Property investment in Singapore has long been touted as a sure-fire way to reap attractive returns due to the scarcity of land in the city-state and its status as a global financial hub. Much of this view has also been fuelled by an 83.7% surge in property prices over the last decade. However, this widely-held belief is being put to the test as the Singapore property market enters into a period of softness brought about by a combination of rising interest rates, a supply overhang and the government’s implementation of cooling measures.
Residential Property Investments
While there are many considerations involved in the assessment of a property’s investment potential, the Holy Grail for property investors is a dwelling that promises high rental returns and large capital gains. Based on real estate transactions in the last 6 months since July, the gross rental yield of private residential properties fell within the range of 3 – 4%, with non-landed properties in city fringes fetching higher yields than that of prime districts and outlying districts. After taking into consideration mortgage payments and miscellaneous expenses, which include amongst others maintenance costs, property taxes and agent costs, investors can realistically expect a 2 – 3% rental yield on their private residential properties.
Rental yields for HDB flats, in stark contrast, commanded a good 5 – 7% gross rental yield based on median subletting rents and resale prices in 2Q 2015, with 3-room flats fetching the highest gross rental yield of 7.48% on average. The gross rental yields of 4-room flats, 5-room flats and executive condominiums came in at 6.41%, 5.74% and 5.15% respectively. Net of mortgage payments and miscellaneous expenses, HDB flats can potentially provide landlords with a more attractive rental yield of between 3 – 5%.
To illustrate the potential return on investment of residential properties, we will use a hypothetical example of a 4-room HDB flat in Clementi with a transacted price of $508,000. Taking into account the down payment of 20%, stamp duties of about $7,000 and other miscellaneous fees estimated at $600, the initial cash outlay is $109,200. The property has a three-year subletting tenancy with a monthly rental of $2,600, giving a gross annual rental income of $31,200. Over on the expenses side, if we assume a 2.6% interest rate (0.1% above the prevailing CPF Ordinary Account interest rate) on the 80% loan to be repaid in 25 years, the annual mortgage payment will amount to $22,128. Adding on to this amount is the $3,120 annual property tax and an estimated monthly maintenance cost of $200. After deducting expenses, which add up to $27,648, the net rental income received each year is $3,552, giving investors an annual yield of 3.3% on their initial investment amount of $109,200. Not too shabby! However, investors may wish to note that the return on investment in this example has been enhanced by leverage, and if interest rates rise, the expected returns will fall. Moreover, there is a risk of capital losses if the property was sold at the end of the tenancy agreement, given the current soft property market.
While rental yields are a good indicator of the attractiveness of residential property investments, investors must take into consideration the prospect of a rising interest rate environment, as higher mortgage payments will further dampen the net cash flow generated from rental income. The key 3-month Singapore interbank offered rate (SIBOR), which is used to set interest rates on mortgages, is currently at 1.071% (as of 1 September 2015) and is expected to rise to 1.25% by year end. Furthermore, an oversupply of residential properties over the next three years is expected to impose downward pressure on rents and resale prices. The possibility of higher mortgage payments, falling rents and capital losses make residential property an unattractive investment vehicle, at least for now. Investors who are still interested to snap up residential properties as a form of investment are advised to exercise caution and do their sums before taking the leap.
Millstone or nest egg? That is the question facing every property investor, both current and prospective. While there may not be a clear-cut answer, one thing is for sure – property investment in Singapore is certainly not the be-all and end-all in the search for attractive investment returns. The investment landscape in Singapore still offers other viable investment alternatives for investors to build their nest eggs. In the following sections, we will be highlighting some of the noteworthy ones.
Singapore Equity Market
The Singapore equity market, as represented by the Straits Times Index, has taken a tumble of -18.6% since its peak in the middle of April this year. Instead of panicking in the face of market volatility, investors should welcome the market correction as an opportunity to buy on the cheap. While the Singapore economy has lost some momentum in 2Q 2015, it is likely to benefit from a gradual pick-up in global growth for the rest of the year. The US economy recovered in 2Q 2015 following a poor start to the year, while the Eurozone economy is expected to grow at a modest pace this year, supported by the quantitative easing measures that kicked in since March. Moreover, recent stimulus measures implemented by the Chinese government are expected to spur the economic growth in China.
