When it comes to asset allocation, how much property is too much?

Is property investment sustainable for long-term financial health? How big a role should it play in providing for retirement? We ask the experts.

Published Wed, Nov 18, 2020 · 09:50 PM

Roundtable panellists:

Moderator: Siow Li Sen, senior correspondent, The Business Times

PROPERTY ownership is, much like food, a bit of a Singapore national obsession. But just as overindulgence with food can be unhealthy, is it sustainable for our long-term financial health if we spend our weekends visiting showflats? In terms of asset allocation and, even more critically, how big of a role should real estate play in providing a stable income stream for retirement? We ask the experts.

How much should property or real estate form in one's asset allocation?

Alfred Chia: It really depends. In Singapore, we have very high home ownership of more than 90 per cent. It is a very important asset class and big liability if there is mortgage loan tied to it. Here are two scenarios to consider.

Scenario 1: An ordinary salaried worker owns a Housing Development Board (HDB) flat worth S$500,000. He has very little cash savings and only S$50,000 in his Central Provident Fund (CPF) Special account. Property will form 90 per cent of his entire assets. While he should start saving in cash, he may not be able to do that effectively due to other commitments. If his housing loan is S$100,000, his net worth will be S$450,000.

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Scenario 2: High-income earning couple owns two properties worth a total of S$3 million. They have cash savings, CPF, Supplementary Retirement Scheme (SRS) and equities worth a total of S$1 million. Property will form 75 per cent of their entire assets. If their housing loan is S$2,000,000, their net worth will be S$2,000,000

Christopher Tan: Unfortunately, there is no absolute answer for this. Real estate is an asset class that can give both income and capital growth. It also hedges against inflation.

However, since the potential high return from real estate really comes from leveraging, this makes investing in real estate risky. So the decision on how much real estate one should have in his total portfolio will depend on two factors.

Firstly, from the investment perspective, one should not hold so much real estate that it forms the majority of one's overall portfolio. They will be taking too much concentrated risk.

Secondly, from the financial health perspective, in holding real estate, your total debt-to-asset ratio should not be more than 50 per cent. In addition, your total debt servicing ratio should not be more than 40 per cent.

James Cheo: The global pandemic has resulted in the sharpest economic contraction on record. However, asset markets have held up surprisingly well and better than might be expected given the size of the downturn. The swift and big intervention by central banks and governments has supported risk assets and put a floor under their prices, including real estate.

At the current juncture, we have a broadly neutral allocation to global real estate. We recommend moderate-risk investors to hold about 3.3 per cent of their portfolios in global real estate, while a higher risk investors can hold up to 7.4 per cent.

Within global real estate, we have preference for industrial and logistics sector, and a lesser preference for retail real estate.

Evy Wee: Owning a residential property is still seen as a sound investment for most Singaporeans, even after the implementation of cooling measures such as the Additional Buyer's Stamp Duty (ABSD) and Total Debt Servicing Ratio (TDSR).

With the ABSD, the opportunity cost of owning a second property has gotten higher. Although real estate might not be as attractive as before the anti-speculation measures were implemented, it is still a viable asset class and could still form part of an asset allocation strategy.

Historically, residential property has yielded returns higher than inflation. And, depending on the timing and investment horizon, the return from property investment might have exceeded that of some shares.

Real estate also helps to diversify an investor's portfolio as it is less correlated to traditional asset classes. However, there are several factors to consider before buying a property, which is a big-ticket item for many people. These factors include affordability, lack of liquidity, transaction costs, and sustainability of rental yields.

Angie Lee: For an Asia-Pacific (Apac) client with a balanced risk profile, Credit Suisse's strategic asset allocation (SAA) currently recommends 5 per cent in global real estate investment trusts (Reits) and another 5 per cent in private equity funds, which can include private real estate.

Credit Suisse's outlook on real estate is that listed real estate is expected to continue to benefit from low interest rates for longer, though structural challenges have intensified due to Covid-19. We expect a total return for listed real estate in developed markets of around 5 per cent over the five-year horizon.

The US is one of our preferred developed markets, supported by favourable sector exposure. We expect Asia Pacific and emerging markets to deliver the best performance, as they should benefit from stronger economic growth relative to developed markets.

Closer to home here in Singapore, we expect real estate equities in the Apac region to return 6.5 per cent per annum over the next five years, driven by strong economic growth and a relatively high dividend yield of 4.4 per cent. Singapore real estate equities are expected to deliver a return of approximately 7 per cent per annum over the five-year period.

Kelvin Goh: Typically when it comes to investing, we would not usually consider property as part of one's asset allocation. However, mortgage payments would certainly factor into an individual's expenses and be a consideration in financial planning.

