The road to riches isn't just paved with keys of condos
02 Mar 2015 16:41 by CAI HAOXIANG
AS the Central Provident Fund (CPF), Singapore's pension scheme, was in the news recently, I was having a debate with a colleague on whether restrictions should be placed on the use of CPF savings to buy property, especially private property. It was not financially smart to commit that money - meant for retirement savings - to buy a pricey apartment, I said.

She responded: "Why deny people the chance to break into the upper classes? You'll exacerbate inequality if you prevent people from buying private property."

But the bigger issue is retirement adequacy, which is the original goal of the CPF - and remains the main goal - I argued. After wiping out your CPF savings to help pay for the S$240,000 downpayment on a S$1.2 million home, as well as your monthly CPF Ordinary Account contribution to help pay for the $4,000-a-month 30-year mortgage (on a 3 per cent interest rate), how much will you have left by the time you're 55 when you have to pay for CPF Life? You might still be paying the mortgage by then. Will you still have a job?

People can choose to pay their mortgage in cash instead of using their monthly CPF contributions, she countered. And the mortgage won't necessarily last 30 years if people pre-pay after some more years of working and saving. Salaries can still go up. And as for prudence concerns, loan curbs are already in place.

What is important, she maintained, is that people be allowed to use the CPF to help with the lump-sum downpayment first. And as for whether CPF should be allowed to be used to buy private property, that ship has sailed a long time ago - in 1981, to be exact, when the Residential Properties Scheme was introduced to let people do so.

The CPF has become such a big part of most people's savings that people expect to be able to use it to pay for whatever they wish, including an expensive piece of physical property.

Property always goes up? But so do other assets

It takes a brave and politically suicidal government, perhaps, to reintroduce restrictions on the CPF's use.

A strong argument can be made for the use of CPF to finance government Housing Board (HDB) flats for people to stay in. There are socio-economic benefits to home ownership. Political stability is arguably fostered. Build-to-order (BTO) flats, priced cheaper than the resale market, have generally gone up in value when they can be sold.

Yet the same story of price appreciation cannot be said of private property, which people also buy for investment purposes.

Despite a slowdown in the housing market, the urge to buy private property remains extremely strong today. Many people are waiting for prices to crash or, at least, correct by a larger amount, so they can jump in. Others have already bought their condos in the low interest rate environment. Some have stretched their finances to do so.

There are two premises to their views: First, private property prices will always go up; and second, it is therefore the best investment one can make.

Is that so?

It depends on the time period and measure used.

Statistics on the Singapore Exchange (SGX) website compiled from Bloomberg show that if you take a 10-year view from 2005 to 2014, property, as measured by the URA Private Property Price Index, has returned an average of 6.1 per cent a year. Blue chip Singapore stocks, as measured by the Straits Times Index (STI), returned 5.3 per cent a year, which is slightly lower. Both indices exclude rent or dividends.

Yet the property figures might be skewed. The mid-2000s saw a long period of stagnation for Singapore property. By taking 10-year returns now, we are benchmarking returns from a low base. By contrast, the STI had begun rising from their 2003 lows by 2005.

Measure property returns from the last major market top at end-1996 to end-2014, and returns will average just under 1 per cent a year. Measure them after the Asian financial crisis, at end-1998 to end-2014, and property returns average 4.6 per cent a year.

Meanwhile, on a shorter, two-year time horizon, the STI comes out ahead. It returned 3.1 per cent a year on average, while property has lost 1.5 per cent a year in 2013 and 2014.

Yet the STI lost to pretty much every developed or Asian market. The S&P 500 index returned 25.1 per cent a year in Singapore dollar terms, the FTSE 100 returned 7.6 per cent, the Nikkei 225 returned 14.3 per cent, India's Nifty index returned 15.4 per cent, and the top 50 A-shares on the Shanghai Stock Exchange, 18.3 per cent.

If you had spent a fortune buying a private property in Singapore two years ago, you would have regretted it. You bought at a temporary top. If you had put the money in US stocks, you would have made over half your money back.

Peak to peak: property versus stocks

Statistics can be used to prove almost anything. But it is clear that based on Singapore's experience with property in the last 20 years, buying a property is anything but a sure bet to riches. It took 14 years after the last market top in mid-1996 before prices in mid-2010 surpassed their old levels.

Of course, go back 40 years and prices increased more than 16 times at an average annual increase of 7.3 per cent a year.

Yet stock perma-bulls also have history on their side. US stocks, which we have the biggest set of data for, have returned 5-7 per cent a year in the long run of up to 80 years. On that grand, historical scale, what looks like a flat period of returns (see charts) actually represent a boom.

Where returns are concerned between property and stocks, we have a tie.

Complicating the issue is how there are so many different types of property, from mass-market to high-end, with different rental markets and locations. Everybody who bought property would have had a different experience.

It would not be surprising if there are people who bought at the last market top almost 20 years ago, and have just broken even. Others might have reaped big rewards.

Property, just like stocks, foster a get-rich-quick mentality.

Singapore property prices more than tripled between 1989 and 1996, and almost doubled between the end of the financial crisis in 2009 and the last market top in 2013. The story for stocks can be equally dramatic. For five years in the 1990s, the S&P 500 gained 20 to 30 per cent a year, an increase of almost four times.

Taxi and bus company ComfortDelGro, a blue chip that many investors know well, notably gained 50 per cent in 2014.

