It is with some trepidation and reluctance that I venture into the topic of property investing, for Singapore is a country whereby its residents fall in love with property, and where most of the rich folk make their money from properties. Personally, I also know a few relatives who are sitting on very good rental yields on property which was purchased a few decades ago. With the steady and relentless rise in property prices, for both HDB flats and private properties, I think now has come the time for me to voice out my views on this matter. Firstly, it is to highlight the salient aspects of property investing; secondly it is also a “diary” of sorts to remind myself of my thoughts at this point in time (when property is hitting new all-time highs).
The Essence of Property Investing
Property investing generally differs from equity investing in one important aspect – it makes use of leverage and collateral to “multiply” gains. This is what I had observed in the majority of cases as Singaporeans are generally not cash-rich enough to purchase the entire property outright, therefore most will pay a downpayment of say 20% and finance the remaining 80% through the use of a bank loan. Since those who can fully pay for their properties are just a small minority, I can conclude that most people make use of leverage for their property purchases, and when it comes to property investing, most may already own 1 property (in which they live in), and are contemplating a second property purely for investment purposes.
Even with equities, one can make use of leverage (commonly known as “margin”) in which shares are used as collateral to purchase even more shares. However, this blogger has always discouraged the use of leverage in equity purchases because during good times, your gains are magnified; but during bad times, your losses are exacerbated manifold. The same scenario also plays out in property investing as leveraged is usually heavily employed. Assuming a S$1 million piece of property, the down payment will then be S$200,000, with the remaining S$800,000 financed by a bank loan.
Assuming that property prices go up amid bullish sentiments, the property is then worth S$1.2 million, and you can sell it to pocket a S$200,000 gain. Considering you only put down S$200,000 worth of cash in the first place, this translates into a gain of 100% on your initial investment! On the flip side, assuming the market tumbles and sentiment turns bearish, the property may be worth just S$800,000. Assuming you sell, you then incur a loss of S$200,000 which will wipe out your entire capital. This simple scenario did NOT take the cost of debt into account, and I shall elaborate on that in a later section.
Risks and Rewards
The risks are as mentioned above with regards to property prices, and these are similar to stock prices in that they can rise and fall. However, property is far more illiquid and there may not be a ready market out there, which means it may be hard to sell or the bid-ask spread may be large and significant. Another risk is that of the bank asking for the topping up of the loan quantum as the collateral (which is the property you purchased) has fallen in valuation. This is a risk unique to leverage as there is no such risk of topping up if you had paid up fully in the first place. So the important thing about buying properties is the ability to stomach such dips by having sufficient cash buffer, and also being able to buy and hold if things go wrong.
The rewards (positive) side of holding a property is that it is a tangible asset, unlike shares which are essentially intangible (i.e. scripless). This means there will always be value in a property, unlike shares which can crash to zero if the company goes bankrupt and needs to wind up. The value, however, is based upon independent valuations as well as last transacted prices, and can be unique to the area (location) and the tenure (whether freehold or leasehold). Another positive about properties is the ability to rent it out to earn rental yield. This is unlike shares in which the dividend yield is determined by the company and the economy at large. Of course, one can argue that tenants may be in short supply during periods of economic turmoil; and in extreme cases, rental income may also not be able to cover the monthly instalment payments assuming you had purchased close to the peak of the market cycle.
Interest rates are an aspect which property investors have to keep a close eye on, and much research needs to be done to ensure you get a good loan package; otherwise you may bleed more cash than is necessary just to service the loan. For HDB, they offer concessionary loan rates of 2.6% per annum, which has been “fixed” for the last couple of years. Most banks offer 2-year fixed rates (lock-in period) and thereafter start floating the rate, using SIBOR as a guide. The idea is to get a low interest rate on your mortgage and then re-finance once the lock-in period is over. It may be useful to look for a mortgage broker who can offer their services to hunt for the best home loan package to suit your needs, rather than to do the tedious homework yourself.
The often talked about threshold for affordability is that the debt servicing ratio must NOT exceed 35% of your total income. This is defined as the monthly payment amount divided by your total gross income (per couple). An example would be a couple earning S$10,000 a month – they should not service debt which is higher than S$3,500 a month, including car loans and other loans as well. Interest rates are currently at multi-year lows which makes many loans appear “cheap”, but take note that when rates rise in the near future due to inflation the impact on instalments may be quite significant. Do factor in potential rate increases to budget and buffer against such events and to ensure one is adequately covered and that the debt servicing ratio remains below 35%.
Conclusion: The Property Cycle
To conclude, one must be able to read the property cycle very well, as I had mentioned earlier that property involves leverage; and is also illiquid. Thus, one would really look to “buy low, sell high” rather than “buy high, sell higher”, as the risks are a lot higher for property compared to equities due to the two reasons mentioned.
With housing prices hitting new all-time highs recently, for both HDB resale as well as private, to me at least, it does not seem like a good time to commit to an investment property, even if one has the cash.
I would like to hear readers’ views on the property market and property investing. Is this really the way to make “big money” in Singapore? Have there been any cases of “horror stories” that you had heard? I will be blogging more about property in the months to come, as I read more and digest the news bits.