Sunday, June 26, 2011

Property – Expectation Theory and The Perfect Storm

It’s been a while since I wrote something on property, since there was nothing really new or ground-breaking for me to comment on since Mr. Khaw Boon Wan (KBW) took over from the reins of Mr. Mah Bow Tan after 11 years at the helm of the Ministry of National Development. However, on June 10, 2011, Mr. KBW blogged about a possible “perfect storm” which may brew in 1-2 years time, and which may either cause the property market to cool significantly, or, in the worst-case scenario, crash resoundingly. He said that housing prices could not go up indefinitely, and cautioned many speculators and investors to do their sums carefully and to make prudent purchases to ensure they could hold in case of falling prices. The perfect storm consisted of three aspects: record-high land supply, possible drop in influx of foreigners (demand-side) and the rising of interest rates. I shall tackle each of these points separately, then offer a summary of my thoughts and comments.

Record Supply of Land

In response to runaway property prices and the frustrations of young couples yearning to purchase their first HDB BTO property, Mr. KBW has released an unprecedented number of sites for development of residential units. For 2010, there were 13,945 units for private homes but for 2011, it is planned that 17,510 units will be released to cater for the strong demand. This bumper supply is supposed to assuage the fears of Singaporeans who constantly complain that there are insufficient HDB flats for application. Their complaints are not unfounded though – some of the recent BTOs have seen over-subscriptions by up to 6 to 7 times the number of flats offered. With the injection of such a massive supply of land in such a short time, the Minister’s aim is that an equilibrium will be reached in terms of prices as demand will then be balanced by adequate supply.

However, some experts and veterans have been quick to point out that as a result of KBW’s zealousness in solving the problem of under-supply, he may have inadvertently pushed the property market into an over-supply situation. Keeping in mind that property cycles are longer than stock market cycles and that a lot of the price determination depends on Government policies (especially those relating to % loan quantum), the effects of such a significant supply of land coming onstream probably will only be felt in 1-2 years.

Falling Demand

With Greece facing problems once again and the USA’s economy stagnating after the effects of QE2 have worn off, it looks as though the world in general may face another prolonged and painful slowdown. The usual suspects embroiled in economic hell are Europe, UK and the USA; and it looks as though the problems will get much worse before they get better. If printing cheap money is the way to solve problems, then the USA would have solved their problems long ago! As it is, inflation and the falling value of the USD may precipitate another crisis in terms of lowered consumer spending; coupled with a stagnant housing market, this means the projected US recovery may falter and splutter for the next few years at least. Even China and India are not spared from economic problems, as they seek to tame runaway inflation and soaring property prices (in China and Hong Kong). China recently raised its banks’ reserve ratio to curb bank loans for property speculation, while Hong Kong has reduced the amount which can be borrowed for property from 60% to 50%, in desperate but vain attempts to rein in prices.

Assuming the troubles persist in Greece, USA and other areas of the West, this would have a spillover effect over in Asia as less foreigners will be sent over here for work attachments or seconded here for jobs. This will lead to a fall in demand for foreigners renting apartments. A sharp fall in demand may also be the result of a combination of the above-mentioned, coupled with a tighter immigration policy, especially after it was made known that the foreigner influx has been continuing unabated for the last 5 years; and which has resulted in a lot of discontent and dissatisfaction amongst Singaporeans.

Rising Interest Rates

Probably the worst whammy of them all – rising interest rates will hit property investors hard, as though they had been pummelled by Thor’s hammer. The problem, of course, is that interest rates have been hovering around historical lows for more than 2 years (since late 2008), so there is not much fear or trepidation among the masses that it may rise. This may explain the somewhat gung-ho and cavalier attitude taken by investors who are rushing to leverage and lock in the low rates for the next 2-3 years. The flood of liquidity has also further exacerbated the problem and 4 rounds of cooling measures have failed to dampen the demand for loans and property. This is because the measures have only tweaked the loan quantum % but have not affected the interest rates charged by banks, as this is by and large pegged to USA Federal Reserve rates.

Problems will most likely arise only after most of the current crop of investors’ lock-in periods have expired, which will probably be in 2012 or 2013 (assuming most loans were taken up in 2009-2011 and have a lock-in fixed period of 1-3 years). Once interest rates start to float, and with banks charging their usual 125 to 150 basis points spread, the rates charged by then could be significantly higher than what they are presently. If an investor only has to cough up say $2,000 in instalments at 1.5%, then this will more than double when interest rates hit above 3% once the world economy normalizes, and there is reversion to the mean in terms of long-term interest rates.

