Of property options and market distortions

After months of trying to persuade private housing developers not to indulge in the continual re-issuance of options to purchase (OTPs) upon expiry, effectively allowing buyers to defer their purchase and payment, the authorities finally clamped down on the practice on Sept 28.

While the newly introduced restrictions on options are aimed at fostering greater financial prudence for buyers, the move also curbs use of a scheme that encouraged sales for developers.

Before the change in rules, a developer could keep re-issuing the OTP each time it expired, to the same buyer and for the same unit. This allowed buyers to avoid any forfeiture of the booking fee if they did not exercise the option within three weeks.

The re-issuing could go on for an extended period - say, six months, 12 months or 18 months, and in some cases even longer - from the date of the first OTP.

This could tempt buyers who lacked the upfront finances required to nevertheless commit to a property purchase in the hope that they would be able to secure the funding later.

However, given the recession and uncertain jobs market, some of these potential buyers could end up having to abort the deal eventually. They would then forfeit a quarter of the 5 per cent booking fee - amounting to 1.25 per cent of the property purchase price.

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"Purchasers should only commit to a property purchase when they are ready to exercise the OTP within the validity period," said Ling Hui Lin, the Urban Redevelopment Authority's Controller of Housing (COH), in the URA circular announcing the change.

Beyond urging financial prudence, industry observers expect the move to reduce distortions caused by the practice of re-issuing OTPs, which first surfaced after the July 2018 property cooling measures. Loan-to-value limits were tightened and the additional buyer's stamp duty (ABSD) for Singaporeans on their second residential property purchase was raised from 7 per cent to 12 per cent. This has to be paid upfront, presenting a cash flow problem for many HDB upgraders who want to buy a private condo (although they are eligible for a refund of the ABSD if, among other things, they sell their first residential property within six months of the completion of the second property).

To give such buyers more time to sell their HDB flat and marshall their financial resources before they exercise the OTP for their new private condo, some enterprising agents collaborated with a few developers to come up with the idea of continually re-issuing the OTP to such buyers - without any forfeiture of the booking fee - until the buyer is ready to exercise the option.

The scheme netted impressive sales for the developers, and in herd-instinct fashion, their competitors soon joined the bandwagon.

Some agents got carried away, using the scheme to hook financially tight buyers who felt they would lose out if they did not buy a private property right away. In a liquidity-driven market, savvy property investors and speculators also gamed the scheme, which they saw as providing a relatively low-risk entry into real estate.

It may be tempting for potential buyers to enter into a deal where they do not have to exercise the OTP within the stipulated three weeks of receiving the sale and purchase agreement from a developer who instead agrees to keep re-issuing the OTP for a fairly long period.

If during this period, property prices have appreciated, the option holder would be incentivised to exercise the option entered into earlier at a lower price. If the market goes down, the option holder may walk away by forfeiting 1.25 per cent of the purchase price. Property agents and developers have found this marketing strategy effective for chalking up sales.

However, the strategy is also thought to have had the effect of distorting developers' sales figures, since there is no certainty that all of the continually re-issued options would eventually be exercised, whereas the impression given to the public in the interim is that the units have been sold.

Initially, the scheme was offered selectively, mostly to buyers who had indicated they needed more time to sell their HDB flat before committing to a private condo purchase. By late-June this year, the incidence of re-issuing options had become widespread at some projects, market insiders told The Business Times Weekend.

The practice was one of the ingredients among a cocktail of factors - which also included low interest rates and pent-up demand after the two-and-a-half month period when showflats were shut during Singapore's partial lockdown to contain Covid-19 - that fuelled a surge in new private home sales from the second half of June to September.

Increased incidence

While there is no official data on the extent of re-issuance of OTPs, CBRE's head of research of Southeast Asia, Desmond Sim, says: "I think the occurence has probably increased and that has been brought to the attention of the authorities culminating in the Sept 28 circular from COH."

Agreeing, Alan Cheong, Savills Singapore executive director, says: "The re-issuance of options was not a bad thing initially but later on, it took on a life of its own."

Clamping down on the practice should reduce associated distortions - at least until market players find new loopholes to exploit.

CEL Development executive director Michael Ng says: "The latest COH action is not unexpected. It is to curb too much 'forward buying' activities which can lead to distortion in sales numbers and market trends. Overall, it prevents a false market - long options can mean potential default in sales, say, next year if the market weakens and developers will be left with much more unsold stock than anticipated."

DBS Group Research analyst Derek Tan, too, notes that selling properties on a re-issuance of OTP scheme can give a developer a "false sense of achievement".

