Vacant Possession Vs Tenancy: What’s Best for your Condo Sale

Imagine this: you own a condo in a highly sought-after area that can fetch a good rental income. You’re planning to sell and wondering if having a tenant in place could help you get a higher price.

We must consider several factors before we can conclude. If you decide to sell your property after your tenant has moved in, it could disturb their living situation. It often takes numerous viewings before receiving an offer, and there’s no guarantee you’ll get one. If you plan to do this, inform your tenant and obtain their consent if the tenancy agreement does not say they need to accommodate viewings during the tenancy.

Setting the price right

One of the most critical factors when selling a property is setting the right price. If the price is too high, it could deter potential buyers. On the other hand, if the price is reasonable, it could attract more interest and lead to a quicker sale.

You have to be patient when selling a property. Depending on market conditions, receiving an offer could take 3 to 6 months. After signing the sale and purchase agreement, the sale would take 3 to 4 months to complete, sometimes longer. If approval from the Foreign Investment Committee is needed, this could add another 1 to 2 months. If there’s no tenant, it will sit empty during this time. The process can be lengthy, especially if your property is a leasehold title.

Before you proceed, contact a property valuer in your area who is familiar with your condo and its location. They can provide you with a valuation report or an estimate subject to a full valuation report. This gold standard will give you peace of mind that you have priced your property accurately. You may also consult with experienced real estate agents who have recently sold units in your condo.

I would advise against relying on median prices displayed on property portals, particularly if the units in your condo vary in orientation (facing), size and layout. Even without those variations, higher-level units or those with better interior fittings can fetch higher prices. The analysis might produce a lower median price if most transactions involve lower-value units. The perception might negatively influence the price of a high-value unit.

Higher prices justified for properties with tenants?

The common belief that a property with tenants would sell for a higher price isn’t always true. Potential buyers who want to live in the property would only be interested if they are willing to wait until the current tenancy ends. Only investors would consider buying a property with tenants.

I have seen calculations deducting every cost, including agency fees, mortgage interest and rental income taxes, to get yield over purchase price. When they crunch the numbers this way — which is not precisely correct — you could get a low offer. More on this later. Investors are primarily interested in the return on investment. A lower price would result in a higher return.

Selling a property with vacant possession, especially if the property is well-maintained and attractive, can attract a larger pool of buyers. You can get a higher price from a special buyer who is enthusiastic about living there due to personal preferences. This option is also suitable for investors who are selective about the tenant’s profile and may not like your current tenant.

Comparison or investment method

Specifically, we will look at whether using the comparison or investment method (income method) of valuation would yield different results for your condo. By large, the comparison method is more suitable for determining the market value of a condo. This method compares the subject property to similar properties recently sold in the same area. This approach heavily relies on market data and is usually used for residential properties. The value is assessed by adjusting the prices of comparable properties to account for differences in location, size, layout, condition, level and facing.

When comparing, it is best to focus on recently sold units within your condo development. Specifically, look for units similar to your property’s size and orientation. Conventional wisdom tells us that units with obstructed views generally have lower prices than those with open views. Additionally, buyers prefer higher floors depending on the orientation.

One thing to bear in mind is that the recorded transactions don’t provide details about the condition of the properties or if they were sold at auction. You’ll need to seek additional data on your own. A high transaction amount might be due to property renovation, while a low transaction amount could result from distressed sales, poorly maintained interiors or defects. It’s also essential to have sufficient transactions for reliable analysis.

The investment income approach is mainly used to determine the market value of income-generating properties. Most commercial properties adopt this method. This approach considers factors like rental income, operating expenses and the capitalisation rate. It focuses more on the property’s potential to create future income.

You can get different valuations for the same property as the two methods consider different factors. The comparison method looks into current market conditions and recent sales, while the investment method focuses on the property’s income potential and financial performance. The comparison approach is more appropriate for condos. A tenanted condo with high rental doesn’t necessarily mean it will fetch a high price. It depends on the specific property. A heavily renovated or decorated property may appeal to a tenant rather than a buyer. Some buyers may prefer an original unit if they plan to remodel.

Investment method of valuation

If you want to learn more about the investment valuation method (income approach), here’s a simple model and calculation to consider for a condo.

A.  Gross Annual Income: Rm X

B.  Annual Expenses: Rm Y

-Maintenance charges

-Assessment rate

-Parcel rent (Quit rent)

-Insurance

-Repairs (as per tenancy agreement)

-Void allowance

C. Net Annual Income: A – B

Market Value: Net Annual Income * Years Purchase in Perpetuity ( 1/Capitalisation Rate(%) )

In this rental model, the tenant pays for all utilities, including water, electricity, sewerage and internet charges. However, if the tenancy agreement specifies that the landlord covers the cost of utilities, you should include that amount when calculating annual expenses. If the property is an old condo that requires significant repairs, major repainting and electrical appliance replacement, the market value must reflect these costs. If minor repainting is needed yearly, factor in the price every year.

Agency fees will only be included under annual expenses if it is the norm that the tenant leaves after one year. Investors will likely include this cost or a portion thereof in their calculation. The expenses incurred periodically, not yearly, must be divided over the years.

The market value assessment excludes rental income tax, mortgage interest, and stamp duty cost for the transfer of title.

Note: Investors usually want to factor in financing and all relevant costs. They would have to use the cash-on-cash return method, which looks at net income relative to the amount of cash paid and not purchase price or market value.

The Capitalisation Rate (%)

Divide the property’s net annual income by its purchase price or current market value, and you’ll get the cap rate. It’s expressed as a percentage and provides a snapshot of the expected annual return on the property, disregarding mortgage payments. Derive the net annual income from gross annual income by deducting all operating expenses. The current market value is the present-day value of the property based on current market conditions. Yields are similar, but you can calculate yields as gross or net. Net yields typically exclude mortgage payments, too.

Cap Rate = Net Annual Income/Current Market Value

You can use the cap rate to compare the profitability of different properties. Properties with higher cap rates generally indicate a higher potential return but may also come with higher risk. Those with more stable income indicate lower risk and would have lower cap rates.

Prime properties and prime locations generally have lower cap rates due to lower risk, higher demand and higher market value. Newer or well-maintained properties tend to have lower cap rates. Cap rates might increase in a slow market.

The ideal cap rate can vary significantly depending on the type of property and its location. Investors often seek higher cap rates in less stable markets and lower cap rates in more stable, desirable areas. Residential properties generally have a lower cap rate than commercial properties. A lower cap rate would result in a higher market value. Perform calculations based on the formula with lower and higher cap rates to observe the outcome.

The cap rate is a useful metric but it has drawbacks. It does not factor in financing costs, the impact of income and expense variances over time, changes in market conditions or potentially all expenses.

Conclusion

Before, we said the comparison valuation method is better suited for a condo. You can also try the investment method. Because the methods focus on different aspects, they may not produce the same results.

Generally, the investment method might show a higher market value for a rental property in a high-demand area with stable rental income due to its strong income potential. Conversely, the comparison method might yield a higher value if recent high-sales transactions exist for similar properties.