WEALTH INSIGHTS
Resist excessive debt in buying property
Property investment is not risk free, and leverage can cut both ways, magnifying gains and losses
Wong Sui Jau
General Manager
Fundsupermart.com
AS WITH all investments, it is always more risky to put all your eggs into just one basket. Lately, rising property prices has become a hot topic and many investors have jumped into the property market. While the gains in property prices, even among resale HDB flats, have been eye catching over the last one year, it is important not to become over-leveraged into property.
It is odd that many people keep large amounts in their bank savings accounts or fixed deposits, refusing to take any kind of risk with it, even for low-risk fixed income type investments. Yet, once the opportunity to buy a property crops up during a property boom, they unhesitatingly take out all that money and place it into the initial down payment for the property. Buying property as an investment entails risk just like every other investment. It is by no means guaranteed or anywhere near the same level of risk as money being parked in savings accounts or fixed deposits.
In fact, most people have to take up a housing loan to buy property. Thus, there is leverage involved. You are essentially borrowing money to make an investment. This can cut both ways. On the upside, you gain more without having to fork out the full sum. This is why people feel that you can make big money on property. It is because your gains are magnified relative to your actual investment, the rest are all made on borrowed money. The current very-low interest rates make it that much easier to borrow large amounts. However, on the flipside, if the property market falls and you are forced to sell at a loss at some point, then your losses would be magnified due to your loans.
As an example of this, let's assume you borrowed $800,000 to buy a $1,000,000 property. If that property fell by 20 per cent after which you were forced to sell at a loss, then your actual loss is tremendous. For an initial capital of $200,000, you have now lost $200,000, so all your capital has been wiped out. On top of that, you had to pay for the interest on the loan, plus the legal fees and taxes on purchase and sale of that property. This is why leverage cuts both ways and this makes property far more risky than money in savings accounts. Yet, while some people are not willing to risk investing in any other kind of financial instrument with their bank savings, they seem willing to throw it all into property as an investment, when the relative risks of property investing are far higher.
A further worrying trend is with investors using a bigger and bigger chunk of their wealth for property investing. We have often heard of this phrase 'don't put all your eggs into one basket'. Fund managers always buy a whole basket of stocks instead of just one, and no matter how much they like a stock, they can't put more than 10 per cent of the fund into that one stock. The same should go for property. No matter how much you are convinced that property prices are going up, or that the property you bought is going to shoot up, you shouldn't put all your money on this one thing. Many advisers recommend putting at most 30 per cent of your wealth into property. And this includes your monthly housing instalment payments as a percentage of your monthly income. With the rise in property prices over the last one year, I believe that there are many investors who are committing well over 30 per cent of their money towards property. This is because with physical property, you can't choose to buy it in bite-sized amounts. These days, a resale HDB flat, depending on location, can cost $500,000 to $600,000. And most condominiums are selling at over $1 million, if not higher. It is difficult to say you want to choose to buy 'only' a $400,000 condominium because you don't want to spend over 30 per cent of your wealth on just property. Right now, it would probably be next to impossible to find such a condominium.
Based on the Singapore Department of Statistics recent report on household income last year, the medium monthly household income for households with at least one working person was $5,398 in 2009. This means that for the median household earning $5,398 per month, if they want to stick to the 30 per cent rule, they shouldn't be spending more than $1,799 per month in housing instalments. Not unless they wish to over extend themselves so much into property investing.
Based on a monthly housing instalment payment of $1,800 for a loan period of 30 years at 2 per cent interest (I am assuming this would be closer to the normal rate after the super-low first year rate which most banks give), such a household should be servicing a loan of not more than $487,000. This would allow this median household to purchase a property worth just $608,750 assuming they borrow 80 per cent. And that means they have to fork out $121,750 in upfront capital, not counting taxes and agent fees.
These numbers also go up significantly as one goes for bigger, more expensive property. To buy a $1,000,000 property, which many condominiums are being priced at these days, with a 80 per cent loan, the monthly instalment payment at 2 per cent over 30 years will be $2,956 (around $3,000 per month). They also get worse if interest rates go up (please refer to table).
Thus, despite the desire to own property, it is important to do your sums first. While the potential for capital gain is there, try to resist the temptation to buy as big a house as you can. People max out the loan amount, and saddle themselves with huge monthly housing loan instalments in their desire to buy property. This is dangerous for two reasons. Firstly, the upfront capital you will have to commit is huge and there is absolutely no diversification. If something happens to that property, or perhaps that area becomes less attractive, or simply, the entire property market takes a knock, most of your money, locked up in that property, will then take a big hit.
Not only that, a big property loan is also a loan on all of your future income. It is not just the big upfront payment, you will be paying big sums to service the loan every other month once you choose to buy as big a property as you can. Your future income is a very risky thing to bet to the limit on in a quest to get a big house. All it takes is a change of a job, or a layoff, and it is possible that your income will accordingly change as well. But your bank doesn't care if your income happens to shrink, they will just repossess your house if you can't service the loan! So, unless you are absolutely sure that your job and future income is rock-solid secure (perhaps you work in the civil sector), otherwise, it is not advisable to put most of your income towards paying off your housing loan.
What if you have done your sums, realise that you can't quite start off with that dream condominium home immediately, but you really want to invest your money? There are many other investment options which don't quite require the kind of 'all bets on the table' scenario that buying a property often requires. You can buy property stocks, Reits, or property unit trusts, all of which can give you exposure to the property market without having to bet everything on just property alone and you can do all these without having to take on leverage. The leveraged aspect of property buying in general only makes things that much riskier. People read about hedge funds using leverage, about margin trading, derivative trading, and they associate all these with high risk. But consider that if you borrow 80 per cent to buy a property, then effectively, you have leveraged yourself up to five times your original capital in your investment. That, in itself, is a substantial amount of leverage.
In conclusion, the desire to own your own property is very strong in Singapore, and this trend is likely to continue. The rise in property prices over the last one year has also made many people jump into the property market in search of gains. But property investment is by no means risk free. In fact, due to the leveraged nature of having to take on housing loans to buy a property, investing in property can result in one losing all of one's capital or more if the property market goes south. As with any kind of market, there are cycles, and it is by no means a given that property can go only up. There are some properties bought at the height of the previous property highs in 1996 which are now only barely breaking even or still underwater (and this is a 14-year wait for these investors already). So, as with all investing, exercise prudence, diversify, and don't commit all of your money into just one thing alone even if its property. It is risky to be over-leveraged into property.
Copyright © 2010 Singapore Press Holdings Ltd. All rights reserved.
ADDING UP
The Pinnacle@Duxton, Singapore's tallest public housing project to date. These days, a resale HDB flat can cost $500,000 to $600,000
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