Should you 'Invest' in a home?
Owning a home is a wonderful thing. Home ownership gives you a sense of pride as it is quite an achievement to be able to afford one. It’s where your children grow up, it’s where you build wonderful memories and it connects you to your community, city, and country. Whenever our clients or friends tell us that they are buying a home, it’s a real cause to celebrate. However, when those in our network tell us they’ve purchased a second residential property and we ask why, often their response is “Investment.” This, makes us a bit skeptical. Now to caveat, we are no experts in investing in Singapore residential properties, and we do know of quite a few people who have made fortunes buying at the right times (ie 2008 or during the SARS outbreak). But like all investments, we like to explore our ‘alternative project.’ In this case, we believe the alternative to purchasing residential property as an investment is REITs. REITs (or Real Estate Investment Trusts) are a great alternative to get exposure to the Singapore property market. So which is a better investment? Let’s compare the two and take a look at the quantitative and qualitative aspect of each.
The Quantitative
While all of us have heard stories of that friend or that auntie who made 2-3 times their money in 2 years on that flat they always insist on driving by when you’re on your way to lunch, we know relying on outlying data points can be dangerous. So how have private residential properties done in Singapore overtime?
Price Appreciation
Since the end of 2002, according to data released by the Government, Singapore private residential properties have returned a cumulative 186% or around 3.54% annualized (info from data.gov.sg).
(We are using 2002 as our starting point as that’s from when we can find comparable REIT index data)
Now to see if this was a good or bad return, lets compare it to the FTSE ST Real Estate Investment Trusts Index (data from Bloomberg). At the end of 2002 the index had a price of 324.22 and at the end of Q32019 it had a price of 925.18 resulting on a cumulative return of 185%! So just on a pure price appreciation both buying rental properties and REITs have performed almost the same!
Rental Yield
So far the data suggests that perhaps residential property is a comparable investment to REITS, but let’s now look at Gross Rental Yields (remember, this is before any expenses/payments).
According to URA, rental yields, Island-wide, have trended down from around 4.3% at the end of 2002 to around a low 3% today. Current yields for the REIT index is 4.6% and was around the same level in 2002 (in that time period has fluctuated from 4-6% typically).
Now it’s clear that yields for REITS are higher than residential property, but not by that much. However while REIT yields come with no additional costs, rental yields come with a number of liabilities including repairs, insurance, agent commissions, property tax, sinking fund/society fees that could eat up a significant portion of your rent. If we assume this lowers your gross rent ~20-30%, we end up with an actual yield of mid to low 2%. Now the difference is starting to add up, as that ~3% (on average) difference in net yield leads to an additional 76% since 2002 returns for REITs versus residential property.
Do note, we are considering unleveraged assets (i.e. you are buying the investment property outright), but if we do consider mortgage payments then residential net rental yields can fall to zero (or go negative!).
So to wrap up our quantitative analysis – on a property value basis it seems that REITs and residential property have returned roughly the same amount (although we didn’t account for stamp duty and other taxes, which would tip the favour towards REITs) however once you account for the differences in rental yield, it’s very clear which asset as the advantage.
The Qualitative:
On the qualitative aspects we’re going to go ahead and tell you the conclusion. REITs win hands down. Why? See below
No Slippage: REIT yield is constant, however if you own a property you may not always have renters.
Being a landlord is no walk in the park – difficult tenants, repair issues, dealing with agents, in-laws coming to stay!
Re-investment risk: Even if you can eke positive rental yields, you can’t reinvest the monthly amount in more residential property. However every $ earned from a REIT distribution can very easily be reinvested into the REIT index (or an individual REITs). For just a few dollars, you can own a piece of the Singapore skyline!
Liquidity: Selling a property takes a lot of time and effort, and if the market is bad, liquidity dries up. You can buy and sell REITS almost instantly as long as the market is open. Further, while we didn’t include it in our analysis, most investors do end up taking a mortgage to buy their investment properties, and you have to remember when you do this you are leveraging an illiquid asset. If for any reason the job market turns ugly, and you lose your ability to make your mortgage payments, you risk losing all of your investment.
In Conclusion:
Go on, buy that first home, we’ll be the first ones to celebrate with you. However if you’re considering buying residential property as an investment, we’d really urge you to think twice. REITS seem to both quantitatively and qualitatively outperform residential property. To put it in perspective, if we look at the total returns of the REIT index over the time period we’ve been exploring, the annualized return is a whopping 11.5%.
Counter-arguments:
Often the pushback we get is that due to the leverage, residential property returns look very attractive. While this has some merit, for any comparison you have to make a like-like analysis. Also, private banks will lend you against your REITs assets (60-70%) if you really wanted to juice those returns.
Some might argue this is an unfair comparison and that we are comparing residential properties to Singapore listed REITs which mostly own commercial properties. The goal of this piece is to explore viable alternatives to a target investment (remember it’s not as important what your benchmark is, it’s more important to have one). Also, for most of our clients, commercial real estate is not a usual investment.