"Price is What You Pay; Value is What You Get" - Warren Buffet
Ever wondered about the price discrepancies among properties in different part of Singapore, or even within different parts of the same estate? What explains the huge observed variance in psf from $6xx to $2xxx?
What exactly is fair value?
FRS 13 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
What valuation techniques are available?
The market approach uses prices and other relevant information generated by market
transactions involving identical or comparable (ie similar) assets, liabilities or a group of
assets and liabilities, such as a business. For example, some people might refer to recent transacted prices at the HDB resource
here to determine what an appropriate price could be.
The cost approach reflects the amount that would be required currently to replace the service
capacity of an asset (often referred to as current replacement cost). In the Singapore context, this could be more relevant to landed property where in addition to the land price, the parties could also consider how much Additions and Alterations costs have been, or would be incurred.
The income approach converts future amounts (eg cash flows or income and expenses) to a
single current (ie discounted) amount. When the income approach is used, the fair value
measurement reflects current market expectations about those future amounts. This can be easily understood in the scenario of holding an investment property: typical inflows could be receipts of tenants' rental, and outflows would be the mortgage repayments and/or the future sale proceeds.
Application to the Residential property market
At the heart of the model is the observation that market forces should adjust to make households indifferent between buying and renting.
There is a ”user cost relationship” linking house prices, rents and interest rates. According to this relationship, market forces should equate the cost of renting – the rent/price ratio – to the cost of home ownership – the interest income forgone upon purchasing a property net of expected house price appreciation
A second relationship represents demand for housing, and states that rents are higher when the stock of housing is lower, but also that rents increase when households have more income to spend on accommodation services and when population increases.
The third leg of the model is relationship capturing housing supply, which assumes that new
housing is built when house prices increase relative to the marginal cost of building new dwellings.
The framework implies that house prices increase when interest rates fall; when disposable income and/or the size of population increase; and when building costs rise.
Since housing purchases are typically financed through mortgage loans, and many potential
homeowners are constrained in the amount of credit they can obtain, credit supply ought to impact house prices. An increase in credit availability and a loosening of borrowing constraints, for example, is likely to reduce the interest rates faced by households and push prices up
Pressures on the housing market may also arise from abroad – for example, because foreign investors with abundant liquidity and a high willingness to pay acquire property in local residential markets
While this blog is primarily concerned about Singapore real estate, it is interesting to note that the sensitivity of house prices to drivers varies across jurisdictions depending on the structural characteristics of each economy. For example, the interest rate sensitivity of prices ought to be greater in countries where mortgages are predominantly adjustable rate rather than fixed rate. More broadly, changes in housing demand drivers should have a larger impact on house prices in countries
where the price elasticity of supply is low. Price sensitivities to demand drivers could also be expected to be greater in jurisdictions with tax incentives for home ownership such as tax deductibility of mortgage interest payments.
For more details, including empirical observations (i.e. with real data), please refer to the paper
here
What can I do with this model?
In summary, the framework returns the following predictions regarding the sensitivity of house prices to different drivers: prices should be higher when
- households’ disposable income are higher;
- population growth are higher;
- interest rates are lower;
- credit conditions loosen; and
- footprint of international investors is higher.
Anecdotally, in the current Jun 2020 environment:
- Household income should be lower due to lower consumer confidence
- Population growth should be lower due to possible reduction in foreign workforce
- Interest rates are lower directly/indirectly due to monetary policy
- Credit should be simpler to obtain for example the MAS SGD facility for esg loans
- There could be more international investors particularly from Hong Kong
Depending on your views on each of those drivers, and the relative weightage accorded to each driver, how do you think residential property prices will behave? How can you benefit from the price trends? Let me know in the comments below.
