There was an article published recently in propwise.sg named “Residential Property: Why are investors still buying?” This article is a very one to look at the rationale of buying expensive properties and also demonstrates how investors can be as short sighted as the short term speculators. This is important because policy makers as well as economist tend to think if someone is not a flipper, he is a sound investor. But an investor is still a speculator and although his risk factor is lower than a short term property speculator, he may still be deceived by a long term distortion in the market and can perceive it as a norm without evaluating all possible scenarios before investing.
In the article there is an example given which involves a 1.02 million Singapore Dollars property transaction at Blue Horizon in West Coast Crescent. After paying 408,000 Singapore Dollars in cash (the writer serves to high net worth individuals) 25 years 60 percent loan translates into 2,040 SGD per month which is lower than the rental yield of 3,800 SGD per month the property generates. So the investor pockets a 7.3% cash-on-cash return which is 10 times higher than placing the 408,000 SGD in a fixed deposit income.
Nowhere in the article the writer considers the most realistic future scenario: current unrealistic and artificial low interest rates goes up and current ultra-high rents go down! (he tells us that the interest rate hike will be probably due to better economy in which rents will be higher). But we are in the year of 2 extremes now:
1) Current interest rates are not low, they are ultra-low! They will significantly go up in the near future; FED just cannot print more money to buy US debt.
2) Rents are not high, rents are currently ultra-high since there is a rental supply crunch and there was a fast foreign intake last few years. Rents will have pressure from large number of completed units of 2012-2015 periods (most will be rented out with the logic described above) and reduced number of foreign influx.
Current interest rates are lower than normal and rents are higher than normal. One just should not assume this is norm or a relatively unusual situation and it will continue like this in the near future. One should definitely not think this will be the situation in the next 25 years and he/she will have positive cash flow for years.
“People think they can afford an expensive flat with a reasonably cheap mortgage. Their dreams will burst and the flat will become unaffordable when the interest rate rises." The professor has a point. Variations in interest rates can mask or magnify structural affordability, which is measured by the Median Multiple. This is because interest rates are subject to fluctuation, while buyers and sellers do not renegotiate sales prices after the deal is concluded.”
Singapore Dollar Swap Offer Rate (SOR), a popular benchmark used for home loans hover around 0.2 per cent today but it was at more than 3 per cent just 5 years ago! A rise to normal (even without considering a sharp rise to higher rates from normal) can convert the positive cash flow to a negative one even the rents stay in this level.
Current ultra-low SOR rates translate into just 2,823 SGD per month for 35 years, 1 million SGD loan. If rates go back to 2006 levels of 4 per cent the payment rises to 4,300 SGD monthly![1] In fact rates can go up further since current ultra-low rates due to USA money printing machine will most probably result in ultra-high rates in the near future. Combine this with rental decreases, one can find him easily in red for years.
This mind set of perceiving current ultra unusual environment as a norm is very worrying. The Monetary Authority of Singapore (MAS) also seems worried about this unrealistic expectations of property investors (interest rates will stay low and rents cannot go down) so it wants home buyers to take a reality check before going into years long loan payments:
“A residential property loan is a long term financial commitment. The current low global interest rate environment will not continue indefinitely” the central bank warned yesterday. [1]
In june 22 2011, MAS has proposed that financial institutions (FIs) to provide a Fact Sheet, in a standardised format, when marketing residential property loans to consumers. MAS invited feedback on its proposal, which was published in a consultation paper today.[2]
“Specifically, MAS proposes that the Fact Sheet contain the following information:
a) tenor of loan, loan amount, lock-in period (if applicable), and whether the FI has the right to vary the interest rate;
b) Monthly and annual repayment amounts;
c) Monthly instalments at different interest rate levels and past trends in the benchmark rate of the loan;
d) Fees payable; and
e) links to Money SENSE-Association of Banks in Singapore (ABS) and CPF websites which guide consumers to online resources for information relevant to their home loan decisions.”[2]
But you should be the first one who does these reality checks even if your bank or property agent does not do it for you. 2008 financial crisis made it very obvious that as long as they get their commissions, specialists do not bother to look at or make you aware of all possible scenarios, especially these scenarios involves loss for you and can prevent sales (and commission they earn). I do not think they are different now, there is no reason for them to behave different.
