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REAL ESTATE

It's all about the timing

Private residential properties have always appealed to investors but over-commitment through gearing at times makes them a liabiliy

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Economic shocks such as the global financial crisis in 2008-2009 impaired the homeowners’ ability to afford the mortgage payments, and this led to a significant drop in prices.

PRIVATE residential properties have always appealed to Singaporeans, as it is often perceived that they offer higher investment return than other assets, are less risky, and offer diversification benefits for those who can afford to invest in multiple assets.

This is especially true for those who make their wealth by investing in property at the right time. To some, private residential properties are assets that can better hedge systematic risks and are suitable for those who seek wealth preservation. This is especially so given Singapore's limited land supply.

The lumpiness of real estate and the cash reserves needed to purchase properties imply that many investors tend to become over-exposed in the market, with their residential properties accounting for a large part of their wealth. While residential properties are good assets to have, over-commitment through gearing at times makes them a liability. Additionally, investors who rely on the rental market to finance their mortgage payments may face problems, especially if there is a downturn and there are many units completing in the year.

Timing and animal spirits

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The private residential property market tends to be cyclical and this is evident in its booms and busts. First and foremost, prices and sales of private residential properties reflect the economic cycle.

Economic shocks such as the global financial crisis in 2008-2009 impaired the homeowners' ability to afford mortgage payments, and this led to a significant drop in prices. Separately, Singapore prices grew when the economy rebounded, aided by the buoyant growth of China.

Second, supply tends to lag demand. While demand reacts quickly to economic shocks, it takes time for new supply to adjust accordingly. The constraints on supply due to the lack of land availability or zoning ordinances, the financing of property purchases through gearing and the buyers' herd instinct further amplify the magnitude of the cycle.

The real estate cycle implies that the returns on residential property are highly dependent on timing. Examining the URA All-Property Price Index, buyers who purchased at the peak in Q2 1996 only managed to breakeven in Q2 2010, after nearly 14 years. If the buyers had sufficient financial capability to sustain through the troughs, they still earned 19 per cent capital appreciation over the span of 17 years. Notwithstanding, these buyers could still have benefited from collective sales, if the opportunity arose.

Separately, for those who purchased during crisis or lull periods when sales were low, the appreciation gains would be very significant. For instance, those who purchased during the SARS outbreak (Q4 2003) would have benefited from an appreciation of 57.4 per cent by Q2 2008, in a span of less than eight years.

The buyers during Q4 2003 were not affected by the global financial crisis, and they still managed to earn a return of 18.3 per cent. However, buyers are largely driven by sentiments and sales tend to be highest when prices peak.

Animal spirits, a term John Maynard Keynes used to describe the instincts, proclivities and emotions that ostensibly influence and guide human behaviour, are likely among the reasons why buyers and investors alike tend to enter the market at the wrong time. Nobel Prize winning economists George Akerlof and Robert Shiller chronicled how the residential market in United States was influenced by animal spirits. It is key to understand the motivations behind a home purchase, and investors should take a relatively contrarian approach.

How do we manage the risks?

Nevertheless, a homebuyer is largely driven by needs, and some buyers are forced into buying a property at the peak of a cycle.

At times, buyers overpay because of the need to stay near their parents, and their bargaining positions are weakened due to rising market expectations.

One strategy to ensure owner-occupiers are not adversely impacted is to plan their housing consumption ahead. Homebuyers purchasing for owner-occupation during the peak have to look for homes that satisfy their physical needs for at least the next 10 years, as the property market tends to appreciate given such a long horizon, as shown in the URA index.

Flipping: The underlying risks

Private residential properties are especially appealing to many during a rising market, as investors see it as an opportunity to flip the property and earn fast cash. Using subsales as a proxy for speculative flipping of homes, we find they tended to be most prevalent during the run-up in prices prior to global financial crisis and the sharp rebound after the crisis.

Nevertheless, the possibility of flipping was significantly reduced due to the government measures, such as the additional buyers' stamp duties and the Total Debt Servicing R atio framework. Hence, the number of subsales dropped significantly to below 200.

There are fewer speculators in the market, although there are many investors for residential properties with a three-to five-year horizon. Investors with a shorter horizon may enjoy large returns but they have to be able to read the market and navigate the uncertain external environment.

Those who did well tended to be sophisticated investors with a good feel of the market and of policy risk.

Rental reliance

One of the "trade secrets" to investing efficiently in private residential properties involves the use of rental income to finance the mortgage payments. Yet such investors are exposed to two risks: the volatility of interest rates and rents. With interest rates expected to go up, investors relying on rents have to monitor upcoming completions (supply) and economic growth. The vacancy rates and the number of private residential units completed are highly correlated, and the impact of the new completions on rent is a lagging factor as the market recalibrates to the new equilibrium.

Economic growth, in contrast, has a direct impact on demand for rental homes among expatriates and foreign workers. These segments account for at least 60 per cent of the transactions in Singapore based on anecdotal evidence on the ground.

Restructuring of the economy, coupled with the government initiatives to increase productivity, however, will impact rental demand of residential properties.

Investors who are reliant on the rental market need to purchase the properties with the tenants in mind, and understand the main employment clusters their tenants are working in. It will be great to be in developments near MRT stations, as this increases their rental catchment.

Thinking ahead: Exit strategy

Like in investing in all assets, investors in private residential projects need to consider their exit strategies. When and how to dispose of the properties should be considered with respect to one's financial conditions and likely changes in lifestyle in future. Notwithstanding, sellers have a plethora of information through online platforms to transact. When properties can be transacted online and information is available in real time, investors will be able to make better decisions. W