Monday, July 20, 2009

Prim and Proper Property

If two investments are similar and one is trading at a higher yield, what is likely to happen to the one with the higher yield? Price compression is likely to ensue. With the direct property market burning red hot, it is surprising that the S-REITs have not re-rated more strongly.

Investors are chasing condo projects in the residential market at yields of apparently 3%. Note the word apparently because rentals are likely to come under pressure due to the supply of 20,000 units coming on stream in the next two years. A Singapore minister alluded to the same per annum supply figure recently. S-REITs on the other hand, are yielding at least 6%. Their yield spread to the risk free rate is probably the largest on record ever. Take A-REIT for example. If you think its quarterly DPU can be annualized, one is looking at an investment which is liquid and tradable and yielding 8%. The indicative yield on a 10 year SGS is about 2.3%. So that's over 6% yield spread. Of course, you are taking on equity risk premium and yes, some REITs are pricing in blue skies scenario and investors have ignored balance sheet/credit risk. But that is not to say that there are good REITs going for a song in the market today. Another benchmark was when CMT first went to the market in 2003. Then, the first incarnation of CMT failed. A revised offer, from memory, of a 7% yield helped get investors attention and thus, planted the seed for our S-REIT industry. With yields where we are at today, are we back at the same spot in the 6-7 year cycle? We are vested and do not want to offer names. But any serious yield investor who ignores this segment of the market, we believe, would be missing out on an opportunity to get yield with upside potential.

At this juncture, we also would like to clarify our comments on the Singapore residential market. Whilst we will not participate in the queues, it is not to say that the rise in prices and buying activity will abate anytime soon. So is this a bubble? Maybe so. But there could be rational reasons underlying the frenzy.

If one were to take a step back to examine the Singapore household balance sheets, you may come to a similar conclusion. Do not quote us on this but the cash and housing investable savings are about 140% of our GDP and our medium household income is approximately S$7000 per month. Unlike the US and UK counterparts, Singapore households have no deleveraging issue and are not net in debt. So to put a downpayment for a S$1 million property and service its monthly interest is comfortable for many households. Loan servicing may only become a challenge if jobs are lost. But lo and behold, isn't the papers reporting that banks are hiring back investment bankers and private wealth managers again - the same segment of the market who are likely to buy these units? So although the huge supply in the coming months ahead should put a dampener on capital values and rental prospects, the price may find support at a level that may not represent fire-sale prices. If you need to buy, buy into unique projects with good location. Its amazing how the 2 room or studio units get sold so quickly these days. Yes, the absolute ticket size is small but I really wonder how many occupants want to live in such small confined places? An expat family wants a sizable unit, not a tiny 60 sqm compound which sees Junior running into the family's domestic help at every turn.

Yes, the market is irrational. It may not really matter if we don't have understand why it is irrational. We just want to be able to profit from it.