Singapore Property Buyer forecast for 2010 and 2011

Singapore Property BUYER forecast for 2010 and 2011.

Recently the government has done the people a favour by releasing land and stopping the property prices from going out of hand.

We felt that the error was created in the first place because there was a squeeze in the HDB supply side. HDB was building massively inadequate supply for annual demand.

Although HDB can say that there is nobody queueing up for their BTO flats, but it could also be that the flats are priced too expensive due to benchmarking it to resale prices. Therefore if people cannot afford HDB flats, does it mean that there is no demand for it?

So the supply shortage in HDB is leading to a bottom up rise in prices of HDBs. This is pushing a wave of HDB upgrades into Private housing and condominium.

This demand is then pushing upwards and depleting supplies in the lower end of the private property segment (at least for this year 2010 and maybe next 2011) leading to massive demand for land. (Strangely so, as the supply in the pipeline is still some 60,000 units at at March 2010, equal to easily 6 to 7 years supply)

We can only speculate that perhaps it is because: -

1. Those supply of property in the pipeline is concentrated mainly amongst the big players.
2. Those supply of property in the pipeline is concentrated in certain districts or in certain price ranges, while demand is coming from the "MASS segment".

With increased demand for land due to HDB's miscalculation of demand by under-building, this leads to huge demand for land. Property developers seeing a possible opportunity may want to get in on the act by bidding for land.

Singapore government is happy to release land for sale
Singapore government is in turn happy, because it can be seen to be doing the public a favour by releasing land and cooling the market, whilst at the same time, the property developers are frantically meeting the land reserve price and starting a bidding war for land.

Our guess can only be that Property developers see this as a start of a price hike in land and therefore property prices. What this means is that if the Property developers bid and win at the early part of this property supply imbalance cycle, design and launch the properties quickly (say within 1 year), they can get out at the peak of the market or before the peak of the market. While during this time, the property prices are rising, so by the time they launch for sale, they could be sitting on massive profits.

But not all property developers will be lucky. Some smaller ones and those that mis-time their purchase can go bankrupt. While if again it is the big property developers who win, Singaporeans and Singapore property buyers will be unlucky. This is because with their holding power, they will then be able to continue to set new price benchmarks.

Will Singapore land supply catch up fast enough?

The supply of land will need around 2 to 4 years to be ready. So during this time, the property prices will continue to be squeezed from the mass market end all the way pushing up to the mass and mid market Private housing.

Singapore government and it's coffers are the major beneficiaries

So this time round, the Singapore government is the major beneficiary as it yet again was able to release land for sale at very high prices on the run up to the peak. And it is sparing no effort to sell much land to maximize land productivity.

Singapore government shows hand in wanting to make smaller HDB flats

Singapore government wants to make smaller flats - essentially raising prices.
Commentary by www.PropertyBUYER.com.sg

"SINGAPORE: Instead of reducing the HDB flat lease of 99 years to make the flats more affordable, the government prefers to use other methods to help those with a lower income own a flat, said National Development Minister Mah Bow Tan.

Mr Mah told Parliament the HDB now provides additional grants to the lower-income group and builds smaller flats that are priced more affordably. Another way is to make sure higher-income flat applicants do not compete with them for the same flat - this is why the HDB has a income ceiling for applicants of two-and three-room flats. "With all these in place, we do not see any problem in making HDB flats affordable for first time lower-income families."

Having shorter leases of 60 years for young couples could also be an issue with time - "we are going to run into trouble especially when that particular family grows old", said the minister."

Mr Mah was also asked by MP Cedric Foo if Singaporeans are not buying the flats situated in poorer locations because they are not "priced correctly".

(TODAY, Ong Dai Lin, Grants, smaller flats instead of shorter lease tenure, 9 March 2010)

Voila, Singapore Government finally shows hand in one of the most blunt admission that it is building ever smaller flats. We predicted this in many earlier articles in Q4, 2009 and early this year that the government land sales program will lead to 2 possible outcomes.

One outcome is that the property prices quantum rise. If affordability is not there, the developer will instead sell a smaller size unit at higher per square feet (PSF) to maintain their margins after paying through their nose for land.

Another outcome is that property developers will sell a lesser lease. As seen in quite a few developments already, the property developer maintains a master lease of Freehold or 999 years leasehold and sells the property as a 103 years lease hold.

Now even HDB wants to it's flats at rock solid prices. If you cannot afford those properties at the prices HDB is asking, then HDB will help you afford it.

HDB will offer you smaller size flats.

Isn't this great? At least you will not be left behind.

