Property Cycles – Singapore Exempted?

By on December 12, 2012

Experienced property investors put their money into real estate for rental returns. For a new kid on the block, the focus is always on capital gains.

So while a seasoned property player has a preference on rental demand and rates, a rookie will key his eyes on the potential profits from capital gains when the investment property is eventually sold off.

There are many investors who invest in properties solely for capital gains. They are not concerned with making a rental profit, and are sometimes even happy to make a rental loss!

Understanding why property prices go up and down is essential for anyone who is taking property investing seriously unless you are just another person who buys a second property just to brag about it in social gatherings.

Singapore’s property market is performing so well that it is easy for us to forget that we have our ups and downs in the past. This is one of the key reasons why so many people are in a mad rush to buy more properties.

It is as if anyone who misses out will never get another chance again.

Because rental is more stable compared to property prices, it becomes even more of an essential skill to read into price fluctuations as a serious investor.

Overview of how the sub-prime crisis developed

The heart of the American dream

Traditionally, when we borrow money from a bank to purchase a house, the mortgage payments are paid to the lender.

The lender makes money from interest charges over the years. And that’s the end of it.

But because of deregulation or the lack of regulations, a complex system of mortgages in USA developed.

Lenders started to sell these mortgages to investment banks. And investment banks started to package complex financial products that include these mortgages to sell to investors.

They may combine a flurry of different products, bundle them together into a package and start marketing these products to investors.

These complex products are called Collateral Debt Obligations (CDO).

From then on home owners who are paying the mortgages are effectively paying to investors all over the world. No longer are they paying to the lenders.

This is already complicated to understand from reading once. But there is more.

Now for international investment funds to buy CDOs, they have to have the very best ratings so that it can be judged to be a safe investment.

Retirements funds are good examples of funds that only look for investments with the best ratings.

The danger comes when rating agencies that give these ratings are privately run entities.

To take it further, the ratings that they give to CDOs are just their opinions. Making them not liable for any organization that make their investment decisions based on these ratings that rating agencies publish.

This is a disaster waiting to happen for a nation that champions capitalism.

Mortgage lenders started to focus on issuing more and more mortgages as it does not matter to them anymore if the home owners are able to repay.

They started to issue riskier and riskier mortgages. This is where sub-prime mortgages started to explode in volume.

Investment banks also stopped caring about whether home owners can pay as the more CDOs they sell to investors, the more profits they make. Rating agencies continued to give the best ratings to these CDOs. They are after all remunerated by the investments banks to give a rating.

It then came to a point where CDOs are mostly made up of subprime mortgages.

In fact, everyone preferred to sell high risk loans as there is more profits to be made from higher interest rates.

The easy access to mortgages to buy properties became a home owner’s dream come true as they can now be able to buy their dream homes even though they are unable to afford it.

Demand for properties explode and prices rise exponentially.

In economics 101, we learned that when demand exceeds supply, prices go up. As property prices explode, so does the loan quantums issued.

Eventually when more and more risky loans go bad, it became harder and harder to sell these mortgages to investments banks and CDOs to investors.

When the market for CDOs finally went bad, investment banks suddenly find themselves holding billions of dollars in junk mortgages, CDOs and properties that nobody wanted to buy.

One thing led to another and we all know what happened next was one of the most shocking corporate meltdowns in economic history.

A bigger drama unfolded when mortgage insurance came into the picture. But let’s not talk about that.

How an unrelated event can cause the property market to crash.

When a financial crisis takes root, banks will start restricting lending to keep their own liquidity. The general public will also go on a mad rush to withdraw their money in the bank.

Money will be in short supply overnight and interest rates will jump. This makes sense as banks will now only be willing to lend at a high profit.

As most property buyers buy with home loans, the lack of loans will mean that lesser people will be able to buy properties.

Because let’s face it, how many people can afford to buy properties with cash?

This sudden tightening of money supply will cause demand for properties to fall and prices will follow.

As valuations fall, sky high interest rates will cause a segment of home owners to default on their home loans.

At this time, banks may start recalling loans, or repossess the house.

But since, the value of properties have crashed, the bank will still be unable to be fully repaid on the loans they gave out in the first place.

This will further negatively impact the property market as banks enforce more credit tightening to stay liquid and sell repossessed properties at below their already low market value.

At this point property developers will have to decide whether to to abandon projects or sell new launches condos at a loss. Is is a scenario that nobody likes to see. Except if you are a savvy investor who saw this coming a mile away.

This cannot happen in Singapore

What if it can happen?

Are you really sure this cannot happen here?

We are too small a global player and are highly supported by a chain connecting foreign investments and economies. Almost half our population are even foreigners.

Yes property prices are hugely determined by demand and supply and credit availability. But do you see that crashes are in fact caused by the greed of players in the value chain?

If we go back to the subprime example, it could have been stopped by any player in the value chain.

But because of greed and capitalism, it happened.

Billion dollar corporations received their bailouts and the common men on the streets get their properties devalued.

If you look at the Singapore property market now in December 2012, a lot of things defies logic.

Thousands of new launch condominiums are unsold with many more thousands being built. Yet prices are rising!

The property market explosion inevitably spilled over to a mortgage explosion. Yet mortgage rates are hovering around levels that international investors would consider as free money!

The government has introduced waves and waves of policies to curb property prices. Yet prices are still rising!

Lesser and lesser transactions are happening. Yet property prices are rising!

The great Singapore property rush is on.

A big event that does not necessarily have to happen here can trigger a property panic. Or it might even just take a major property player in Singapore to panic and the cards will fall. Take heed and be careful with your money my friend.



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