Readers react to earlier article on the measure of real private property price rises.
Wed, Jun 15, 2011
By Teh Hooi Ling
IT's undeniable that surging property prices and real estate as an investment are topics which are very close of our hearts. My column last week on the 30 year compounded appreciation of private property prices after adjusting for inflation elicited quite a few e-mails from readers.
Below are some of the points brought up by three readers.
'You compared equity market prices to property price appreciation. Stocks represent equity interests in companies so it is after leverage returns.
For property, folks put on leverage so the equity return for real estate is higher than 3.9 per cent real return or 6 per cent nominal. My sense is that it would be better to gross up the real estate return by assuming a 70 per cent loan-to-value (ratio).
Finally, a heightened appreciation of the cyclicality of real estate should be overlaid should one wishes to invest in such an illiquid asset class.'
'As stated, the real return of 3.9 per cent does not include rental income. Would you be writing another piece to build this in?
Is our measure of inflation correct? The Department of Statistics seems to adjust for improvements in quality by imputing price decreases but does not do the reverse when quality declines. It's hard to get a seat on a bus or train although ticket prices are the same. Also, new HDB flats are about 15 per cent smaller than equivalent ones built 20 years ago.
All things being equal, nominal property price increases should track or lag nominal GDP per capita growth rates. I think price increases are ahead of nominal GDP per capita. Why? Perhaps because of falling interest rates.
What is the performance of the property rental index compared to price index? I think it has lagged over the past 30 years. The rise in prices over 30 years appear to be driven by the fall in interest rates - a result of an excessively high savings rate.
The high savings rate may have backfired. We have excessively high property prices but yet there are 70-year-olds cleaning tables at hawker centres. Looks like there is a misallocation to property across our economy. Banks have about 50 per cent of loans to property and property related activities.
At the end of 99 years, what is the value of a 99 leasehold property? Regardless of how healthy GDP growth has been, it would be zero. Oh, dear, homeless in old age.'
'Having read the article on real property prices in Singapore in Saturday's BT, I somehow felt that the numbers presented do not fully reflect reality for a property investor (which I was for a short while some years ago, but after weighing the pros and cons I'm now living happily in a rented flat). One issue is transaction/annual costs.
For stocks, the only cost involved is that of commissions and fees to be paid to brokers or SGX. Typically that would be roughly 0.5 per cent upfront when you buy, and another 0.5 per cent when you sell.
In the case of a private property of say $1 million, your upfront cost would roughly be 7-8 per cent (stamp duty, agent commission, legal fees) plus more legal fees for an eventual sale after 30 years. Thus a property investor starts his investment with a real expected 'loss' in the form of fees and taxes of 7.5 per cent (mid rate) plus 1.5 per cent legal fees (after 30 years). If equally distributed over the 30 year timeframe, that's roughly 0.3 per cent pa.
Then there is the property tax, condo management fees, etc. In total (and not factoring in costs for repairs/renovations which will always happen at some point, just that the extent is uncertain!) the fixed costs no condo investor can escape from amount to roughly 0.9-1.4 per cent pa.'
Basically, his argument was that equities makes for better investment.
Response to readers
In response to the e-mails, I did more calculations. Here are the results.
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Chart 1 and 2 show the return of a private property investor. The return includes price appreciation and rental income. The assumption is that the property investor bought into the market at various points in the past 12 years and held on till end 2010. Calculations are based on a 100 sq metre condominium. The purchase price of the property is raised by 8 per cent to account for the various fees, and likewise the selling price was reduced by 2 per cent. Deducted from the capital appreciation are the interest charges paid to the bank during the holding period of the property. Interest rates are pegged at 1.5 percentage points above one-year interbank rates. Meanwhile, rental income is net of management fees. The rental cash flow is then further reduced by 15 per cent to account for property tax and rental income tax.
Chart 1 shows that timing is everything. Investors who got into the market in the second quarter of 2000, between the fourth quarter of 2007 and third quarter of 2008 lost money on their private property investments after all the costs are taken into account. Those who bought in Q2 2008 are down by some $97,000 relative to their initial capital outlay of $218,000.
Those who entered the market between 2001 and 2006 have seen more than 100 per cent return on their initial capital.
Chart 2 shows annualised return on equity of the investments. Just like in stocks, those who have the courage to buy when sentiment was poor, between 2004 and 2006 and in early 2009 have been well-rewarded. For example, those who bought in early 2009 have enjoyed more than 80 per cent return on their equity. Those who got in between Q4 2004 and Q4 2006 have been enjoying in excess of 20 per cent return a year on their equity.
On the other hand, those who rushed in when the market was hot - in Q2 2000, and Q 2007 to Q3 2008 - have lost money.
Finally, Chart 3 shows the growth of Singapore's real GDP per capita vis-a-vis the real private property price index. The property index lagged the GDP growth in mid 80s to early 90s. Then the property fever took hold of the market in the mid 90s. That was one huge property bubble, with the property index running ahead of GDP by more than 100 points in 1995 and 1996. Both were set at 100 points in 1980.
Singapore government pricked that bubble with tough policy measures. That deflated the property market to below that of GDP. Between 2004 and 2006, the property index was trailing the GDP by more than 50 points. In hindsight, that was a major indication of undervaluation of the Singapore real estate market.
Big income disparity
The gap has since been closed following the sharp run up in property prices in the last five years or so. As of end 2010, the growth in private property prices as been in line with that of Singapore's GDP per capita in the last 30 years.
But that doesn't necessarily mean that the affordability of private property for the average Singaporean has remained the same. The thing is income disparity has widened significantly in the last 10 years as well. This explains the widespread unhappiness among the have-nots about the continued rise in the private property market. And the government has made it clear that this is one issue it will spare no effort to address.
The writer is a CFA charterholder
This article was first published in The Business Times.