HDB is indeed benevolent.


www.PropertyBUYER.com.sg Singapore Mortgage Consultants

Tel : 6100 0608
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email: loans@propertyBUYER.com.sg

REAL OPTION CONSIDERATIONS IN PROPERTY INVESTING

REAL OPTION CONSIDERATIONS IN PROPERTY INVESTING
Strategic Finance (MGSM 985T)
by: Paul Ho Kang Sang

Tel: 6100-0608

(Paul Ho Kang Sang is available for consulting roles for companies and corporations)

Executive Summary

HardUp Pte Ltd, a property holding company is caught unprepared in the sudden economic downturn and needs to let go of one of their priced asset to raise $1m dollars, in order to move the property, they have promised to buy-back the property at a price of at least $800,000 anytime from the 3rd to 5th year. The property’s plot ratio is not optimized as the current cost to build another storey is not justified based on the current price per square feet.

Opportunist Pte Ltd evaluated the various investment scenarios and by using URA’s Price index as a proxy for calculating annual asset price volatility.

As Opportunist Pte Ltd is given the 1st right of refusal, it represents itself as an option. A series of scenarios were analyzed.

• NPV analysis
o The decision is not clear cut as asset price valuation is uncertain
• Purchasing the investment with Buy-back option
o This option is valued at $126,341, while cost is $230,000
o The buy back option is only worth $1,405, not as valuable as the impression it gives.
• The expansion option
o This option in only worth $35,330.
o The option including rental cash flow is $160,672.
• American Perpetual Option – Held into perpetuity
o As the option (down-payment) has no expiry date, some assumptions were made, and it returns a value of $1,513,135.

The bulk of the returns came from the rental cash flow and the option has very little value due to the low volatility because URA’s price index is already an aggregate weighted value. This probably reduces the volatility and option value of the investment. However due to the nature of the landed property, transaction volumes are low, URA index best represents a broad spectrum.

As the Option does not have an expiry date, the $200,000 downpayment used to buy the property becomes equity while $30,000 is transaction costs. So the true option price is around $30,000. The Investment is $230,000, the possible returns based on expansion or buy-back options range from $126,341 and $160,672 (at risk free rate), this represents a very good investment return which is amplified by a 5 times leverage.

Although the value of American perpetual option value seems arbitrary and high, Opportunist Pte Ltd can use the figure as a guide and get around the Optimal Stop time by using a Time-bounded way to re-evaluate the investment after the 5 years is up, whether it meets their internal Selling criteria. However there are also risks of Opportunity cost if asset values falls. This means that the company would then be “forced” to hold on to the option.

Overall, the management of Opportunist Pte Ltd recommends the Board to INVEST.
Introduction
The investment scenario involves a property investment scenario.

With the recent turn of economic events, HardUp Pte Ltd, a property holding company is looking to sell one of their many properties in the open market to raise cash for operational needs. As the market condition is not favourable, HardUp Pte Ltd has to make the investment attractive.

HardUp Pte Ltd put up their priced asset, for sale for at valuation of S$1 million dollars in District 15, a well-known enclave for Expatriate living. HardUp Pte Ltd has received a 5 year lease commitment with no diplomatic clause nor exit clause, therefore rental income is virtually guaranteed, but paid in arrears of 12th months. This is of not much use to HardUP as they really need to raise S$1 million dollars NOW. So HardUp Pte Ltd approached Opportunist Pte Ltd with an offer to sell the house at S$1 million, with rental contract transferred to Opportunist Pte Ltd and a buy-back guarantee option of S$800,00 anytime after 2 years, up to end of year 5 in case Opportunist Pte Ltd wants to offload the property and there is no risk of default of HardUP Pte Ltd.

The property description is: -



As HardUP Pte Ltd provides a buy-back guarantee at S$800,000 after the end of 2 years up to end of year 5. The proposition seems attractive and therefore wants to evaluate whether to go ahead with this investment.

Net Present Value Calculation



Net Present Value of investment if asset value remains at S$1m. Based on this scenario, Opportunist Pte. Ltd. should invest, based on the Risk Free hurdle rate.



However, if the asset price falls to S$921,800, NPV almost equals ZERO.



At a minimum Hurdle rate of 10% (required by Opportunist Pte. Ltd. and assuming asset value stays at S$1,000,000 the NPV just made it). It seems that the investment is borderline.
Given that this opportunity is not deferrable, the worst case that will happen is a loss of S$101,000 at a Risk Free rate of 3.8%. The buy-back guarantee only limits the loss, in the event of a loss and Opportunist Pte. Ltd loss is capped at S$101,000.



