Saturday, April 24, 2010

Numbers say that property still has legs

It's attractive for investment as long as interest rates stay low, rentals hold firm and capital value is maintained

PROPERTY has always been a hot topic in Singapore, and it has gained even more limelight of late given the continued strength in the prices. Some government measures introduced to cool the market have not overly dampened investors' sentiment.

Yesterday, the Urban Redevelopment Authority released some detailed data for the property market in the first quarter. I've decided to update some of the charts and analysis that I've done before with the latest set of data.

The first chart plots the growth of Singapore's gross domestic product (GDP), the URA private property price index and the Straits Times Index since 1975. In that 35 years, the stock market and the property market more or less tracked the growth of the economy. But there were bouts of over exuberance and excessive depression for the property and the stock markets. In that short history, the property market has shown itself to be more prone to over exuberance or the formation of so-called bubbles, though the stock market too has had its fair share of both irrational exuberance and pessimism.

The Singapore property market started to race ahead of the underlying economy in 1994 and 1995, and peaked in 1996. That huge deviation proved to be a bubble. The bubble was pricked by the government's anti-speculative measures, and later by the Asian financial crisis. Property prices then corrected severely and closed the gap with the domestic economy. In 2007, property prices started to climb again. The correction came soon after in 2008, but it now appears that could just have been a blip. Prices have again resumed their north-ward march, and properties are now at their highest level relative to the GDP since 1999. The years of 1994, 1995, 1996 and 1997 of course saw significantly higher property prices relative to the GDP.

But a few things are different this time round, primarily the low interest rates that we all enjoy today.

Chart 2 plots the one-year interbank rate against the rental yield. Here, you can see that there remains a relatively big buffer between the interest rate and the rental yield of a private non-landed property. The rental yield is calculated based on the median rental of a non-landed private property over its median price.

And as a result of the very low interest rates today, an investor who takes up an 80 per cent loan to be paid off over 30 years can entirely service his or her monthly mortgage payment from the rental income. Here, the mortgage rate is calculated based on the one-year interbank rate plus 1.5 percentage points.

Based on URA's numbers, the median price of an apartment in the first quarter of 2010 was $9,952 per sq metre (psm), and for condominiums, $10,490 psm. Let's take the average of the two to represent the median price of a non-landed property. That works out to $10,221 psm. A 100 sq metre unit would cost some $1.02 million. Assume that an 80 per cent loan is taken and that the housing loan rate is 1.5 percentage points above the interbank rate, which was at 0.625 per cent. For a $818,000 loan on a 2.125 per cent interest over 30 years, the monthly mortgage payment is $3,074.

On the rental side, the median for a non-landed private property is $34.06 psm per month. So the rental income from a 100 sq metre unit would be $3,406. That more than covers the mortgage payment. However, additional expenses relating to owning a property like property tax or property maintenance are not taken into consideration.

There was negative cash flow for property investors between Q2 2005 and Q1 2008. Since Q2 2008, however, there has been a positive cash flow. Indeed the positive cash flow could have been bigger for those who had opted for floating rate housing loans. They are in fact paying much lower rates than 2.125 per cent.

Such a situation would last for only as long as rentals stay firm and interest rates remain low. But rates are at their lowest in the last 20 years. The median level of interbank rate in the last 20 years was 2.7 per cent. Based on current rentals, the interbank rate has to go up only by less than one percentage point to 1.5 per cent for cash flow to turn negative for property investors. Unless one is of the view that the low interest rates today is the 'new normal', it is logical to assume that interest rates will rise to more 'normal' levels sooner or later. For perspective, the median interbank rate in the last 10 years is 1.375 per cent.

The current low bank rates also means that the rental return on equity (ROE) for a property investor is high, at 9.5 per cent. Here, the rental is reduced by 10 per cent to factor in property tax and some of the other expenses. It however does not take into consideration potential capital appreciation. Again, the assumption is 80 per cent loan at a rate of 1.5 percentage points above the interbank rate. A rise in interbank rate to 1.5 per cent would reduce the ROE to 6 per cent, while an interbank rate of 2 per cent would slash the return to 4 per cent.

On the affordability front, the numbers continue to look reasonable. I take the average income of the 71st to 80th percentile households in Singapore. According to the Department of Statistics, the average monthly income for this group was $8,010 in 2006, $8,730 in 2007, $9,720 in 2008 and $9,559 in 2009. I then compare these to the median price of condominiums in those four years.

Again, assume the condo is 100 sq m, the loan is 80 per cent over 30 years, and the rate is 1.5 percentage points above the one-year interbank rate. In the above scenario, the mortgage payments these households need to fork out has fallen to 29 per cent, well within the recommended range of how much each household should set aside for mortgage payments.

So, the above analysis shows that one, the top 30 per cent of Singapore households can still comfortably afford a non-landed private property. Two, from an investment point of view, property remains attractive for as long as interest rates remain low, rentals holding firm, and capital value being maintained.

There is only a small buffer for interest rates to go up before properties become unattractive as a rental yielding asset. Meanwhile, rentals are not expected to chalk up significant gains. Not helping matters are the substantial number of new stock coming onto the market in the next few years.

But what is unknown is the demand. Singapore's status as a happening and safe hub city in Asia is gaining traction. Given the small size of the city, a small increase in demand can translate into big price movements. No one can tell how the market will look like in the future. But for as long as one can afford to own a property with an ample margin of safety, it remains one of the best places to park one's money in, over the long term.

Source: Business Times, 24 Apr 2010

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