Saturday, March 7, 2009

Stocks or residential property investment?

Needless to say, property and stock markets are the most unlikely places you want your money to be right now. But the question is, given that you have $300,000 to invest now, do you buy a private residential property beside a MRT or a blue chip like DBS for passive income?

Many would argue that in Singapore, buying property would never go wrong. Well, perhaps it is because you have not seen people who have got their hands burnt in property market to live and tell their stories?

Which one offers a higher return and lower risk?

Some parameters of comparison:

DBS: $6.80/share

Assuming you purchased 44 lots.

Dividend per quarter: 10 cents (conservative guesstimate, could be higher or lower)

Income per annum: $17,600

Probability of losing 40% of your $300,000 in 6 months time: 30% (my conservative guess)

Income tax payable: None, as it has already been taxed at source

Yield: 5.89%

Probability of selling and earning a profit in 20 years time: 90% (guesstimate)

Net dividend income at the end of 20 years: $352,000
Assuming a conservative adjustment of 30% error, net dividend income would be: $246,400.

The argument here is that even the best banks in the world can fail, can we even trust to put our money with Singapore blue chips?

There is still a fair chance to lose 100% of our money in stocks.

Next

99 year leasehold Property: E.g: Kovan Melody/Compass heights

Cost: 1000 sq feet, 2 room property purchase @ $580/sq foot, costing $600,000 after stamp duties and other transaction fees. Minor renovations and fixtures have also been accounted.

Loan amount: $300,000 @ 2.5% for 20 years (interest is more likely to be 3.5% on average)

Monthly installment: $1500 (conservatively speaking)

Income from rent: $2100 (conservative estimate)x12= $25,200

Property tax: 10% of $25,000= $2,500

Agent expenses: $1,100

Wear and tear yearly maintenance: $600

Net rental yearly income: $3,000

Yield: 5,400/300,000= 1.0%

Probability of losing 40% of your $300,000 in 6 months time: 30% (my conservative guess)

(Should the property market falls another 20%, the fall in your property price will be $120,000, or 40%.)

Net rental income at the end of 20 years: $60,000

Probability of selling and earning a profit in 20 years time: 99% (based on historical records)

Apparently, property market is a more appealing investment as most people can tap on their CPF funds to finance their property while earning cash returns. From the above example, it is likely that the owner is able to sell the property 20 years later for at least $540,000 and earn a little profit, or carry on renting out the property for a $20,000 annual income.

This risk is considered “lower” as it is unlikely that the property will “fail” due to earthquakes or tsunami.

In the event that nobody wants to rent, the owner can simply move in and enjoy the home himself. You cannot even use the DBS’s branch toilets even if you are a major shareholder!

However, the short term risks are more or less the same. Yet the investment emotions involved are different. The feeling of seeing my property price falling 20% and pain of seeing my investment portfolio falling 50% is totally different even if the amount involved is the same.

Property gives people a sense of security. People need a roof over their heads, no matter what happens. It let investors feel that they can earn some rental income as long as they lower rent. However for stocks, investors do not see themselves owning an essential business. Actually, many businesses are also essential ones. Without them, people cannot own houses or even get a job.

Personally, I feel that property investment carries a higher risk of failure. The rental income might not be stable and one depends on rental income to service the loan. Tenants may default or destroy your house fittings, there might be unhappiness when negotiating new rental contracts or handle difficult tenants.

Still stocks for me for now.

Any inputs?

10 comments:

Derek said...

Hee, this post comes at the right time. My friend is looking to buy a condo. He has no knowledge in stocks whatsoever and it's kind of puzzling as to where he wants to buy one when he already has a house.

Of course, one of the reason could be to stay in it eventually. I guess why he prefers a property over stocks is because many of us deem that property is safer. Like you already mention - with something that you can feel and touch gives you a higher sense of security as compared to just numbers.

Cheers!
Derek

Kay said...

I think this can be slightly related to behavioral finance. If I'm not wrong, the long-term returns of stocks is higher as compared to properties. However, properties alway seems to be more attractive to stocks at first glance. This is probably due to leverage as people usually take loans on top of the equity that they are providing to service the mortgage. On the other hand, I wonder why don't people use leverage to invest in an index fund for the long run. It should be equally safe too.