The Perfect Storm

Yes, I know the title sounds like a bad Hollywood movie on tornadoes, but remember that if this potent cauldron of three factors comes into play almost at the same time, it most likely will result in a crash in the property market. Though it is unlikely that all three factors will converge at the same time, what we do know is that supply will most definitely come on-stream, while demand may or may not taper off in 2012 and 2013. Interest rates in Singapore are unlikely to rise in the near future, but it is very hard to see past 2012 as the economic picture looks very murky and uncertain at the moment.

Expectation Theory

Expectation theory ties in with markets in general (not just property), and is rooted in psychology. In brief, it simply means that if market players anticipate and expect changes to the macro-economy which may impact their investments or their decision-making process, they would take immediate action to mitigate their exposure and minimize their risks. This means that technically, prices could begin to fall even way before any of the above ingredients which constitute the perfect storm actually come to pass; because people are anticipating the storm in advance and are simply reacting to it as quick as they can. Hence, pessimism and risk aversion can set in suddenly and without warning, and like a disease, can spread like wildfire within a short span of time and “infect” more and more people, resulting in either a slump or a mini-crash. We see this occur in fast motion in the equity markets, when a sudden turn of events or a change in mood can precipitate a sudden crash in stock prices. For the property market, I will liken it more to a slow-motion train wreck instead.

Another Sign of A Bubble - New players in Property Scene

In a further sign of possible exuberance in the property market, there have been a rash of new players entering the property scene, some of whom have had no prior experience. It is generally acknowledged that many new entrants flooding into property is a tell-tale sign of a possible market top, and so one should view such signs with immediacy and a sense of trepidation that things may go downhill soon. For starters, Ron Sim of OSIM has, in his personal capacity, bid for commercially zoned land in Paya Lebar and Punggol. JL Asia Resources (owner of K-Box) teamed up with Mary Chia to open Porcelain Hotel in Mosque Street; while Thakral Corp, an electronic goods distributor, has taken stakes in several property projects in Sydney and Melbourne. All these were recently reported in the news barely a month ago, and most property booms have led to companies jumping into the deep end to capture a slice of (seemingly) lucrative money-making opportunities. Whether or not this will end in pain and misery, I guess only time will tell.


So the perfect storm may indeed come to pass, and for those who are willing to wait till 2013, the answer may turn out to surprise everyone, as such trends are difficult if not impossible to predict accurately. With recent news that a new DBSS flat was being offered (by Sim Lian Group, no doubt) at $880,000 (Centrale 8 in Tampines), I too am beginning to wonder if the market is getting way too frothy for my own comfort!


Brian Chan said...

A nice take on the current economic situation. It's important to know where we stand now in the economic cycle. It's tough to find real bargains today, the market in general is in the range from fair to full value. To see the unusual suspects playing the property game suggests that they are 1) chasing for yields, 2) having too much excess capital, 3) in an environment where prospective returns are low, they are making up for the current inadequate yields - that cash generates - to adequate yields by putting the cash in a more risky proposition to boost returns, without taking the risk/return equation into consideration.

Well, that doesn't suggest the market would turn around tomorrow. A fully value market can get fuller tomorrow as long as there're buyers. But the more imprudent others conduct themselves, the more prudent we should be and wait for the elephant to come by, which sooner or later will happen.

Singapore Man Of Leisure said...

The pendulum tends to over swing to the left and right when it comes to policies...

When I read new entrants to the market, I was not expecting "institutions" too! LOL!

It reminds me of a "big" Xiamen supplier I was working with when I was in Shanghai. The owner made so much money out of property that he gave the day-to-day running of the factory to hired hands... We are a big account there but felt very "2nd class".

Which works well for us since this owner don't mind giving us good prices with razor thin margins - he is more interested to use our invoices to get more loans for his property foreys!

Musicwhiz said...

Hi Brian,

Haha yes indeed. It's good to be prudent and conservative when the crowd is going nuts. Though it can feel really bad when you "miss the boat". Not very sure if and when a property crash is coming. The last one was actually SARS as pointed out to me by someone.

Perhaps there is too much money chasing too few assets, and hence prices have gone up. Oh well.


Musicwhiz said...


Sounds like a classic bubble building. Then again China has had this "bubble" for so long now and prices are still moving up. It seems Hong Kong and Singapore are happily joining the fray too.

Not sure when the party will end (if ever), but I don't want to be left holding the baby!