Market may be in state of denial

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Business Times - 23 Sep 2010

Market may be in state of denial

KELVIN TAY looks at how the new measures introduced by the government will affect residential property prices here

THE 1980s witnessed one of the most spectacular property bubbles in modern history. It was brought on by a combination of a buoyant Japanese economy, the forced appreciation of the Japanese yen by virtue of the 1985 Plaza Accord, and low interest rates. The mixture was so potent that, at its height in 1989, prime properties in Tokyo's Ginza district were being sold for $125,000 per square foot (psf).

In 1991, the Japanese property market bubble burst spectacularly and almost 20 years later, the market remains moribund. More recently, the collapse of the US housing market brought capitalism to its knees in October 2008, with the resulting de-leveraging ramifications still being felt in the global economy almost 24 months later.

Although some market observers are still debating whether there is a bubble in the Singapore property market and therefore a need for price stabilisation measures, the fact that there is such debate is already proof of a pie in the making. As of the second quarter of this year, the HDB resale price index was 18 per cent above its previous peak in 1996. Prices in the mass market segment of the private residential market are as much as 23 per cent above its previous peak in 1996 as well.

In fact, the HDB resale and mass market segments may currently be in a state of denial - that prices will keep rising forever, a fundamental myth of asset bubbles. During a bubble, people generally believe prices would not fall. Although this has been proven wrong so many times in the past, many have not learnt from the past. And very often, homeowners are often the biggest victims of any property bubble.

It is with these thoughts in mind that we view the latest round of government policies to stabilise property prices in Singapore with relief. This is especially so as the recent run-up in property prices in Singapore has been concentrated largely in the HDB resale and mass market segments of the private residential market, where the majority of Singaporeans reside.

Most of the policies that were introduced three weeks ago are targeted at the HDB resale market, which in turn underpins prices in the mass market segment of the private residential market. Any decline in HDB resale prices will in turn affect the private mass market segment and vice-versa. The measures are broad-based, targeting both market demand and supply, with the 'demand' focused measures largely aimed at reducing speculative demand.

For example, buyers with a second mortgage now require a higher down payment of 30 per cent (previously 20 per cent), while the minimum cash payment has been increased to 10 per cent (previously 5 per cent). In our view, these two measures are likely to seriously dampen the HDB dweller's enthusiasm to upgrade to private property at current prices, as it reduces affordability.

A typical HDB upgrader would be looking at purchasing a 1,200 sq ft apartment at $850 psf, or around $1 million. Assuming that the couple still has an existing mortgage for the HDB flat they are upgrading from, they would need to cough up at least $100,000 in cash to meet the 10 per cent cash requirement and fund the remaining $200,000 from their CPF accounts. If we include the usual renovation expenses of about $30,000, then the cash requirement becomes a rather prohibitive $130,000, or close to 11 months of the couple's monthly net median income of $12,000.

Over time, the increase in supply of Design, Build, and Sell Scheme (DBSS), Build-to-order (BTO), and executive condominiums (ECs) in the market will also affect prices of the HDB resale market as buyers have a greater choice of homes available.

Some of the latest measures also reversed a long-standing policy that sparked the previous upturn in the HDB resale market in the 1990s. Back in 1991, the Ministry of National Development allowed HDB flat owners who have passed the minimum occupation period (MOP) of five years to invest in a private property.

Subsequently in 1993, the HDB relaxed mortgage valuations from 1984 values to current values and also permitted funds in the CPF ordinary account to be used for mortgage payments. Arguably, these two landmark policy changes at that point in time started the strong upturn in the HDB resale market in the 1990s, with the market hitting a peak in Q2 1996 before turning down sharply as a consequence of the Asian financial crisis.

Part of the package of measures announced at the end of August now disallow home owners from concurrently owning a private and public property within the MOP.

We expect this tightening to have a meaningful impact on the HDB resale market, as this is likely to reduce volumes and moderate price appreciation, if any. The subsequent impact is a decline in the average cash-over-valuation (COV) of the HDB resale market, which currently hovers at an average of $30,000.

With all these measures targeting the HDB resale market, it is difficult not to envisage the mass market segment of the private residential market being impacted as the former acts as a firm price support and catalyst for the latter. The last year or so has seen the emergence of 'shoebox' apartments ranging from 350 to 650 sq ft in size.

These smaller apartments are usually the targets of speculators as the absolute financial outlay and commitment is smaller and not surprisingly, we believe these apartments are also likely to be among the first to decline as the HDB resale and private mass market segment takes a breather.

Ironically, the most effective 'policy' of the government in stabilising the property prices might be interest rates. The Singapore property market has never been an interest rate sensitive market until 2007 and our sense is that the average home buyer may not be sanguine about how interest rates would impact his mortgage payments.

Prior to 2007, most housing loan rates in Singapore were pegged to the banks' and finance companies' prime lending rates (plus a premium of one per cent), which not only tended to be much higher than the Singapore Interbank Offered Rate (Sibor) or Swap Offer Rate (SOR) but also usually stayed consistently high, regardless of how low the base rates were.

However since 2007, the bulk of home loans are now pegged to Sibor or SOR (plus a premium of 1.25 per cent). With Sibor at historically low levels (0.51 per cent as of Sept 16, 2010), mortgages are currently artificially low, making homes that were once out of reach based on the old lending rates very affordable. However, the current low Sibor rates will normalise at some point. It is just a question of when and how fast.

Have there been instances where Sibor behaved erratically? The Asian financial crisis was one such example. Sibor spiked to a high of 7.75 per cent before finally sliding to 1.9 per cent in December 1998. The average rate of Sibor during that 18-month period hovered at 4.9 per cent.

As Asia was fortunately not at the epicentre of the credit crisis in 2008, Sibor did not behave erratically but averaged around 1.3 per cent, almost three times the current rate of 0.51 per cent.

So what is the likelihood of the above scenario panning out? At this point in time, with the global economic recovery still wobbly, a high interest rate environment looks rather unlikely. The good news is that history has shown that there are usually several warning signs before a financial crisis engulfs an economy.

We are also hopeful that history would have taught the average Singaporean buyer not to overextend his debt like his Japanese and American counterparts, buying property that cost more than they could rationally afford because they assumed that values would only rise and interest rates would always remain at such levels. The bad news is that humans seldom learn from history.

The writer is chief investment strategist Singapore, UBS Wealth Management

My Value Investing Blog:
With interest rate so low, it is a matter of "now or never" for the value investor based on the lowest $ per ft2 valuation and not those expensive new housing; is the way to go, I believe.

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