Typically, when a developer has reached a certain level of sales in a project, it can anticipate cash flow coming in as buyers make progressive payments into the developer's project account based on the stages of the project's construction.

However, when a sale is done through an arrangement where the developer repeatedly re-issues the OTP over a prolonged period, the developer does not receive follow-through cash flow, beyond the initial 5 per cent booking fee - unless the buyer eventually exercises the OTP, says Mr Tan.

Mr Sim of CBRE says: "At the end of the day, if you remove the re-issuance of OTP situation, it gives a better conversion rate - that is, conversion of OTP to a true sale. The clampdown gives developers certainty of the sale, no matter how things transpire in the market.

"You need to be more certain. And especially in this kind of times, the performance of the market after a couple of re-issues may change drastically; we never know, especially the liquidity status of the buyer might change. Or even the pricing expectations might also change."

Not all developers liked the idea of continually re-issuing options to buyers. Even before the clampdown by the URA, the chief executive of a mid-sized developer recounted to BT Weekend the pitfalls of the scheme to a developer: "If the market goes down, and my competitor launches a project nearby at a lower price than mine, or for whatever other reasons, my buyer can just walk away from my project with the forfeiture of 1.25 per cent of the purchase price."

Still, even those developers who frowned upon the practice had to acquiesce to such requests at times - or risk losing buyers to developers who were more keen to indulge them with this scheme. Following COH's Sept 28 circular, most analysts expect some moderation in developers' sales as potential buyers do their sums more carefully before entering into a deal.

This, in turn, is expected to temper prices.

As DBS's Mr Tan, who expects developers to continue launching projects, says: "Previously, when developers achieved strong sales, they would raise prices for subsequent phases of a project's launch. That strategy may be off the table for now."

Based on URA's flash estimate, its benchmark private home price index rose 0.8 per cent quarter-on-quarter (q-o-q) in Q3 2020. This followed a 0.3 per cent q-o-q gain in the second quarter. The Q3 flash estimate reading of the index is up just 0.1 per cent from the fourth quarter of last year.

Outlook going forward

Savills' Mr Cheong expects prices to be flattish in the fourth quarter. "Next year, if there is no follow-through momentum in terms of recovery in the jobs market and household incomes, reality will come back to the fore and we may see prices starting to lose steam in Q1 2021.

"That said, any price reduction next year will be limited as long as developers still do not want to adopt a policy of chopping prices and dumping their units in the market, and assuming that there is no liquidity crunch in the credit markets."

Observers say that despite the overall economic slowdown and jobs uncertainty, several countervailing forces may continue to be in play in Singapore's private residential market. These include high liquidity, the low interest rate environment and continued foreign buying interest in Singapore property.

Moreover, some folks here may be in sectors that are still growing and, having benefited from strong income growth in the past decade, have the wherewithal to seize opportunities to buy their dream home or pick up an investment property.

JLL Singapore's senior director of research and consultancy Ong Teck Hui says: "Between 2010 and 2019, median monthly household income from work rose 48.6 per cent while property prices rose 10.3 per cent based on URA's private home price index. With income increase far outstripping home price increase, buyers find residential properties much more affordable today, compared with 2010. This is a major factor underpinning the current buoyant demand."

Tan Tiong Cheng, a retired property consultant and former executive chairman of Knight Frank Singapore, cites another reason that will give people confidence to buy residential properties here.

"When people see the government dedicating nearly S$100 billion to support businesses, workers and households since the start of the Covid-19 outbreak - and this must be one of the highest per capita globally - potential buyers are likely to conclude that Singapore's property market should improve. Or at least, it won't be worse off," he says.

CBRE's Mr Sim suggests that demand for new private homes will also be buttressed by a recovery in resale markets for both private homes and HDB flats. This will help to unlock capital for the purchase of new homes.

What next?

Property agents are taking the restrictions on re-issuance of OTPs in their stride.

Some have been busy over the past week, thinking of ways to potentially exploit loopholes under the new rules.

Meanwhile, developers continue to hope for a relaxation of cooling measures. These include allowing first-time upgraders from a HDB flat to a private property to defer payment of the ABSD till six months after the completion of the private property.

Some industry observers have also suggested bringing back the deferred payment scheme for uncompleted private housing projects.

CBRE's Mr Sim, however, thinks that any sort of tweaking of cooling measures will be put on hold, especially when the stability of the market seems to be countered by two quarters of price growth.

"These increases come during very challenging times; so that's why the authorities are concerned about the prudence of Singapore property buyers."

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