Strategy is rooted in differential borrowing costs

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Reference no: EM132003520

Background

A popular investment in Singapore has been overseas real estate. Melbourne, in particular, is a favoured location to invest. Restrictions on foreign investment limit non-Australians to purchasing newly-built housing only, which in Melbourne’s CBD takes the form of the many high-rise apartment buildings being erected each day.

The popularity of this strategy is rooted in the differential borrowing costs in Singapore and Australia. Floating-rate loans in Singapore are currently about 1.4% APR (monthly), as opposed to about 4.25% APR (monthly) in Australia. A two-bedroom apartment in Melbourne’s CBD sells for around 700,000 AUD and can fetch approximately 2,150 AUD per month in rent after accounting for maintenance and fees. Banks in both Singapore and Australia require a 20% down payment, meaning an investor in either country must have the equivalent of 140,000 AUD in order to obtain a loan for a 700,000 AUD apartment. In this assignment, you will analyse this investment strategy

For Question 2, use the following information:

? The current SGD/AUD exchange rate is 0.95. That is, 1 Singapore Dollar buys 0.95 Australian Dollars.

? Both apartment sale prices and rents in Melbourne are expected to grow at 1.8% APR (monthly) per year, in line with inflation.

? Singaporean investors take out 25-year loans with monthly repayments. The first repayment will be due 1 month after the loan is made.

Please include any formulas/equations/etc that you use with your calculations.

a) If the interest rate in Singapore is not expected to change over the life of the loan, what is the monthly loan repayment in SGD?

b) If the SGD/AUD exchange rate does not change over the life of the loan and the apartment is always rented, what are the net SGD cash flows to the investor in months 1 and 180?

c) Given the assumptions in parts (a) and (b) above, can you solve the IRR for the Singaporean investor who does not intend to sell the apartment? If yes, what is it? If no, explain why not.

d) Given the assumptions in parts (a) and (b) above, can you solve the IRR for the Singaporean investor who sells the apartment after fifteen years if the price increases as expected? If yes, what is it? If no, explain why not.

e) In deciding whether or not to invest in the Melbourne apartment, a Singaporean investor reaches the following conclusion: “If I do not invest in the Melbourne apartment, I will invest in the Singaporean stock market. Since Singaporean stocks average about 9% return per year, as long as the annualised IRR of my investment in the apartment is greater than 9%, I should buy the apartment.” Is she correct? Justify your answer.

Reference no: EM132003520

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