Understanding in Property Investing

In share investing, you look at a company’s fundamentals, future earnings, industry segment growth, momentum, etc. For the serious analyst, you will look at pricing power, purchasing power (cost), environmental factors (including regulatory frameworks) as well as product renewal cycles, research and development capability, core technological strength and lastly and perhaps the most important thing, disruptive technologies.

These days, from the time a disruptive technology is born to full adoption and eventually becoming mainstream takes about 5 to 7 years. And in this short span of time, a market leader with a dominant position can be toppled. Therefore when analyzing a share of a company, the discounted cash flow method must only be used sparingly and not into the indefinitely future in estimating future company revenue. All in all, estimating where a share will go is as good as predicting a child’s propensity for crime at age 3. Your guess is as good as mine.

Property investing is a much more predictable science, sometimes.

All you need to do is to model the property segment. As in any business analysis, you try as much as possible to model your investment and make assumptions (much as it’s not 100% possible).

The 2 important things to consider in property investing are: -

· Total Property supply

· Total Property demand

Total Property Supply and demand will decide the eventual price points of properties. However the devil is in the details.

Supply

In order to arrive at Supply of completed properties, the supply chain must be complete. In this supply chain, the upstream is land and consulting work, further downstream is construction material followed by labour, renovation, finishing works, toiletries and electrical systems, etc. The enabler or (impediment) for supply is often government regulatory controls, through it’s various ministries. These controls could impact the supply chain.

Demand

Demand for housing is always based on demography. There is the local population demand, and there is and foreign demand via expansive population programs, via mass importing of foreign talents.

Supply and Demand marks the push and pull of the property market and in determining a property's eventual price level.

What about affordability?

The earning capacity and affluence of the country (as well as taxation) plays an important part in determining the total Money supply and disposable incomes available for property purchase. The supply will supposedly be available to cater to this demand. (Alternatively, supply can be built ahead of an anticipated demand.)

If the affordability is higher (i.e. higher incomes and higher savings level), such that developers are able to price the developments higher and yet make money after incurring property development cost, there will be more supply.

Ultimately, affordability is based on the number of times annual income the property is priced at. If the median and average income rises, provided that there is no over-supply of housing, the property prices will tend to rise.

However, as more supply comes on, it doesn’t matter that incomes are higher, because people have choices, their demand is sated, the rental yields drops and so does the capital values, putting a lid on selling prices and hence the margins of the developers.

Is the market homogeneous?

The property market is never homogeneous. In other words, there will be supply and demand distortions in different locations and different segments of the market.

In shares, such price distortions are usually quickly arbitraged. In Property investment, such distortions tend to persists longer, giving people ample time to react. The distortion stays open for longer due to property being not as liquid an investment compared to shares and equity and in part to the larger investment quantum and high entry barrier.

So can people spot an anomaly?

Are supply data accurate?

Supply is in itself not static, government land sales programs continue to be announced, and total land supply available for development is added onto the total number of units.

The statistics are not perfect. This gives rise to differences between academic research versus the real research. Simply looking at the data without having a feel of and understanding the market is futile as the data is imperfect. For example, the number of units announced for supply is based on “units”. And as unit sizes shrinks in recent years, the same amount of land can churn out more “units”. So this causes distortion to the “supply” data in the residential market, unless you can analyze it together with average size per unit. Therefore the research data becomes more and more inaccurate and expert opinion becomes more valuable.

Supply can also suddenly come from existing stock of properties zoned for other use, when arbitrage becomes possible due to regulatory permits being approved or when lowering of development charge cost. There were cases where commercial properties were converted into residential condominiums as residential properties are priced higher and vice versa.

In the commercial property space, the supply is measured by the total amount of area (i.e. square feet/meters). Hence matching the supply of space to actual commercial demand will depend on a range of factors such as human flow and business needs. Will high price force the demand to shrink? (i.e. instead of using 100 square feet per staff to 70 square feet per staff?)