Furthermore, properties are more tangible in a sense than stocks. You can literally see the house or the condo sitting on a piece of land whereas for stocks, our perception is mainly the stock quotes or the electronic entry in our CDP account. In this aspect, properties seems to be more secure as compared to stocks.

Kay

Everlearning said...

My upstair neighbour sold his unit after renting out for more than a decade. Reason: the tenants were out of jobs and unable to pay rent. To sell the unit is easier to get them out; besides property was at its peak.

My opposite neighbour has been renting out her unit for the last six years. Let me count: about three or four different tenants staying less than a year. The recent ones always banged the door so hard when they returned home. They left a few months ago and the unit is unoccupied.

I strongly feel that having a residential property as an investment is too costly and risky. I will go for stock investment but with such economic climate we are facing, with no dividend payout; it is also not too attractive to me.

I suppose moderating an investment is crucial. Any investment one holds should not bankrupt the person is ideal. That is just my opinion.

BL Trading Team said...

Forget about both stock and property investment, not the time yet.

la papillion said...

Hi SBC,

The potential returns for property could be higher if you put in less down payment. From your example, you seem to put in 50% for the down payment, whereas the norm is 20 to 30%.

Given the kind of leverage employed in property, the yields will be higher and the potential returns after cashing out the property is higher too. Still, we have to compare apples to apples. We can say the same for stocks if we buy on margins. But I guess you know this: Leverage cuts both ways, you increase both your potential gains and losses multi-fold.

I think buying a property for its yield is definitely not attractive. The absolute amt put in is too big. It's like you have 1 mil but you put all into one SINGLE stock. If you want income from yield, split your 1 mil into different dividend yielding stocks so that you can sleep better at night.

Property should be milked for its capital gains, IMO. The property market is much less efficient than the stock market, hence it's so much easier to predict the bottom and the peak. There's a whole lot of sentiment you can gather at property launches.

Porcupine said...

I personally feel that with a property, you are as good as being your own boss and you are more involved in the decision making process. You get to choose who to rent the flat to. Definitely you will only rent to someone that has hit most of your criteria on your checklist (e.g. race, nationality, own pets, have children, have any debt problems ...). But if you dump your money on a counter or diversify to several counters, your rights as a stockholder is limited.

Sgbluechip said...

Thanks all for you valuable inputs.

Apparantly, property gives investors physical "control" over their investment, compared to stocks. However, in accounting terms, one of the essential characteristics of asset is "control" where the owner can deny the benefits of their assets from others. Both stocks and properties qualify for it. Hence strictly speaking, there should be no preference for it other than treating them as a different asset classes in an investor's portfolio.

However after factoring the aspect of diversity, liquidity, ease of transaction, "maintainence free" and other qualitative factors, I would continue to favour stocks as investments compared to properties.

It has nothing to do with yield actually.

Createwealth8888 said...

You may like to view

http://createwealth8888.blogspot.com/2009/02/property-investing-case-study-3-edited.html

Lemizeraq said...

You are pretty well versed in financial matters for someone in your 20s.

A lot of people live payday to payday and don't have any conception of what they will live on when they retire.

You have a good site, I'd be looking forward to reading your posts on Google reader.

@Kay, you can use leverage to buy index stock- max out your housing loan to 30 years if buying HDB and use the money you would have to pay the housing loan earlier to dollar average into at least two different index stocks.

The Joemeister said...

Hi SBC,

I've read the comments so far. 3 points I'd like to add/ponder.

1. The original comparison included a property loan. So perhaps we should also take share financing to make the comparison more level. Compare $600k worth of property versus $600k worth of stocks, both using roughly 2x leverage.

2. With regards to the hassles of property, I've seen presentations from foreign alternative property investment schemes. These claim to provide 5% to 8% rental yield plus (non-guaranteed) capital appreciation over 5-7 yrs. The min. entry is also not six-digits. Seemingly lots of advantages over direct property purchases except it's completely unregulated by any authorities. Perhaps those who bought such schemes care to share their experiences?

3. I've read that property market and stock market are highly correlated. So is portfolio diversification the right reason to buy an investment property?