The sensitivity analysis is unable to help the management make up it’s mind. There are many un-factored variables such as Asset Price fluctuation.

METHODOLOGY

The management evaluated a few methodologies, including Monte-Carlo simulation of a large number of outcomes for multiple variables to have a better gauge of investment risk.

However, landed housing supply is lumpy and transaction volume is low, therefore obtaining these large number of relevant samples are hard. There is also time-factor uncertainty as the large number of samples would have to be obtained over ten years of record, meaning that there could be potentially data which were not comparable over the years. Other factors such as political risks, policy risks and various changes cannot be adequately factored. In other words, the analysis would only be as good as the data that you put in.

Therefore the management of Opportunist Pte Ltd decided to use the aggregated Urban Redevelopment Authority (URA) residential price index as a proxy for private property asset values. As the data is already an aggregated and weighted average index and aggregated over the whole of Singapore, this data would have less volatility than the actual investment and the management recognizes this characteristic.


Volatility Using a Lognormal Returns Table




The management have arrived at a volatility of 9.9% based on 10 years of price data and in the calculation uses a round-up figure of 10%. However it is recognized that actual price volatility in the investment property would likely be higher.

ANALYSIS OF INVESTMENT OPTION ON IT’S OWN AND WITH BUY-BACK OPTION AT $800,000

Management of Opportunist Pte. Ltd. thinks that there is another way to value this option to invest. As the investment presents itself now and has to be decided now, there is no option to defer. Management can however value the option to take up the BUY-BACK option from HardUP Pte Ltd to abandon the house at S$800,000 at a loss anytime from year 3 to year 5.




Using a Risk-neutral approach, based on volatility of 10%, the asset price varies from 606,530 to 1,648,720.




We replaced the lower value with the guaranteed buy back in year 4 and year 5.

The buy-back option is only worth 1,405 dollars (1126,745 – 1125,35), however the asset (in cash flow) that can be had from this investment cash flow alone would be worth S$126,341.

If $230,000 down-payment has to be made for this house, $126,745 is definitely not a viable investment.

The next investment scenario is to look at construction of another storey and add 1000 square feet to the build-up area at a cost of $600,000. For ease of calculation, we will assume that the project can be completed very fast and completed in negligible time.

CONSTRUCT AN ADDITIONAL FLOOR (BUILT-UP INCREASE FROM 2000 to 3000 SQUARE FEET)

The expansion option is first evaluated. The Cash flow from rental is added back into asset value during the backward induction process. The rental alone gives $125,341 value. It is still smaller than the required down-payment “option” of $230,000. Even with Expansion option, the expansion option only gives an extra $35,330, raising the asset value to $160, 672.



It is assumed that the construction continues without intrusion to the current lessee for simplicity of calculation.

ANALYSIS OF INVESTMENT

Both the buy-back option and the expansion option do not significantly increase the option value given the low volatility of the property market based on URA residential price index.

DOWN-PAYMENT = $230,000

WORST CASE ~ -$100,000
BEST CASE (With Expansion option) ~ $160,672
ASSET VALUE UNCHANGED ~ $125,341
PERPETUAL OPTION ~ $1,513,135

None of the above cases support going ahead with the Investment.

However, the investment should not be viewed purely as a Real Option with a time-limit of 5 years although that is the investment time-horizon of the investment company. The down-payment more resembles that of a Perpetual American Option.




Reference: http://finance.bi.no/~bernt/gcc_prog/recipes/recipes/node9.html, Norwegian School of Management (BI), Department of Financial economics.



This is because since the house is rental guaranteed for 5 years and at the end of year 5, Opportunist Pte Ltd could sell the house back into the open market and make a return of $125,341 (With a 3.8% hurdle rate). Based on that scenario, due to leveraging, the management would still make ~ 10% per annum on this property investment.

In the worst case scenario, if the property drops in value, opportunist Pte Ltd could opt to keep the investment option. If the net rental yield of 2.9% (Average of rental of 5 years) could be maintained, the Perpetual Option Price would be worth S$1,513,135.

Valuing a perpetual option is really hard, there are many methodologies and calculation out there. If it is perpetual, then when would be the optimal stop time? (Geoffrey Poitras, Risk Management, Speculation, and Derivative Securities) One way for Opportunist Pte Ltd to get around this issue is to evaluate the property investment in 5 years and every year thereafter. If it meets an internal hurdle rate of returns, then the company can decide to offload the investment, assuming there are better opportunities out there.

Opportunist Pte Ltd also considered to forego this opportunity and wait 1 year for another opportunity to come by. However, based on the locked in net rental yield average of around 2.9%, waiting represents leakage, the worst case scenario would likely be an asset value of $929,840.