If I use the mortgage servicing ratio as a guide, it should not be more than 30 per cent based on the Monetary Authority of Singapore's guidelines. That means the individual should not spend more than 30 per cent of their gross monthly income on mortgage payments.

I would rationalise that, given the Covid-19 situation, the increased odds of a potential job loss and the longer runway that may be needed to find another job, you should budget for a significantly lower mortgage payment and deploy cash as far as possible.

Jacquelyn Tan: Real estate can form part of a diversified investment portfolio. Real estate has low correlation to other asset classes such as stocks and bonds and has lower volatility in comparison with them.

As an investment, real estate also offers a stable albeit slow rate of return over the long term. As part of UOB's Risk-First approach, we advise that investors consider the risks of any investment over returns, focus on core investments to protect and safeguard their assets before taking on more tactical investments.

Can property provide a stable source of income during retirement?

Alfred: Continuing on from the two scenarios mentioned before, here is what will likely happen.

Scenario 1: Property will be this individual's major asset. As long as he has paid up his mortgage by age 65, it can be monetised for his retirement through renting any spare rooms, right-sizing the property to a smaller one, and making use of the HDB Lease Buyback scheme.

Scenario 2: Properties are assets in which the couple has chosen to invest. As long as they have paid up mortgage by age 65, they have a place to stay in while collecting rental income from the other. Combined with their financial resources, they will have a very comfortable retirement.

Christopher: Generally speaking and of course depending on the quality and location of your property, it can indeed provide a stable source of income during retirement. Many of our clients hold real estate and we integrate it with their total retirement portfolio together with their CPF, bonds and equities to give them a reliable stream of income throughout their retirement years.

James: We advocate a multi-asset income portfolio with diversified income streams to meet investors' needs. A well-diversified portfolio is needed not only to generate income but to preserve capital.

There are various income streams investors can use to build income portfolios. To construct a resilient income portfolio, investors have to combine income from bonds, equity dividends, and income from alternative assets. Real estate - whether from Reits or income from property - is one such income source for portfolio construction.

Angie: Rental yield, along with other dividend yields from other asset classes, certainly form a stable source of income during the golden years. At Credit Suisse, we offer investors a suite of investment products which include private-equity fund solutions covering the real estate space.

In 2020, we continue to grow our real estate book as we successfully launched a private Reit with one of the largest property investors and owners, which offers an interesting yield to our clients in a volatile market.

The stable monthly distribution of this solution in a low-yielding environment was an important consideration for our Apac clients who continue to be very income-focused.

Evy: The classic formula of owning an investment property is to make money through holding and renting the property while it appreciates, then selling it for a profit or leaving it as a legacy for our beneficiaries. When this is done via leverage - that is, using a small amount of our own money while borrowing the rest - it can be an attractive proposition for accumulating wealth.

Real estate as an asset class also acts as a diversifier in an investment portfolio. The rental flows from investment properties can provide a stable source of income during retirement, as most tenancy agreements are renewed every 12 or 24 months.

However, the sustainability of rental yields is dependent on various factors such as the economy, the property's location, amenities and rental demand. It is prudent to expect challenges such as rising mortgage rates and fluctuating tenant demand, and avoid relying solely on rental income during your golden years.

Do set aside sufficient financial resources to cushion you in the event that your rental income is unable to cover the running costs of the property such as the mortgage, maintenance and repair costs. And be mindful to review your housing loan package when the opportunity arises, and have an exit strategy.

Kelvin: For a retiree who has paid off their investment property and can enjoy regular monthly income from a rental unit, this notion certainly holds true. However, if there is one thing this year has shown us, it is that traditional assumptions can be thrown rapidly out of the window. In the case of rentals, what happens when your tenant loses their job, is unable to pay their rent, and has to move out?

Based on selected property websites, the typical property rental yield in Singapore is around 2-3 per cent. There are other viable investment and income alternatives for investors, given this pay-out range and the liquidity risk involved for a property investment, especially if you are tied down by a huge mortgage.

Property is practically a national obsession. Is this sustainable or healthy for one's financial planning?

Alfred: Property has proven to be a very good asset class in Singapore. While we always say "past performance is not a guide to future", it is also a vote of confidence in Singapore as a stable country with stable economic growth. For example, some key reasons foreigners purchase expensive properties in Singapore are to preserve their wealth and legacy planning.

Another reason why property is a very high-performing asset class over years is the leverage effect.

But when it comes to loans, it is also a double-edged sword.

