t cover the youngest buyer until the age of 95, the amount of CPF funds that can be used will be prorated. This limitation can reduce the appeal of your property to potential buyers who rely heavily on CPF for their purchase.

Mitigating the Impact of Lease Decay

While lease decay is an inevitable aspect of owning a leasehold property, there are ways to mitigate its impact:

• Monitor Lease Periods: Keep a close eye on your property's remaining lease. If it’s approaching a critical point (e.g., less than 60 years), you may want to consider selling or refinancing before the value drops significantly.

• Evaluate Your Investment Horizon: If you’re purchasing a leasehold property, consider your investment horizon. If you plan to hold the property for an extended period, factor in the potential effects of lease decay on your returns.

• Consider Freehold Alternatives: If you’re concerned about lease decay, you might prefer to invest in a freehold property, which doesn’t suffer from the same issues. However, freehold properties typically come at a premium.

Conclusion

Lease decay, illustrated by the Bala Curve, is a crucial consideration for any property owner in Singapore, especially those who own or are considering purchasing a leasehold property. Understanding how lease decay works and its implications on property value, marketability, and financing can help you make informed decisions about your real estate investments. Whether you're looking to buy, sell, or hold, being aware of lease decay will ensure that you’re better prepared to navigate the complexities of the property market.

By staying informed and planning ahead, you can mitigate the effects of lease decay and make the most of your property investment.