Published April 27, 2007

Yields losing shine as rents lag run-up in property prices

Study shows highest increases in yield in projects outside prime areas


(SINGAPORE) Property prices have risen significantly in the past year, and rents too - but not by as much. As a result, yields are up marginally, leading some analysts to say they may not support current high prices.

An analysis of data from 14 residential developments by CB Richard Ellis shows those that registered the highest increases in yield are outside the prime districts, in places where rents have recovered from a lower base.

The analysis compared figures for Q4 2005 and Q4 2006. Figures for Q1 2007 were not definitive, although some data pointed to a marginal difference from Q4 06.

Yields in prime districts registered only slight increases, with the popular Ardmore Park actually showing a drop in gross yield per annum to 2.8 per cent. The reason: the average price at Ardmore Park soared 32.6 per cent between Q4 05 and Q4 06 - the highest of all the properties sampled. But the increase in average rent there was the lowest at 7.4 per cent.

CBRE Research executive director Li Hiaw Ho says rents have risen faster than prices in some fringe areas, so developments like Caribbean at Keppel Bay, Queens, Dover Parkview and Heritage View are enjoying higher yields than those sampled in the prime districts.

Gross yield is now 4 per cent on average, with net yield about 3 per cent, he says. 'Not particularly attractive, as risk-free bonds are yielding more than 4 per cent.'

So what is driving property prices?

'We are back to the good old days of buying for capital gains,' says Mr Li. 'This is where deferred payment and gearing come in. A buyer pays 20 per cent - sometimes less - upfront on a typical deferred payment scheme. If prices go up 23.5 per cent within a year or two, the net gain is 20 per cent after paying 3.5 per cent for stamp duty and legal fees. That is a 100 per cent return on the 20 per cent downpayment.'

Roy Varghese, senior vice-president at ipac Singapore, says the total return to an investor is the sum of rental yield and capital growth. 'So a 4 per cent yield and an 8 per cent per annum growth rate will give a total return of 12 per cent per annum.'

He reckons that for top-tier properties the net yield is one per cent, on a gross yield of about 2.5 per cent, and capital appreciation may be 10 per cent, giving a minimum total return of 11 per cent. The components will be different for different types of products, he notes.

As investors attach more importance to real estate as an asset class, they may look beyond yields to justify a purchase. Return on equity (ROE) has become an increasingly important measure of the profitability of real estate.

'ROE is relevant because the investor is not buying the property outright in cash. The bank is co-funding the investment,' says Mr Varghese. 'When interest rates are stable and asset values are rising, debt can be an advantage for an investor.'

Can current yields support prices? Income yield should be benchmarked against risk-free fixed deposits, says Mr Varghese. 'So if cash deposits offer 2 per cent per annum, then rental income yield must be 2 per cent per annum plus a margin of, say, 2 per cent per annum. But if the estimated gross yield is about 2.5 per cent per annum, then the investor is seeking capital gains to supplement the low income yield.'

OCBC Research Analyst Winston Liew believes that, generally, people do not look at yields. 'It is only important if it helps to defray the financing cost of the property purchase.'

The relationship between yields and prices is also complicated. With Ardmore Park, the lower yield should put prudent buyers off - but the market reacts differently. 'When people see high prices, they believe prices may rise even higher,' says Mr Liew.

And the numbers can be quite compelling, with projected 100 per cent ROE based on increasing prices not uncommon.

'But when you start looking at ROE, it's like buying shares,' Mr Liew cautions. 'The return is proportionate to the risk you are taking. Would you borrow 70 per cent (of the value) to buy a share?'

The 'normal' property buyer does not need to look at ROE, he says. 'It's what a hedge fund would do.'