On current forecasts (as of 1 September 2015), the Singapore equity market trades at PE ratios of 12.3X, 11.4X and 10.4X based on 2015, 2016 and 2017 earnings estimates respectively, representing a significant discount to our fair PE estimate of 16.0X for the Singapore market and offering investors a potential annualised return of 15.4% by end 2017 (based on reversion of valuation multiple to fair value). While the market has not performed in recent months, dividend yields are still attractive at an estimated 3.92% (as of 1 September 2015).
Singapore Real Estate Bonds
The SGD bond market boasts an approximate 194 real estate bonds amounting to a rough SGD 33 billion outstanding principal, including issues by non-Singapore property developers such as Henderson Land and China Vanke, but excluding those issued by the Housing and Development Board. While Singapore real estate bonds are generally characterised by their low yields of around 3.2%, there are some that offer yields in excess of 4 – 6% if investors look hard enough. As an added bonus, these issues have fairly short maturities of less than three years, mitigating the interest rate risk faced by investors.
Singapore Real Estate Investment Trusts (S-REITs)
Property investments are illiquid and usually requires a huge capital outlay which some investors may not readily have. S-REITs, on the other hand, enable investors to participate in the ownership of real estate with a significantly smaller initial capital outlay and can be traded easily on the Singapore stock exchange. Furthermore, S-REITs enjoy tax transparency if more than 90% of the taxable income is distributed to unitholders. As a result, investors have been embracing S-REITs in recent years for their attractive yields, typically between 5 – 7%. In the recent months, however, eyebrows have started to furrow as S-REITs took a hard pounding, with the FTSE ST Real Estate Investment Trust Index plunging -16.3% from its peak in April (as of 1 September 2015).
While quality picks can provide investors with a decent return, the growth outlook for the S-REITs sector as a whole remains muted due to weaker retail sales, labour shortage, falling tourist arrivals and an increased supply of space, particularly in the office sector. As S-REITs usually employ leverage in their real estate portfolio, a rising interest rate environment will lead to an increase in refinancing costs, putting further pressure on distributable income. The end of cheap financing, together with the newly implemented 45% leverage limit, may also cap the S-REIT’s ability to pursue growth by picking up additional debt to fund their acquisitions. The alternative source of funding for S-REITs will be to issue additional units that results in the dilution of existing unitholders’ equity.
In spite of the limited room for capital gains, dividend yields are expected to come in at a mouth-watering 7.05% by year end (as of 1 September 2015). However, investors who are immediately seduced by the headline dividend yields should take a deeper look before making any investment in S-REITs. A double whammy of a weak rental outlook, as well as rising interest rates, may weigh on distributions per unit (DPUs) this year, which is expected to see a modest growth of 3.0% from 2014. Nonetheless, S-REITs yield spreads have started to widen from its recent lows in 2013 and 2014. Its current dividend yield of 7.05% represents a spread of 422 basis points over the 10-year Singapore government bond yield. While still below the long term average spread of 465 basis points since December 2007, the current dividend yields spotted by S-REITs are near their highest levels since February 2012.
Rather than focusing solely on the S-REITs sector, a regional approach to REIT investing might be a better proposition for investors, given that the property markets of different countries and regions can be at different stages of the property cycle.
The Singapore property market is expected to remain lacklustre due to an absence of policy catalysts, rising interest rates and a large incoming supply of residential properties. As a result, the possibility of higher mortgage payments, falling rents and capital losses make residential property an unattractive investment vehicle, at least for now. Investors who rush in to the property market may end up burning their fingers should there be a prolonged downward trend in property prices and rents. That said, inaction is also not the best way forward. At this juncture, we believe that the investment landscape in Singapore still offers other viable investment alternatives, such as the Singapore equity market and real estate bonds, for investors to build their nest eggs.