Is condo or stock a better investment?
The Business Times, 17 May 2005
By DAVID LIANG
I just moved to Singapore from New York City several months ago. I
can't help but notice the stark difference in the investing
mentality between investors in the US and their counterparts here
in Singapore.
In the US, the most 'popular' investment is stocks. Even after the
bursting of the Internet bubble, the percentage of US households
that have some exposure to the stock market remains above 50 per
cent. Those who cannot afford to put a downpayment for a house are
likely to have some types of brokerage accounts.
In Singapore, real estate, particularly the condominium, is the
first choice of investment. The stock market is regarded as one
giant casino, and a lot of people here have the perception that
putting money in the stock market is akin to gambling.
Because of the way most market participants trade stocks and the
overwhelming popularity of technical analysis, I am not surprised
that the stock market has such a bad reputation.
This makes my job as a fund manager that much tougher - although it
is somewhat offset by the fact that I see many opportunities to
make money in the Singapore stock market.
Because most market participants here treat buying and selling
stocks like gambling, some valuations are completely out of line
with the companies' fundamentals. At present, there are a lot of
good companies selling at ridiculously cheap prices.
Then there is the fact that residential property investments offer
extremely low returns. This is consistent with the law of supply
and demand: because so much investors' money goes into real estate,
property prices are sky-high, driving down rental yields.
The opposite occurs in the stock market. Lack of investors'
enthusiasm keeps prices low - which means earnings yield combined
with dividend yield from stocks are much more attractive than
rental yield from properties.
Let's look at one example: a three-bedroom unit of about 1,100 sq
ft on Killiney Road less than 10 minutes' walk from the Somerset
MRT station.
According to the Urban Redevelopment Authority website, which
compiles past property transactions, the fair market price for the
condo should approximate $800,000.
Let's assume you buy the property by putting down 20 per cent
($160,000) and borrowing 80 per cent ($640,000) for 30 years.
The bank may charge you lower interest rates in the first two years
of the loan. But after year 3 and beyond, the interest is likely to
climb to over 3 per cent.
Yield vs inflation
The market rental price for similar apartments in the area is less
than $2,000/month, but let's say you manage to get a tenant who
does not mind paying $2,100/month - just slightly below your asking
price of $2,200 (according to late March/ early April 2005 rental
property listings).
After paying the building maintenance fee of $200/month, you are
left with $1,900/month to meet the monthly payment to the bank. At
a 3 per cent interest rate, your monthly payment to the bank comes
to about $2,700/month, which means you have $800/month or
$9,600/year negative cashflow from this property.
Let's say you do not mind paying the principal portion of the
payment from your own pocket as long as the rental income covers
the interest. Over the 30-year life of the loan, the interest
portion itself averages $1,600/month.
After deducting $200/month maintenance and $1,600/month average
interest, your profit is $300/month or $3,600/year. Because you
paid down $160,000, this means that you make about 2.25 per cent
annual return on investment on your rental property.
A 2.25 per cent rental yield barely beats inflation which,
according to the Singapore Department of Statistics, stood at 1.75
per cent in 2004. In fact, there are even some bank CDs that offer
annual interest rates higher than 2.25 per cent.
You may think you can profit more if the price of property goes up.
Well, think again. So far we have been ignoring the fact that if
you had bought the condo directly from the developer in the late
1990s, it would have cost you $1.25 million instead of $800,000
today.
Whoever bought the condo then would have lost $425,000 in equity by
now. Also, just drive along River Valley Road, which is adjacent to
Killiney Road, and count how many new residential projects are
currently being built. With so many new units entering the market
in the next few years, how can prices go up?
The laws of supply and demand suggest it is highly unlikely.
The situation is exacerbated by the fact that many property owners
currently have negative equity on their property investments. In
other words, the proceeds that they stand to collect by selling out
are less than the loan balance they owe to the banks.
This structural problem keeps prices artificially high because even
the most desperate property investors cannot afford to sell out,
unless they compensate the banks for the balance.
Stock yields
What about stocks - can they provide investors with more than a
paltry 2.25 per cent return? Yes, very likely. First of all, just
from dividend alone, there are a lot of stocks that offer yields
higher than 2.25 per cent.
In addition, stocks are selling at relatively cheaper valuations
compared to residential properties. According to Bloomberg, stocks
in the Straits Times Index traded between 11x and 14.5x P/E
multiples in the past 12 months. This 11x to 14.5x P/E translates
into between 7 per cent and 9 per cent earnings yield.
Outside the STI, there are many stocks that are selling at even
lower P/E multiples, which means even higher earnings yields (P/E
multiples are inversely related to earnings yields).
There are even profitable companies whose stocks are selling very
close to their net cash per share. Therefore, just from the
dividend alone, stocks can be a more profitable investment vehicle
than property.
If total earnings yields are taken into consideration in addition
to dividend yields, investing in stocks certainly provides a better
return than investing in residential properties.
It is true that stocks can be extremely volatile. Just look at what
happened to US equities in April. They declined sharply although
the outlook for profit growth has actually improved. Stock prices
fluctuate up and down every day, every hour, and every
minute.
The underlying business fundamentals, however, do not change that
quickly. Stock prices are influenced by human emotions. The
underlying business is much more stable, and in the long run, stock
prices do eventually reflect underlying business
fundamentals.
Another thing that you have to consider is buying at reasonable
prices. Of course, this is true of all types of investment assets,
not just stocks.
A lot of people lost money after the Internet bubble because they
bought when valuations were highly unreasonable.
At present, however, stocks are selling at much more reasonable
levels compared to residential properties.
The point is that if you buy stocks of companies whose underlying
businesses are in good shape and growing, if you buy them at
reasonable valuations and if you ignore short-term gyrations, you
would stand a very good chance of making good returns on your
investment.
David Liang is a fund manager for
a private investment partnership
