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Equity Versus Property

>> Monday, February 7, 2011

Looking at the wealthiest people in Singapore, one can’t help but notice the strong correlation to the real estate businesses. No wonder Singaporeans have such fascination about the property market.

Often when discussing about investments like equity, most would compare the returns with investing in the property asset class. However, based on absolute returns only is not an apple to apple comparison. Property investments have its own set of risk and disadvantages which needs to be taken into consideration as well.

Firstly, there is inefficient pricing mechanism. Equity market has a transparent price traded on the stock exchange, whereas property is priced at valuation which can be very subjective. Location, facing, floor level, amenities, facilities, accessibility, renovation, etc, all play a significant role in affecting the price and beauty lies in the eyes of the beholder.

Secondly, there is limited liquidity. Apart from the less traded small cap stocks, the index component stocks do enjoy a fair amount of volume on a daily basis. The sale of stocks can be recovered for cash within a week. However, property owners may suddenly have a total lack of buyers when prices start to decline and the transaction takes an average of 6 to 8 weeks to be completed.

Thirdly, although holding a physical asset is what makes investing in property attractive, it brings along the hassle of maintaining it. There are the usual woes of cleaning, plumber services, electrical maintenance, furniture, appliances, painting, etc. Even during rental, there may be tenant issues like contract renewals, debt collection and neighbor complaints.

Fourth, both asset classes allow the use of leverage. However, this can be a double edged sword, affecting the property class more adversely due to the limited liquidity. During a downturn, investors could be holding on to net debt when the outstanding mortgage is above market value of the property. Further, the bank mortgage could be based on fluctuating rates like SIBOR or SOR, adding additional risk if the interest rates were to increase significantly.

Fifth, high capital outlay is required. With the recent cooling measures, one is only allowed 70% mortgage for the second property which will require 30% down payment upfront, excluding Cash Over Valuation (COV) that is also on the high side. Excess cash or CPF will be required for the investment property after the purchase of their first property for own residence.

Sixth, the transactional and on-going costs can be substantial. For equity, the brokerages charges and fees are pretty straightforward and clear. However, property investments involve transactional costs like legal fees, agent commission and stamp duties. On a regular basis, there are also property tax, power supply, maintenance fees, various bills, etc.

In conclusion, this is not meant to down play that equity is superior over property as an investment class. It is more of an analysis of the disadvantages that property investments have to justify their potentially higher returns. Therefore, it is not fair to just compare their returns directly; one has to consider the disadvantages as well.

- Written for IMSavvy

5 comments:

SGDividends February 8, 2011 at 10:16 AM  

Hi,

Property investment at this juncture is really no longer attractive. I did a spreadheet to calculate the returns after the Jan 2011 property rules. Its posted on my website sgdividends.

Btw. Would like to do a link exchange with you?

Sgdividends

Lau February 9, 2011 at 12:17 AM  

No problems.
Yours is already up on mine. :)

This articles was actually written before the new rules. Anyway, nice analysis of the returns.

financialray February 16, 2011 at 2:19 PM  

So far as you mentioned, there are more who became millionaires by investing in properties than in shares. The ends justify the means. Despite all the negatives about property investment in your statement, statistics don't lie. The reason is probably that risks in property investment maybe easier to minimise, if you do your homework.

Lau February 16, 2011 at 10:10 PM  

Ray, there is a flip side of looking at those who are millionaires because of property.

They are the developers and landlords, they are not really the retail investors. So, are they reaping a handsome profit from property buyers and average joe investors?

financialray February 17, 2011 at 10:15 AM  

Hi Lau,

Sorry, I beg to differ. There are many retail investors who are just your average uncles and aunties. Personally, I know a handful and I have heard and seen many retail investors who do their homework and of course time their purchases well. I believe there are 60000 to 80000 millionaires in Singapore and they cannot all be developers.Of course, minus the lawyers, ministers, accoutants, doctors who make high income, there exist retail property investors who are millionaires

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