The Business Times
Cai Haoxiang
17/2/2014
PROPERTY investing has always been popular in Asia and especially in land-scarce Singapore. The common conception of how one can invest in property is often limited to buying a Housing Board (HDB) resale flat or a private condominium.
For the beginner investor with limited capital, a condo unit might not be the best type of investment to start out with. The downpayment for a suburban condo is likely to be at least $150,000. One takes on substantial debt of up to 80 per cent of the value of the property. The private property market, too, is showing signs of a market top. Rental yields have fallen while prices have risen.
The government's cooling measures also mean that most young people will only own one investment property for some time. This makes diversification difficult, but putting all of your eggs in one basket is risky.
By contrast, the publicly traded equity market offers more options. Property development companies, which buy land, build units and sell them off, are one way to get exposed.
A relatively recent innovation in Singapore is the real estate investment trust (Reit). Investors can buy small ownership chunks of portfolios of shopping malls, office buildings or industrial factories and warehouses. For example, one lot of CapitaMall Trust (CMT), the oldest Reit and biggest in Singapore, goes for about $1,800.
The publicly traded Reit market has suffered considerably since last May. Prices for Singapore Reits have corrected by around 20 per cent since fears of rising interest rates left financial markets shaken. Reit prices may very well correct further, depending on how high interest rates go.
This article will touch on why people buy property and outline the characteristics of the investment class. It will also discuss how buying a residential unit differs from buying a Reit. A future piece will elaborate on Reits specifically, and how to value them.
Why buy property?
The reasons why people buy property in general also apply to Reits. There are four main reasons to buy any sort of property: diversification, capital appreciation, rental income and as a hedge against inflation.
Property prices do not move up and down together with other asset classes such as stocks or bonds. This means that if you hold property together with stocks, for example, the overall fluctuations of your portfolio are reduced. You can sleep soundly at night knowing that your net worth is unlikely to change much on a daily basis, compared to the return you can get.
Capital appreciation comes about because Singapore is a relatively land-scarce country. If demand for land outstrips supply, prices are likely to rise. In the last 10 years, average property prices have doubled. This works out to an average yield of more than 7 per cent a year.
Retirees also like to hold property because of the rental income they provide. HDB flats and condos can be leased out to tenants on a long-term basis of six months or more. The Urban Redevelopment Authority's (URA) guidelines also state that the maximum number of occupants in a residential unit is eight, no matter how big the unit is, and each occupant should have at least 10 square metres of space.
Finally, property is regarded as a way to protect against inflation, or rising prices. When prices in an economy go up, rents and property values might also go up.
Residential properties versus Reits
Similarly, the value of a Reit's properties has the potential to appreciate. The Reit can then choose to sell the property and buy another one with a greater potential for growth.
The rental income a Reit collects and distributes to unitholders can also increase over time. Here, a key statistic to look out for is a Reit's occupancy rate. If you have a condo with three bedrooms, you want to make sure that all three rooms are rented out. Similarly, because Reits own large properties such as shopping malls or office buildings, they have to maximise their rental income.
Because of the potential for both capital appreciation and a steady stream of rental income, properties and Reits in particular are said to take on the characteristics of both stocks and bonds. Reits have high liquidity as they are divided into many tiny units which are traded like stocks. They also have bond-like characteristics because of rental payments from tenants. Just as a bond promises its holder a fixed sum of income twice a year for say five to 10 years, tenants pay rentals every month, and sign long-term leases to do so. One way to value a Reit is therefore to calculate, in today's terms, a stream of projected rental payments going into the future.
The risk of a Reit is also somewhere between that of a stock and a bond. Bonds are thought of as low-risk, low-return investments, while stocks offer higher risk for higher returns. Because they take on the characteristics of both, Reit prices should theoretically not fluctuate as much as stocks and offer investors a decent yield. This might make them good diversifiers to a portfolio.
Both Reits and residential property have similar features which potential investors would do well to take note of.
