EFFECTS OF LEVERAGE AND TAXATION ON THE PROFITABILITY OF PROPERTY INVESTMENTS

Abstract

In Singapore, the decision making process of investing in property is as yet ill-defined. At best, it can be considered to be in its embryonic stage. Historically, many of the traditional developers and investors are locals who embark on relatively small projects which did not warrant any form of sophisticated analysis. Funds for the investment would normally be provided for by the investor himself. Alternatively, small sums are borrowed from the local merchant banks in addition to the equity provided. Today, Singapore has developed into a centre for commercial and tourist activities. Foreign banks and institutions with international repute and large sources of funds are now allowed to operate here. The climate has become ripe for investments to take place. With the rapid development of the economic infrastructure and general business environment, there is now a strong attraction for foreign investors and multi-national corporations (MNCs) to operate here. Large commercial developments were needed to accomodate the requirements of these investors. The government played its part by setting up the Urban Redevelopment Authority (URA) to acquire land for office and other commercial developments. At the same time, industrial developments and condominiums were encouraged. Developments of larger size and scale require more funds. The increasing use of borrowed funds was observed. In the months immediately preceding the property boom of June 1981, many so-called 'new developers' entered the fray. They were actually speculators hoping for a quick return. Property investments appeared to be so lucrative that many investors (including some of the more established ones) felt there was no need to waste funds on any form of detailed analysis as the investment would almost always be very profitable. The heydays of June 1981 are all but over. Investments presently undertaken are subject to increasingly complex requirements of technology and scale. Costs of construction and acquisition have risen precariously and is now substantially reducing the investor's profit margin. The use of borrowed funds has been magnified, largely due to the high cost of acquisition. In the past few months, many of the speculating developers and investors have been forced to wind up due to increasing losses. Poor estimation of the market and flimsy planning were usually given as the main reasons. The fact is that many of these developers were plagued with problems of meeting the debt service requirements. It is the writer's firm desire to come to terms with such a situation. In general he is interested in presenting a suitable model for determining the profitability of rental property and in particular, how leverage and the tax implications can affect the profitability of income producing and development property investments.