Sunday, August 21, 2011

Real estate sector in for a correction?

DO we have the making of a perfect storm in the real estate market?
High real estate prices, especially in the public housing market, was one of the hot button issues in the recent general elections. In response, the government vowed to spare no effort in slowing down the price ascent.

Various measures have been implemented to dampen demand. Higher stamp duties and tighter mortgage financing policies are just two of them.

Immigration policy, another hot political potato, has also been tweaked. It is now more difficult to get employment passes, permanent residency (PR) or citizenships in the Lion City. Among the stories I've heard: a Chinese owner of a few businesses in Singapore with a few properties under his name was rejected when he applied for PR or citizenship. Another practically grew up in Singapore, and now in her early 30s, is running a few of her own small enterprises. She too was rejected. A friend was sent by her Taiwanese employer from Penang to Singapore a few months back. Her application for an employment pass was rejected and she's appealing.

Foreigners or new citizens are big sources of demand for housing, be it for purchase or rental purposes. The tightening of immigration policy will further reduce demand for housing.

Meanwhile on the supply side, the Housing and Development Board is cranking up its apparatus to supply what is described as a pent-up demand for public housing. Just this week, the HDB said that it would be launching a record 8,000 flats next month to meet households' demand for public housing. It will launch another 4,000 Build-to-Order (BTO) flats in November, taking this year's total BTO supply to 25,000 units.

Next year, home seekers can look forward to another 25,000 BTO flats and some will even be in sought-after mature estates such as Tampines and Kallang/Whampoa.

'In two years, we'll be building an entire Ang Mo Kio town,' National Development Minister Khaw Boon Wan said. There are around 48,000 dwelling units in Ang Mo Kio.

'That's why I'm so confident that in three years' time, four years' time, when all these units start materialising, whatever pent-up demand of applicants, the problem would have been largely resolved,' he said this week.

Meanwhile on the private property market, the supply is going to be massive as well. As at Q2 2011, there were 57,520 units of uncompleted private residential units. That's some 22 per cent of the current total supply.

Some of the demand for this supply is likely to be siphoned off to the public housing market. Prime Minister Lee Hsien Loong announced over the weekend the raising of the income ceiling for those who qualify to buy HDB flats. So this group, who might otherwise buy private properties, now has the option to buy the cheaper public housing flats.

All these plans of course were made when the property market was still strong, and the global equity markets showed some semblance of stability.

The picture appeared to have changed drastically in the last two weeks, although the sudden change in sentiment can be said to be rather intriguing.

As a seasoned portfolio manager put it: 'This current sell-off is rather strange. The market knows about the sovereign debt issues in Europe and the US. The US debt ceiling issue had been hogging the headlines for months. I can't figure out the trigger for the sell-off that we have now. In 2008, nobody expected Lehman Brothers to collapse. So the panic then was understandable.'

Anyway, that's what we have today. Fear is back in the market. And where the stock market goes, so too the property market, maybe with a lag of two quarters.

From the first chart, you can see that a sustained decline in stock market will almost certainly result in the softening of the property market.

In addition, the stock market is also a leading indicator of the economy. If indeed the decline we are seeing is a harbinger of tough economic times ahead, then buyers will be more cirscumspect in deciding to part with their cash to buying big ticket items.

But of course the property market is not likely to decline in the same degree as the stock market. From its recent peak in October 2007 to its trough in March 2009, the Singapore stock market plunged by some 60 per cent.

The private residential property index meanwhile fell by about 25 per cent from the second quarter of 2008 to a low in the second quarter of 2009. That's a brief decline of just a year. But a 25 per cent decline in the property price is more than enough to wipe out 100 per cent of the equity an investor might have in his or her property.

Interestingly since then, the property index has risen above its 2008 peak - by about 14 per cent based on the Q2 2011 numbers. On the other hand, the stock market, as at Aug 1 before the sell-off in the last two weeks, was still 10 per cent below its 2007 peak.

So, might we see a bigger correction in the property market this time round? Again, it all hinges on how bad the bloodbath in the stock market is going to be, and its implication on the real economy. If the worst comes to pass, then the outlook for the property market is definitely less than rosy.

Meanwhile, I just want to update a chart I did two months back. It showed the total return for investment properties bought in the various periods and held till end 2010. I forgot to total up the rental income earned throughout the years in my previous calculation.

In the new chart, you can see that with the exception of those bought in 2008, private residential properties have yielded positive return for investors who bought any time since 1999.

The thing is, given the way the stock market is going, investors who got into the real estate market in the last four to five quarters may have to wait a while more to see any substantial capital gains on their investment.

So property investment, like in any other investment, is just as much about timing, timing, timing.

Just to recap, for the second chart, the return for the property investment 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.

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