Source: By Teh Hooi Ling, Senior Correspondent – Saturday, Sept 08, 2012, The Business Times
FEW conversations in Singapore can carry on long before the topic of real estate creeps in. It happened again when I spoke to a couple of investor friends recently. One friend contended that there is a property bubble in Singapore, and that it is being propped up by the very low interest rates that borrowers are enjoying today. “Everything will collapse when interest rates rise,” he said.
“No,” said the other. “The only bubbles that we have are in the champagne that we will be drinking this Sunday.” He mentioned something about the relationship between GDP growth and the level of interest rates.
That piqued my interest. What has the relationship between interest rates and GDP growth been like in Singapore in the last 25 years or so?
So I downloaded Singapore’s real GDP growth and inflation rates from the Department of Statistics website. I got the one-year interbank rates from Thomson Datastream. I deducted inflation rates from the one-year interbank rates to get the real interest rates – the return you receive that compensates you for your loss of purchasing power as a result of price inflation as well as for saving the money and not spending it immediately.
I then plotted the Urban Redevelopment Authority (URA) private property index and the Straits Times Index (STI) – both adjusted for inflation – against GDP growth and interest rates over the years.
You can see the results in Chart 1. In the past 25 years, on average, real GDP growth has been higher than the real interest rate by 5.9 percentage points. The median is 6.7 percentage points.
Indeed, property prices tend to rise faster when the gap between real GDP growth and interest rates is bigger. There were eight years when the URA private property index chalked up double-digit growth in real terms (that is, net of inflation). Those years were 1989, 1991 to 1994, 1999 and 2007 and 2010. In those eight years, real GDP growth was higher than real interest rates by an average of 8.4 percentage points. The median was 7.4 points.
So, looking back, the big property bubble of 1993 and 1994 was caused by too low a real interest rate. In 1993, real GDP growth was a blistering 11.5 per cent while the real interest rate was a mere 0.6 per cent. In 1994, real GDP surged 10.6 per cent, while the real interest rate was zero.
No wonder there was such a big rush into the real estate sector in those two years. Property prices, net of inflation, jumped 33 per cent and 38 per cent respectively in 1993 and 1994.
The next big jump in property prices was in 1999. But that was more a result of a rebound following the plunge during the Asian financial crisis in 1997 and 1998.
The next bubble came in 2007, when property prices jumped 29 per cent in real terms. But that bubble was pricked by the global financial crisis in 2008.
In 2010, recovering from the global recession, Singapore’s real GDP shot up 17 per cent. But in a bid to resuscitate the US economy, the US Federal Reserve flooded the world with liquidity. In that year, inflation in Singapore was 2.8 per cent while the one-year interbank rate was 0.625 per cent. Consequently, we had a negative real interest rate; that is, you lose money by keeping your cash in the bank. The amount you take out a year later will buy you less than at the time you put the money in the bank.
So again, money found its way to the real estate sector and the property index went up 14.4 per cent net of inflation that year.
But having experienced how painful it was to cope with the aftermath of a massive property bubble, the government was quick to act in 2010. In August that year, it announced measures to cool the property sector. More measures were introduced in 2011 and in 2012. As a result, private property prices edged up only 0.6 per cent in real terms in 2011. Net of inflation, property prices have actually slid so far this year.
So the question is: do we have a bubble now?
Well, here are some points to note from Charts 1 and 2.
One, after adjusting for inflation, the private property index is still below the peak registered in 1996. As at end-2011, the inflation adjusted index was 131 points compared with 140 points back in 1996.
Two, the STI has been more volatile than the property index. If we start both indices at 100 in 1987, the property index reached 292 points at the end of 2011, while the STI was at 237. Again, both indices have been adjusted for inflation.
Three, during that period, real Singapore GDP grew significantly. From a base of 100, it expanded to 487 points by 2011.
Chart 3 shows how real GDP, median household income and the private property index have moved since 2000. Median household income has tracked, if not gone slightly ahead of, the property index in the past decade.
So now we look at affordability.
Chart 4 shows the multiples of monthly household income required to amass a sufficient sum for the 20 per cent downpayment for a private property. For the median household, it would require 37 months of income in 2000. But this fell to around 30 months between 2001 and 2005. It then surged to 38 months in 2007, and is now at 37 months.
For households in the 70th to 80th income percentile, some 20 months of income is required for the downpayment – that is, under two years. It started at 21, fell to a low of 16.7 in 2005 and is now at 20.4 months. A condominium is used in this example. And its price is arrived at by assuming a 100 square metre condo, based on the median per sq m price as listed by URA statistics.
It would take 12 years of their entire household income for a median-income family to pay off their outstanding loan. This compared with 6.7 years for a household in the 70-80 percentile.
In terms of monthly mortgage payment, the 70-80 percentile income household would have to put aside 30 per cent of their monthly income to service the housing loan. One-and-a-half percentage points are added to the interbank rate to arrive at the housing loan rate.
From Charts 4 and 5, you can see that affordability was reduced in 2006 and 2007. Had it been allowed to continue, we would no doubt have found ourselves in a housing bubble. But the government acted, and prices moderated. Based on the numbers, I don’t think we can say we are in bubble territory.
But what if interest rates were to rise? Based on the numbers, housing loan rates would have to climb to 4.5 per cent before real estate investors with an 80 per cent loan would lose money on their investment – as long as current rental yields hold up. Not a big margin. But at a real interest rate of minus 4.6 per cent and with no sign of nominal rates rising any time soon, perhaps putting money into property is as rational an option as one can find. Barring, of course, any further property cooling measures from the government.
The writer is a CFA charterholder