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

1. Thanks for the excellent article. It is not easy to have a cool mind when the property market are red hot.

Recently there is another article from economist mentioned that Singapore property is 50% overvalued.

Below is the URL for your reference:
http://www.economist.com/news/finance-and-economics/21569396-our-latest-round-up-shows-many-housing-markets-are-still-dumps-home

2. Hi Ziyang, thanks for the compliment and for sharing the URL! Do drop by more often and help share this blog with your friends!

3. didn't realize that GDP per capita = average worker's pay...

on the other hand, there is nothing to stop 4% become 1%, they are relative figures w/ bank interest rate.

4. Hi Unknown,

You are correct in a sense that disposable income should be the one that we use. But as mentioned, other no.s are hard to come by, hence the easiest no. is GDP per capita. The following is from the OECD website.

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Both measures (refer to GDP per capita and disposal income) are compiled according to the definitions of the 1993 System of National Accounts. There are, however, practical difficulties in the measurement of the additional income components, such as remittances, that make up the difference between GDP and dispo-sable income (including adjusted). It is for that reason that GDP per capita is the most widely used indicator of income or welfare, even though it is theoretically inferior, in that context, to measures of disposable income.

--------

On whether yield can go to 1% or not, again you are also correct, it is not a theoretical impossibility. I hold the view that while it IS possible, it is also unlikely because of the social and political consequences. And if it does happen, ie I am wrong. That as I mentioned, it will be a very sad day for Singapore as all our kids will never own their homes (they would need disposal income of SGD 320,000 at least) and we will also undoubtedly become minority in our own countries, as only the rich foreigners are buying up Singapore.

I truly hope we never get to Monaco's 1% yield. Really.

Cheers
8%

5. Latest update: Sky Habitat is just 29% sold of 509 units as of end-Jan 2013.

Data from:
http://sbr.com.sg/commercial-property/news/capitalands-dleedon-mega-project-presales-surged-five-fold

6. U forgot the L word. Leverage.

7. Hi , nice write up but I think you are missing the Killer Punch ! when it comes to looking at Singapore property and that is how fast buildings age !

Basically we are living in a jungle that we have cleared, but the jungle is trying to take the land back again, buildings age fast here and coupled with poor construction depreciation is a killer.

Assuming the market stays flat , over 10 years a new building will become an old builkding and the price will drop and rents fall assuming there is no change in the price of a brand new property.

Consider the following 3 properties all within 100 meters of each other and all considered very nice luxury stylish desirable properties when brand new

aspen heights top 2000 , price now 1450 psf rent 3.75 psf
The imperial top 2006 , price now 1850 psf rent 5.5 psf
Belle vue top 2011 price now 2,300 psf rent 6 psf

So over 10 years a building in river valley area will probably drop by 40% from new with nothing else happing

Now the 2% rental yield looks even worse given price dropping 4% a year

even monaco would be better , dry climate and well built property that even 100 years old trades at the same price as new means your 1% is ahead of the true singapore yeild

And also remember that with the rent dropping as the building ages if prices dont change your yiled on purchase price will soon drop to 1% anyway ....

8. GDP per capita is not even close to national average disposal income per person. Think about it, so many people live in HDB where total household incomes cannot exceed 10k per mth when they first bought their flats from the govt. We know salaries have seen stagnant to little growth due to massive influx of cheap FTs..even if we assume all households make 10k, average salary person is 5k or 60k per year. Take away taxes etc, we are left with closer to 50k.

9. Hi Jay Chan,

I just stumbled onto your blog today and read through all 4 parts of your analysis on Singapore's property market. It was easy to make the decision to add you to my blog-list because your blog is one in which readers will find worthwhile to read.

Like you, I too veer towards stocks rather than property. But unlike you, I do not have the keen insights you have on property.

I avoided property mainly because it is hard to manage risk with property investments compared to stocks. A middle-class Singaporean like me can at most purchase 1 more investment property. No diversification. On top of that, the purchase has to be made with leverage. In addition, property is illiquid in nature. With a portfolio that is super-concentrated (only 1), highly leveraged (at least 4 to 1) and illiquid, how to manage risk? How to avoid financial disaster when things go wrong? Yet so many middle-class Singaporeans have done just that. Although the value of a property does not fall to zero like some stocks, the property market poses huge systemic risks when it crashes because it is perceived by many Singaporeans to be low-risk, hard-to-lose bets.

My steadfast refusal in shunning property has led some acquaintance to brand me as a loser who will never get rich. Nevertheless, I would rather miss the opportunity to get rich than to take the risk of becoming poor.

Do you face similar situations among your peers? Are they also mostly in favor of property?

10. Hi hyom^2

I think anyone should at least own one property - the one that we live in. That way we are at least neutral and not short the property market.

Property as with all investment makes sense when the valuation is right. ie when it is cheap. As I have described in my posts, Singapore property is way over the top now, and is hence very risky.

I think your points on property being big ticket, illiquld, leveraged are all valid. They magnify the wrong decision badly - ie when bought at a high price, the fall will be twice as hard.

But when bought at a cheap, property can also help you grow your wealth fast. In the end, it boils down adhering to a strong value philosophy and understand valuation well.