People fear buying assets at a peak. So how long does it take before the last peak gets surpassed for property versus stocks?

Singapore property took 14 years before prices went past the 1996 top. The STI took seven years to go past the 1999 top in 2006.

It's been more than seven years since the last top in 2007, and the STI is still below where it was then.

The question for most property investors is whether we have reached a price peak a year ago that might not be seen again for some time. As for the US, the S&P 500 took seven years to go past its early-2000 top, and less than six years to go past the 2007 top.

Yet history also offers a cautionary tale. Those who bought US stocks at their 1929 peak had to wait 25 years before values recovered.

It seems that both Singapore property and stocks can stagnate for a long time, possibly beyond the time horizon which investors are prepared to wait it out.

Asset class characteristics

Investors comparing stocks with property have to keep in mind differences between the two asset classes.

Price drivers differ. For stocks, price changes are usually driven by investor expectations on the stock's underlying business. For property, prices depend on interest rates, the state of the economy, disposable incomes, and land supply.

Investment cost is a bigger issue for property. While one can invest in a company with just a few hundred to a few thousand dollars, physical property requires a substantially bigger commitment, as well as the assumption of debt.

Property investors also have to watch out for interest rates, which will affect their mortgage payments. On a S$1 million, 30-year loan, a 2 percentage point interest rate increase means mortgage payments go up by S$1,000 each month. On the flip side, you don't need to commit as much of your own money to reap the rewards of a property bull run.

The ease of purchase differs. Where one can buy a stock any time during trading hours, it can take months before a purchase or sale in a property is closed.

Liquidity might matter. Property is not easily bought and sold, though the same can be said of certain small-sized stocks in the market. If sellers need cash urgently from the sale of their property, they will have to offer a discount. Yet if you want to liquidate your blue chip holdings immediately, you can easily do so and get your money back at a price that is fairly, efficiently determined.

Yield characteristics differ. It is more troublesome to squeeze yield from your property. To rent out a place, you need to advertise online or go through an agent, negotiate the right price, entertain viewings, and finally prepare a contract to sign.

Landlords need to maintain their property and be on hand to address issues such as damaged furniture, leaking pipes, electrical faults or Internet subscriptions.

By contrast, getting a yield from a stock requires no work on the part of the investor. If the business is profitable, and dividends are declared, money is automatically deposited into your bank account.

Another way to evaluate the two asset classes is by their volatility, or how much prices fluctuate. If the price of an asset changes rapidly, with large price movements, the asset might not be a suitable investment for an investor that cannot stand the thought of his investment losing value.

This is the issue with stocks in general. Most stocks change hands thousands of times a day, each trade being an opportunity to sniff out a fair price.

By contrast, property tends to be less volatile. Assets can get traded only once every few years. You will not know exactly how much your property is worth. This is not necessarily a bad thing from a psychological point of view: If prices are falling, you won't know how much your net worth has decreased by until you have to sell.

Price transparency is thus different in both markets. In the stock market, prices are clearly displayed and updated every second. Historical data is readily available. By contrast, the property market is opaque because many factors go into determining even the price of units in adjacent developments.

Because physical properties get traded infrequently, buyers and sellers generally refer to the last-traded price of a similar unit nearby, before making adjustments based on the floor, view, location, and other tangibles and intangibles.

Nobody really does a discounted cash flow calculation based on expected rental income and risk to come up with a shoebox apartment's value.

Finally, stocks are risky because companies can go bankrupt, leaving shareholders with nothing. By contrast, the value of a property will not fall to zero.

However, because people usually take out debt to buy property, the risk is that you cannot meet your monthly mortgage payments. If that happens, the bank that lent you money will have the right to reclaim your property and sell it off.

You can always try to sell your property to someone else in the hope of making a profit from the transaction after paying back the debt you owe the bank. Unfortunately, it is also likely that the property is worth less than what you bought it for, or what you owe the bank. In this case, you will be left with nothing.

In reality, if you are staying in the property you bought, the banks or HDB are likely to allow you to renegotiate your loan on a case-by-case basis. Repossession is a last resort.

Intangibles matter

Given its illiquidity, high costs and lack of transparent pricing, property does not seem to be a suitable investment for beginner investors. They can buy a place to stay within their means, but buying for investment is another matter.

Stock investors can implement strategies such as buying more of a blue chip stock they have assessed to be able to thrive, when the stock is hit by negative sentiment and is trading cheaply against historical norms. You can't really dollar-cost average houses, buying an additional one every month into the dips.

However, people buy property for non-financial reasons. Own a condo and you think you move one rung up the social hierarchy.

You own a tangible asset that you can touch, and the opportunity to enjoy amenities such as a swimming pool and BBQ pit.

If you are buying a place to stay in, then financial reasons matter less. The emotional value you get from owning a place goes beyond the rental you would otherwise have paid every month. People buy property to pass on to their children, as well as to diversify their wealth and hedge against inflation.

Ultimately, young investors have to understand various aspects of both the stock and property market before they decide which path to take with their money.

Both are not mutually exclusive.

But if you do buy a property, be honest - don't think of it as an investment. The purchase is likely not a purely financial transaction. There is no guarantee that you will make a profit.

Property price returns, like the stock market, look attractive only if your time horizon is long enough and if Singapore remains the financial and commercial centre it is today. But in a declining market, you are likely to get worried after just two years.