So the key decision really lies on the holding power of Opportunist Pte Ltd. The option for holding the property perpetually, although the value is clear cut, if the property stays below the price they paid for the investment, it represents an opportunity cost of holding the property as $230,000 less $30,000 cost = $200,000 down payment is locked in perpetually until such time that accumulated rental returns exceed $200,000 at net present value plus required investment hurdle rate or if capital value re-bounds.

The company recognizes the opportunity cost of holding the property as well as the potential value of the perpetual option. As the company is cash rich, it recommends to the board to invest in the property.

References
1. Norwegian School of Management (BI), Department of Financial Economics, http://finance.bi.no/~bernt/gcc_prog/recipes/recipes/node9.html
2. Urban Redevelopment Authority (URA), Realis time-series data.
3. Risk Management, Speculation, and Derivative Securities, Geoffrey Poitras, pg 525

Paul Ho is available for Consulting work. The range of services provided: -
1) Equity analysis (Buy side research)
2) Doing a feasibility Study for business ideas. (Individuals with an idea and not sure whether they should make the plunge, should contact me. I can analyze the business idea and prepare a business plan with go to market strategy)

3) Corporate management consulting or projects.

Call me at 6100-0608

U.S. bets that the FED will lower rates

U.S. sneezes, the rest of the world catches a cold. Singapore is right smack in the middle of that sneeze as Trade (Import/Export) makes up a large percentage of Singapore's Economy. Weakness in the USA directly impact the economic outlook of Singapore.


Source: IMF, http://www.imf.org/external/pubs/ft/survey/so/2008/RES012908A.htm

"In Western Europe, signs of a future slowdown in credit growth are just now emerging and there is some potential for worsening credit quality as lending has been very robust in some countries and several countries face housing markets considered overvalued, the IMF warned.
Lending in some segments of the corporate sector also expanded rapidly in the first half of 2007 with the rise in leverage buyouts. Weaker quality corporates have already seen a substantial rise in the cost of credit although yields investment grade debt have remained relatively stable. Additionally, a slowing economy will likely exacerbate the tighter credit environment further as unemployment picks up and job growth slows.
Emerging markets have been resilient so far, but face challenges ahead. Emerging market equities have outperformed mature equity markets, but prices in some markets have declined steeply since the start of the year on expectations that the U.S. economy may slow more rapidly. "Signs of spillover are most evident in the sharp fall in private emerging market bond issuance, particularly in some emerging European economies whose banks have relied heavily on external financing to support rapid domestic credit growth," the Financial Market Update stated. Generally, flows to emerging markets have remained positive up to now."

Most banks in Singapore charge a Step-by interest rates in which you pay higher interest rates at the later years. In a refinance, the other bank takes over the outstanding loan balance from the previous bank.

However, banks are tightening credit the world over.

If you are expecting some changes in personal circumstances, you may not qualify to refinance your home to get better offers and end up paying elevated rates if the following occurs: -

YOU LOSE EMPLOYMENT
YOU SALARY IS REDUCED
YOUR PROPERTY VALUE DROPS
CREDIT TIGHTENING in general

It may be advisable to get a free mortgage health check to determine your risk level.

REFERENCE:
CHICAGO (Reuters) - U.S. short-term interest rate futures rose sharply on Monday to reflect higher prospects for a rate cut at or before Tuesday's Federal Reserve policy meeting.

Dealers responded to a fresh crisis in financial markets after investment bank Lehman Brothers filed for bankruptcy over the weekend, and to sharply lower calls for the U.S. stock market.

The Federal Open Market Committee holds hold a regularly scheduled meeting on Tuesday.

Implied prospects for the Fed to lower the benchmark fed funds rate to 1.75 percent traded as high as 92 percent and have now subsided to 72 percent. On Friday, prospects for a September rate cut were a slim 12 percent.

A single, quarter-point rate cut is fully priced by the December FOMC meeting.

"It looks like the market is looking at just a 'one and done' scenario," said Rudy Narvas, analyst at 4CAST Ltd in New York.

The Fed late on Sunday announced several measures aimed at mitigating strains in financial markets.

Those moves included enlarging the range of available collateral for the Primary Dealer Credit Facility and the Term Securities Lending Facility.

"It is only prudent to consider all available tools at the Fed's immediate disposal ... The option of adjusting the funds rate per se is probably not at the top of the priority list," said Thomas Lam, senior Treasury economist at United Overseas Bank Group in Singapore.

(Reporting by Ros Krasny; Editing by James Dalgleish)