Thursday, February 14, 2013

Sky Habitat's Crash Landing - Part 4

This is a continuation of a series of posts analyzing the Singapore property market. Interested readers can start from the first post.

We talked about valuation in the last post. We shall examine where the "right prices" should be for Singapore property and what if this blogger is completely wrong.

By "right prices" I mean when prices become less than intrinsic values and hence if we buy, we stand to protect our capital and hopefully earn a decent return. As with the most simple stock valuation method, we need to come up with a good earnings estimate then multiply it by a multiple. In property space, this translates to estimating a good sustainable rental income, multiplied by a multiple, or inversely - divided by a reasonable yield.

To use a specific example, we use our favourite development: Sky Habitat. Say we think that Sky Habitat can rent out at $4psf per month. ie annual rental is $48psf but after taxes and expenses we are likely to get to $40psf. And we think that a reasonable yield should be 4%. So this means that Sky Habitat's fair value should be $40 / 0.04 = $1000 psf. So at $1400psf today, it has to decline another 40% in order to become palatable to value investors.

Now how do we justify these no.s? Why $4psf? Why not $5psf? And why 4% yield and not 1% like Monaco? I have always advocated that investment is an art, not a science. These no.s are merely one set of assumptions. Well we can always explore a couple of ways to triangulate to a real and good sustainable rental and a reasonable yield.

Yield is easy, so let's start with that. Singapore's own historical range is 2-5%. 2% yield today points to super ex, and 5% in 2005 was when nobody talked about property. Globally, as shown on the previous post - 4% looks like a good average yield, with some margin of safety. You can argue using 3% too, but that is not being conservative and hence not giving yourself that important margin of safety. So I would use a 4% yield.

Let's look at rental. How do we come up with the right long term sustainable rental rate for Sky Habitat?

One easy way is to look at rental across Singapore.

River Valley $4-6psf
Orchard $5-6psf
Current Bishan $3+psf
MRT locations $4-5psf

So where should Sky Habitat be? I give it $4psf. Well some might argue for $4.5psf, or maybe $3.5psf but I shall leave it to you to work out the ranges. Remember this is an art!

Another good starting point would be our GDP per capita. Singapore's GDP per capita currently sits at SGD 80,000. This represents the average pay of a worker in Singapore. From here we need to work out what is the comfortable rental that a worker would pay. Yes most Singaporeans have a place to stay and won't rent. And most expats who would rent don't just earn SGD 80,000. But, this is the most easily accessible number so we start with this. Super eng readers (those with lots of free time) can go singstats and dig out better no.s. But do update us here!

Let's say this hypothetical average worker and his hypothetical wife also earning average pay is comfortable with using 30% of their annual combined salary ( of SGD 160,000) to pay the rental, this works out to be SGD 48,000. Assuming they are comfortable living in a 1,000 psf condo and not Mickey Mouse's toilet, this would mean that they can pay $48psf per year, or $4psf per month. So qian right? (As in such a coincidence!) $4 psf is a rental level that can be supported by an average household earning our average GDP per capita.

Well, we could always tweak the assumptions. Say Bishan should not just attract an "average" worker but an expat household earning SGD 200k. So the household income is higher, which can then support a higher rental, which leads to a higher intrinsic value. Investment is an art. So use your own liberty and artistic skills.

But no matter how you tweak, you will probably find it very hard justify $1700psf is Bishan's true intrinsic value. Not today, at our current GDP per capita, at our current rental and yield levels.

It can only happen if we push the yield very low. Remember global rental yield has a 1-9% range?

Just to make things clear again, there are 2 variables here. Rental and yield. In order to justify a high intrinsic value, you either push up rental, or push down yield or both. So to justify $1,700psf, you can argue that Bishan rental should be $5psf (ie $60psf per year or 60-70k absolute annual rental!) and yield should be 2%. So $60 / 0.02 gives you $3,000psf. So $1,700psf is now cheap! Buy Sky Habitat! Buy 2 units at one go! Wait maybe should buy the whole floor!

Ok, need to be serious.

This point on the yield actually leads me to the next important topic. What if all I have analyzed is wrong? Singapore becomes a Monaco and our yield is forever at 1-2%. This is not an impossible scenario. As we looked at the charts on previous post. Most key Asian cities have low yields. Shanghai, Taipei, Hong Kong are at 2-3%. (Though none at 1%, Monaco is still the lowest.)

In investment, you need to bet in a way such that you don't get killed if you are wrong. Nobody gets it right all the time. In fact the best investors gets it right about half the time only. So don't do silly things like selling your only home into this market or go short $300k of Capitaland. A good way would be to buy long dated puts on City Dev, or Ho Bee for that matter (this is for advanced readers here) or simply wait for property prices to collapse and then buy or upgrade to that dream condo.

But back to Monaco. Will Singapore become Monaco? And hence property rental yield is forever at 1-2% (currently it is about 2-3% which translates to 50-100% upside for here!).

This will happen if that is what our beloved Government chooses or what happens if the rich property-vested Singaporeans' opinion overwhelms that of the rest. Singapore becomes the Monaco of the East. A tax haven, a safe city for the region and a playground for the global rich to park money. We now have F1, casinos and yacht harbours, just like Monaco. Damn it, even our flag looks similar! Why not property yield?

Flag of Monaco

It can happen. I am not kidding.

But it will be a sad day for Singaporeans because our kids will never afford their own homes, and the majority (sorry actually Singaporeans will become minority since foreign talent will be more than 50% of the population when it hits 6.9 million) of Singaporeans will become slaves in their own country, working hard, earning relatively ok money but yet unable to afford anything.

Fortunately, recent Government moves sort of mitigated this. Property prices have become a political issue and the government seemed quite determined to bring down prices. And yes the white paper probably wouldn't fly given all this backlash. Let's hope that Sky Habitat lands safely.

The full series:
Part 1
Part 2
Part 3
Part 4
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