[1] The Straits Times, MAS wants home loan facts spelt out
[2] MAS Consults on Residential Property Loans Fact Sheet
In the article there is an example given which involves a 1.02 million Singapore Dollars property transaction at Blue Horizon in West Coast Crescent. After paying 408,000 Singapore Dollars in cash (the writer serves to high net worth individuals) 25 years 60 percent loan translates into 2,040 SGD per month which is lower than the rental yield of 3,800 SGD per month the property generates. So the investor pockets a 7.3% cash-on-cash return which is 10 times higher than placing the 408,000 SGD in a fixed deposit income.
Nowhere in the article the writer considers the most realistic future scenario: current unrealistic and artificial low interest rates goes up and current ultra-high rents go down! (he tells us that the interest rate hike will be probably due to better economy in which rents will be higher). But we are in the year of 2 extremes now:
1) Current interest rates are not low, they are ultra-low! They will significantly go up in the near future; FED just cannot print more money to buy US debt.
2) Rents are not high, rents are currently ultra-high since there is a rental supply crunch and there was a fast foreign intake last few years. Rents will have pressure from large number of completed units of 2012-2015 periods (most will be rented out with the logic described above) and reduced number of foreign influx.
Current interest rates are lower than normal and rents are higher than normal. One just should not assume this is norm or a relatively unusual situation and it will continue like this in the near future. One should definitely not think this will be the situation in the next 25 years and he/she will have positive cash flow for years.
“People think they can afford an expensive flat with a reasonably cheap mortgage. Their dreams will burst and the flat will become unaffordable when the interest rate rises." The professor has a point. Variations in interest rates can mask or magnify structural affordability, which is measured by the Median Multiple. This is because interest rates are subject to fluctuation, while buyers and sellers do not renegotiate sales prices after the deal is concluded.”
Singapore Dollar Swap Offer Rate (SOR), a popular benchmark used for home loans hover around 0.2 per cent today but it was at more than 3 per cent just 5 years ago! A rise to normal (even without considering a sharp rise to higher rates from normal) can convert the positive cash flow to a negative one even the rents stay in this level.
Current ultra-low SOR rates translate into just 2,823 SGD per month for 35 years, 1 million SGD loan. If rates go back to 2006 levels of 4 per cent the payment rises to 4,300 SGD monthly![1] In fact rates can go up further since current ultra-low rates due to USA money printing machine will most probably result in ultra-high rates in the near future. Combine this with rental decreases, one can find him easily in red for years.
This mind set of perceiving current ultra unusual environment as a norm is very worrying. The Monetary Authority of Singapore (MAS) also seems worried about this unrealistic expectations of property investors (interest rates will stay low and rents cannot go down) so it wants home buyers to take a reality check before going into years long loan payments:
“A residential property loan is a long term financial commitment. The current low global interest rate environment will not continue indefinitely” the central bank warned yesterday. [1]
In june 22 2011, MAS has proposed that financial institutions (FIs) to provide a Fact Sheet, in a standardised format, when marketing residential property loans to consumers. MAS invited feedback on its proposal, which was published in a consultation paper today.[2]
“Specifically, MAS proposes that the Fact Sheet contain the following information:
a) tenor of loan, loan amount, lock-in period (if applicable), and whether the FI has the right to vary the interest rate;
b) Monthly and annual repayment amounts;
c) Monthly instalments at different interest rate levels and past trends in the benchmark rate of the loan;
d) Fees payable; and
e) links to Money SENSE-Association of Banks in Singapore (ABS) and CPF websites which guide consumers to online resources for information relevant to their home loan decisions.”[2]
But you should be the first one who does these reality checks even if your bank or property agent does not do it for you. 2008 financial crisis made it very obvious that as long as they get their commissions, specialists do not bother to look at or make you aware of all possible scenarios, especially these scenarios involves loss for you and can prevent sales (and commission they earn). I do not think they are different now, there is no reason for them to behave different.
[1] The Straits Times, MAS wants home loan facts spelt out
[2] MAS Consults on Residential Property Loans Fact Sheet
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