Property investors need to recognise the risks: What if due to economic crisis, tenants cannot pay the rental? What if investors lose the ability to service the loan? What if there is a spike in interest rates?

It is very important to conduct prudent financial planning and risk management.

On that note, the government does recognise this and they try to ensure a stable and sustainable property market through property cooling measures. The impact of a runaway property market will be unimaginable.

Another important policy is the TDSR Framework, to ensure prudent borrowing and lending.

Christopher: In my opinion, as long as one does not overly depend on one asset class and does not overly extend their borrowing such that it makes them financially unhealthy, it is a good asset class to hold.

However, this seems to be unlikely for most Singaporeans.

Given that the median household income in Singapore is about S$9,000 per month, it is not easy to be able to own two or three properties (including residential property) and, at the same time, remain financially healthy and have a well-diversified portfolio. So the property investing game is really for the wealthier families.

But wealthy or not, investors should consider other asset classes such as Reits and equities that can give them the returns they need without compromising their financial health.

James: There is a role for property in investors' portfolio. However, due to the illiquidity and chunkiness of each property investments, there are constraints and limitations. For example, with limited capital outlay, it is difficult to achieved a globally diversified physical property portfolio, as each property requires a sizeable capital outlay coupled with stringent tax rules. Achieving global diversification is challenging purely by owning physical properties.

Kelvin: From the number of Facebook ads touting the benefits of owning as many properties as possible, I would say it is an unhealthy obsession.

It is important to keep in mind the need to manage one's finances well, especially with what is usually considered the biggest expense in one's lifetime. The debate over 99-year leasehold HDB flats show that there may have been some misguided thinking by those who bet big on old flats in prime locations, hoping the flats' leases would magically renew.

Last year, our inaugural OCBC Financial Wellness Index survey indicated that 73 per cent of Singaporeans are not on track with their retirement plans. Given that mortgage payments tend to occupy a significant part of one's salary, and with a decent proportion using CPF to supplement these mortgage payments, there is a direct impact on retirement planning.

The CPF Board indicates that about half of its active members are using their CPF for mortgage payments. And if you add the fact that CPF accounts currently yield a 2.5 per cent interest, it is a significant opportunity cost on retirement planning, especially when compounded over time.

It is also important to note that the property and rental market is cyclical in nature. There are peaks and troughs. Property investors may well retire at the most inopportune time within a cycle, which means they may potentially incur losses at a time when they need their money the most.

Are Reits a better alternative to being a landlord?

Christopher: Reits are better alternatives to physical real estate on many counts. They are more liquid, lower cost and easier to access. When you invest in a basket of Reits, you are investing in a well-diversified basket of real estate in retail, commercial, office, hospitality sectors.

In addition, unlike being a landlord, there is no need to manage tenants - which can be a real pain especially in your retirement years and if you like to travel in your golden years.

Reits typically have a distribution rate of about 4-5 per cent and have been able to deliver some capital appreciation along with the relatively stable distributions. As measured by the FTSE ST Real Estate Investment Trust Index, total annualised returns from Feb 2009 to Oct 2020 are around 7.5 per cent. This puts Reits in between equities (as measured by MSCI AC World) and bonds (as measured by FTSE World Govt Bond Index 1-5 years).

Still, investors like owning real estate as it gives them the psychological satisfaction of being a real property owner, which they cannot get from investing in Reits.

Having said the above, since the risk-versus-reward characteristics of Reits is between that of bonds and equities, how much Reits one should hold in their portfolio depends on whether they are investing for income or as part of their capital growth portfolio. It is not uncommon to see investors who are investing for income to hold 40-50 per cent of their portfolio in Reits.

On the other hand, for investors holding a diversified portfolio for growth, they may hold between 10 per cent to 20 per cent of their portfolio in Reits, depending on their risk appetite.

Kelvin: Reits are listed companies which operate and manage properties. Investing in Reits allows one to, in a way, own part of a shopping mall, and get access to the rental income stream of the tenants within the mall, as well as specialised property management experience. So you can be detached from the day-to-day activities of running the properties in the portfolio, while receiving a steady income stream.

Reits offer investors a liquid vehicle through which to invest in income-generating real estate without having to own the actual illiquid properties, and it is certainly more affordable.

However, Reits come with their own set of risks, as can be seen by the recent closure of major retailers. Should the retailer not be replaced, the cash flow could be lost and this will result in a drop in the distributable income the Reit pays out.

As Reits are also highly-geared, a spike in interest rates will have implications on the price of the Reit. And just like any other investment, you are subject to price risk should anything untoward happen to the Reit in question, which can run from poor management to a pandemic - such as the one happening now.

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