Many times, when an analyst looks at private property supply they forgot to look at those from the adjacent sectors such as Executive condominiums and HDBs, their supply have an overall impact on total supply.

The variability of Property Demand?

Demand manifests itself in the form of “latent” demand and actual demand. Latent demand measures the need for dwelling based on cultural and lifestyle norms of the country or locality. In some countries, when people get married, they move out of their parent’s place to form a new family nucleus, whereas in some countries, 50% of the people prefer to continue to stay with their families and 50% prefers to move out to stay. In the latter cases, we can consider the demand as “Household formation x 50%” as the latent demand.

And measuring intent is one way to measure latent demand. But can you depend on latent demand? You will be very wrong when you come to do your analysis based only on latent demand, because the actual demand differs a lot from the latent demand. Why is this so?

First and foremost, the latent demand could be wrong as there is always the hypocrisy factor at play during surveys which render the latent demand data inaccurate in the first place. Hence the latent demand inaccuracy. Then there is also the actual demand inaccuracy as the actual demand is artificially distorted.

How would the actual demand be distorted then?

Actual demand (demand curve) can vary due to changes in pricing, be it on a per square feet basis or on a total quantum basis. Government regulatory controls as well as subsidies can cause actual demand to distort.

Since we mentioned Pricing, then that also means that the available choices and limits on funding will play a part in such property demands.

If we stretch the home loan to 40 years or 50 years, then our monthly repayment becomes lower. This means that we will be able to incur larger risks and “Afford” a property, thereby fulfilling 1 unit or supply, consequently when we reduce the home loan tenure from 40 years to 20 years, our monthly repayment becomes so high that banks refuse to lend and therefore the latent demand do not translate into actual demand.

But then what is this demand? Is this demand for 1 room studio housing or 2 rooms or 3 rooms or larger units? So such variable demand based on size also cause demand distortion. As affordability “rises” and fall along the lines of credit availability, the supply with also make it’s own adjustments.

Therefore, when we talk about supply and demand, it is not a one for one match, it is often multi-faceted. Demand by itself can manifest in total number of units of demand, demand by total floor area, or by different classification.

For example, in cluster housing, the plot ratio is very high, but the population tends to be low. If a cluster bungalow has 8000 square feet and 2 person stays in it, it is very "build-up" and dense on the plot ratio sense, but in terms of space per person, this 1 unit is 8000 square feet being used by 2 person. And this 2 person has consumed a single unit which could have been built for 8 units at 1000 square feet per unit and accommodated 8 families of 2 persons (i.e. 16 people). And therefore this demand cause the supply stock to distort.

And foreign talent will further add to the complexity as the demography of the foreigners are yet not measured. By observation, Australian expatriates tend to have smaller families, while Indian expatriates tends to have larger families who all move into the same “unit”. Then the usual 3.5 people to a household (unit) could become 2 people to a household (unit) or 7 people per household unit. This causes the "demand" to fluctuate.

Therefore, in order to make money, you must then be able to identify and understand these factors for long term capital appreciation.

There is the yield play and the capital gains play in property market, similar to share investing’s Growth investing and dividend play.

As far as rental is concerned, if this is a rental property, you would need to consider the yield, the leverage from home loan financing and hence the return on invested capital which will determine your income that you can earn from this asset or (Loss of income) from this asset.

The capital gains and yield aspects are similar to share investing. You can buy a growth stock purely for capital gains (but with no or little yield) or you can buy a share which pays dividends from it’s earned income and yet grows it’s share price over time.

As in all kinds of investments, you need to do your homework and then take a bet. Share investing does not normally rely on leverage(unless you go exotic).This explains why many of the newer millionaires are made in the property market as there is leverage in the property market and also many untold bankruptcies. And as to how to leverage and finance a property, a Singapore mortgage broker can help with your Singapore home loan.

Source: Paul Ho 30th August 2013

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