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New normal for buyers, investors of residences
ON JULY 5, 2018, the Singapore government raised the additional buyer's stamp duty rates and lowered loan-to-value limits for residential property purchases "to cool the property market and keep price increases in line with economic fundamentals".
Taking into account rising interest rates and significant pipeline supply, the authorities felt that prices had increased sharply and, if allowed to persist, could lead to a destabilising correction. The decisive intervention by the government in the early stage of market recovery leads to several observations.
- Tolerance limit for price increases
The Urban Redevelopment Authority's (URA) private residential property price index rose 9.1 per cent from mid-2017 to mid-2018, with mild quarter-on-quarter increases of 0.7 per cent and 0.8 per cent for Q3 2017 and Q4 2017, respectively; but in Q1 2018 and Q2 2018, stronger q-o-q rises of 3.9 per cent and 3.4 per cent, respectively, were recorded.
It was after two quarters of stronger price increases that the government decided to cool the market with the measures. The inference is that quarterly price increases of 3 per cent to 4 per cent would be considered excessive. Keeping "price increases in line with economic fundamentals" may well mean that annual price rises may not be allowed to differ too much from economic growth. Real GDP growth in 2017 was 3.6 per cent while the average of the past five years was 3.4 per cent.
- Longer term implications
Figure 1 shows the compounded annual growth rates (CAGR) of private residential property prices for the different property cycles. The CAGRs are based on mid-cycle analysis in order to avoid the extremes in using peaks and troughs.
They reveal that as the market matures, the CAGR of each subsequent property cycle slows. It was 6.2 per cent between Q4 1982 and Q2 1993 but has slowed to 2.1 per cent between Q1 2010 and Q2 2018 (Table 1).
The only exception is the CAGR of 6.5 per cent for Q2 2007 to Q1 2010, which is an outlier, given the trend of slowing capital appreciation. The 2.75 years is also too short a period to consider in the analysis because the holding horizon for buyers would be at least five to 10 years or longer, especially with the seller's stamp duty in place.
The current mid-cycle is not known yet but if Q2 2018 is used for analysis, the CAGR for Q1 2010 to Q2 2018 would be 2.1 per cent which was affected by multiple rounds of cooling measures during that period.
The CAGR is a result of price increases during upcycles as well as price declines during down-cycles. Market cycle behaviour is such that upcycle price increases tend to be robust due to pent-up demand and higher transaction volumes. If upcycle price increases are to be kept "in line with economic fundamentals", then there is a likelihood of the market being interrupted by cooling measures during upcycles.
With price increases being subdued during the upcycle, the positive compensation against the price decline during the down-cycle will be reduced (although it is possible that a moderated increase in prices during the upcycle could be accompanied by a moderated decrease in the down-cycle). Therefore, if policy management of private home prices becomes a norm, the future CAGR of private home prices may be expected to decline.
What this means for buyers and investors
Investment value remains an important consideration for buyers of private residential properties, although it may vary between investors and owner-occupiers. Owner-occupiers would be satisfied if a decent capital appreciation can be achieved over the long term while their short-term focus is more likely to be on how their housing needs are met.
On the other hand, investors are more returns-driven and, traditionally, that has hinged more on capital appreciation and less on income returns. Low net yields on private homes of about 1 per cent to 2 per cent have been accepted by investors as they were compensated by stronger capital appreciation of 3 per cent to 6 per cent in the past, to provide total returns of 4 per cent to 8 per cent per annum. Going forward, if capital appreciation were to decline to between 1 per cent and 2 per cent, total returns would also decline to around 2 per cent to 4 per cent per annum.
What can investors do?
The residential leasing market is currently in early recovery, with moderated completion of new private homes estimated at 21,133 units between 2018 and 2020 - or 62.4 per cent lower than the preceding three years.
However, the recent land sales boom from mid-2016 to mid-2018 will result in a build-up of private home completions in 2021 and 2022 as shown in Figure 2.
Investors have to cope with the supply swings as well as leasing demand being constrained by policies on the hiring of foreigners, which will affect yield performance.
Some pointers for investors
- Be more discerning to maximise yields: In order to maximise rental yields, investors have to be more discerning in selecting their investment property. There is a need to better understand the fundamentals of the leasing market and where it is heading, including the profiles and budgets of tenants.
What types and sizes of units will be in demand? What locations will be more competitive? What attributes of the property will have greater appeal to tenants? It is important to avoid the pitfall of investing in a property simply because it is affordable. During a tough leasing market, it is survival of the fittest.
- Invest in early upcycle: The timing of market entry and exit is fundamental in any investment. Past property cycles were more forgiving of mistimed entries and exits, but when capital appreciation narrows as in the current market, this principle becomes more critical.
An analysis of transactions in the price upcycle from Q2 2009 to Q3 2013 shows that 60 per cent of them were made in the late cycle during the last quartile of the price increase for the entire upcycle, that is, buying close to the peak.
Further analysis shows that 19 per cent of the transactions in that upcycle suffered capital depreciation until Q2 2018, while 48 per cent had low capital appreciation of between zero per cent and one per cent per annum until Q2 2018. (This was computed using the URA private residential property price index and data on units sold in URA Realis time series.)
This analysis would help buyers and investors better appreciate the importance of investing during the early upcycle or late down-cycle.
- Assessing the current market: After the announcements on July 5, 2018, many buyers and sellers would pause to take stock of the market, and the transaction volume is expected to ease while asking prices are likely to be tempered.
There are two likely possibilities in terms of outlook. A more positive scenario is that the July 5, 2018 measures succeed in moderating price increases to a much lower magnitude compared to Q1 2018 and Q2 2018 and the market continues its upcycle at a gentler pace.
The negative scenario is that the measures lead to a correction in prices, causing it to trend downwards. This scenario is possible if the macro environment deteriorates due to the trade war, the negative impact from interest rate hikes or other adverse developments.
Market watchers will be monitoring closely the third and fourth quarters of this year, for possible indications of where things are heading.
- More challenging for investors, possible advantage for owner-occupiers. The analysis in this article shows that investors will face more challenging times in order to invest well in the private home market. However, with greater clarity on capital and income returns, investors would be better informed in making their decisions.
A market regime that is more controlled and managed could potentially benefit owner-occupier purchasers, especially first-time buyers, as slower price increases could keep private homes within their limits of affordability. The trade-off of lower long-term capital appreciation might be acceptable to many for the ability to own a private home more easily.
The writer is national director, research & consultancy at JLL Singapore.
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