My friend who is the landlord with over a hundred tenants for his various properties that we talked about last week also happens to be an active bond and equity investor which is all we really need to have that “helicopter” view of asset markets.

Not impressed with my short write up, he decided to give me another earful to clarify his stance and correct my “misrepresentations”. Therefore, it was whisky time again and another stroke of luck for me with another free double of double shots.

Residential market is “policy driven”

The residential real estate market in Singapore is now well and truly in a slump shall remain so until the additional buyer stamp duties are removed which he thinks will not happen this year, at least.

Historically, the well-heeled have supported real estate markets but with 15% ABSD, there is little buying interest.

Interestingly, the first-time buyers who traditionally have gravitated to new launches are the only real source of liquidity. Thus the premium for new launches versus secondary market sales has widened significantly.

Commercial Property is the “next shoe to fall”

Residential property has always been more volatile than commercial real estate.  Residential real estate has always been an emotional card because home-ownership is not always an analytical decision. In contrast commercial property is a approached from a more logical perspective.

SIBOR, the main funding rate for most real estate loans in Singapore, has more than quadrupled from its lows of 0.1-0.2% last year to its greater than 1% levels today. This means that interest rate burdens have increased four to five fold.

If you add say a spread of 150 bps to 1%, we get 2.5% interest costs. The cap rates of a lot of commercial real estate is at the 3% level, and this is a gross cap rate, which ignores property tax, and service charges.  If we assume that net rent is say 80% of gross yield, then a 3% gross yield translates to a low 2.4% net yield and similarly 3.5% gross yield translates to 2.8% net yield.

Indeed, SIBOR has averaged 2.5% over most of its life, and LIBOR has not even started to go up yet. When the Fed finally tightens, SIBOR could go up more, and thus, why should capital values stay where they currently are?

Commercial property spreads versus Bond spreads

Bond spreads are a function of spread to the risk-free rate. Simply put the spread to the risk free rate for the specific maturity is what you are getting paid for as a bond holder. He very clearly notes that there is actually a huge difference in duration risk between corporate bonds and real estate. A corporate bond is generally a 5 year (or less as it runs-off) risk and should be compared to a 5 year Government Bond. Property is a longer duration instrument, and should be compared to the 10 year Government bond. While this didn’t matter in the last couple years when Singapore interest rates were much lower, it will start to matter more as rates rise.

So if the risk-free rate of the 10 year Government Bond or SGS is 2.2%, how much premium are investors getting for their trouble on an income basis. Worse still, what if the property is leasehold?

In addition, income tax is still payable on any net income, which is unlike a bond (or a REIT). The marginal rate of Singapore personal income tax is going up to 22% from 20%. This matters because the marginal buyer of commercial property has been by individuals.

To be circumspect, all property also has an equity-esque return, the promise or expectation of capital growth. Investors make money on both capital growth as well as rental income, but realistically, what is the prospect of future capital growth?

He notes that office vacancies are still low, but does not see much room for growth. He is even less bullish on retail. He thinks the economy is slowing and retail rent is a function of sales. The undeniable global trend is towards online retail and Singapore is a very wired-up country which is self explanatory.

Finally he notes obliquely that, without exception, every time there has been a surge in interest in strata – titled commercial property, this represents the top of the market.

What a damper from the last time but it does serve to free up investors to look at other investments like he is doing, in bonds and equities in the meantime, until the next rally comes along.