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