One characteristic relates to the use of debt. Property buyers generally take out loans to finance their purchases. If they can borrow at a lower interest rate than the yield they generate on their property, they will make money. Interest rate increases eat into their profits if they have to refinance their loans at higher rates.
The higher one's borrowings and the more one pays in monthly mortgages relative to one's income, the riskier the investment is. If you cannot service the property mortgage payments for whatever reason, the bank that lent you the money will have the right to claim the property and sell it off, because the property was used as collateral for the mortgage. This legal process is known as foreclosure.
Property prices are affected by the general economy. If an economy slows down or goes into recession, leading to retrenchments, some people will not be able to service their monthly mortgage payments. They might then be forced to sell their properties at a discount to repay a portion of their loan to the bank. This is known as a distressed sale. If there are many distressed sellers in the market, property prices are likely to fall. Even those holding on to properties which they have already paid off will see the values of their homes plunge.
Credit rating
Similarly, Reits borrow from banks or private investors to finance their purchases. They can also go to equity holders, but the cost of doing so is typically higher. Reits can borrow up to 35 per cent of the value of their property, and go up to 60 per cent if they obtain and disclose a credit rating from Fitch, Moody's or Standard and Poor's.
Reits typically borrow through short-term loans of a few years, and roll over their debt after the loan period is up by getting a similar loan at the prevalent market rate. In the 2008-2009 global financial crisis, financial markets feared that an economic downturn would cause tenants to go out of business and default on their rental payments. If that happened, Reits would face lower income streams and would not be able to refinance their debts. Many Reits were thus trading at extremely low valuations as investors wondered if they would go bankrupt.
An investor should therefore scrutinise the debt levels of a Reit and ask if they are sustainable. Some Reits are better placed to weather market downturns than others. In a sustained economic downturn, people might still need to shop for necessities, so shopping mall Reits might still perform well. But an office Reit might not if enough businesses decide to close shop or move somewhere cheaper.
Illiquid property
Another major characteristic of property is that it tends to be illiquid. This means that property cannot be easily disposed of. This illiquidity is due to the complexity of most property transactions, as well as the large values involved. To sell a unit without making a loss, one has to find a buyer who can pay more than what one bought it for. This is a process that can take weeks or months. In a weak market, like now, it might be difficult for an average property to fetch a good price. Even if you lower the selling price of your condo, for example, it takes time for the buyer to evaluate whether the price is worth paying, relative to other options he or she has.
By comparison, Reits and stocks of large corporations can easily be sold on the public market at any point of the economic cycle, with brokers and traders standing ready to take a position. If one desperately needs the cash, one would find it easier to liquidate a Reit investment than a property. The underlying property might still be illiquid, but the Reit itself is not.
A final characteristic of property investments is the management and maintenance costs which are required. If you own a condo for investment, you have to spend time and money advertising or sourcing for tenants, negotiating rental contracts, collecting rental payments and fixing property defects. If the property you own is old, you might need to spend money to renovate it so it will be more attractive to tenants.
On the other hand, a Reit employs an agent to help it manage the property. This is advantageous in a way. You do not have to worry about ceiling leaks or ageing facilities at a mall or office property when you buy units in a Reit. A professional manager will do it for you. Of course, the fees they charge have to be reasonable and free of conflicts of interest. Fee structures are disclosed in the Reits's annual report. We will discuss this in a future article.
The best managers will be able to add value to their properties through asset enhancement initiatives, or AEI for short. They can, for example, improve the layout of a mall to increase shopper flow. They can change the tenant mix, taking out unprofitable shops. Profitable tenants mean that Reits have the leeway to increase rentals, for example. Mall managers can also subdivide their space more efficiently to maximise rentals - witness how common spaces in malls are being used for promotional events now.
In short, property investments are usually classified as alternative investments, as opposed to the traditional classes of stocks and bonds. They can take on the characteristics of a growth stock during certain times, and offer the steady income streams of a bond in others. Those who cannot afford a condo but still want an instrument that gives a stream of income can think about getting a Reit first.
haoxiang@sph.com.sg
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