Churchouse Letter
March 2012             by Peter Churchouse

The “Gini” is Out of the Bottle

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Diana Olteanu-Veerman of Green Investments Ltd contributed to this newsletter.

There has been a tendency amongst many factions of society to brand the global financial crisis as very much a problem created by bankers, financiers and greedy property developers. While this characterization may have some substance, in reality the whole chain of cause goes much deeper than this. This crisis is really the culmination of a generation (or more) during which the socio-political pendulum has swung from an environment of greater egalitarianism in sharing of the spoils of economic growth in most countries, developed and developing, to one where there is a considerably greater divergence in the receipt of benefits of capitalism and democracy.

In September 2010 in a piece entitled “The Pendulum, Having Swung, Now Swings Back” we remarked on this phenomenon. The essential observation is quite simple. In the years following World War II, right up to the end of the 1970’s the western world was characterised by an economic and social model where the balance of economic power largely rested with labour. Spoils of economic growth were bestowed largely on labour. The unions were strong and to a considerable extent held their respective nations to ransom. In the UK union strength was epitomized by the coal miners’ union led by the firebrand Arthur Scargill. In the US it was the Teamsters, with Jimmy Hoffer at the helm. In Australia and New Zealand it was the wharf unions and transport unions that ruled the roost, reflecting the importance of agricultural and mineral exports from these countries, primarily to the UK. Half of continental Europe was under communist influence and the other half had strong socialist parties.

Some readers might remember the three day week in the UK in the mid 1970’s when the country ground almost to a halt in response to union action. We remember very clearly arriving for the first time in Europe and the UK in 1975, from New Zealand having spent about three years in Africa, one of those years driving north across the continent from south to north. Arriving in the UK was a truly shocking experience to us. Huge tracts of very expensive and prime London property was occupied by squatters, who simply moved into just about any property that they could find which was empty, even for a few weeks, and simply occupied it. Unemployment was rife, and just about everyone one met was picking up some form of government handout – whether legally entitled to it or not. Legions of people who did in fact have jobs, often receiving cash in the grey market, would routinely sign up for the dole handout every week. One acquaintance took great pride at the pub telling us all how he would park his Porsche outside the dole office before entering to collect his handout every Tuesday. Even those lucky enough to have employment enjoyed a 35 hour work week – to work more was considered a sacrifice akin to losing a limb! And if coffee, tea, and pub breaks were taken into account, the actual productive work week was probably no more than 20 hours in most UK offices.

Figure 1:

The Global Socio-Economic Policy Pendulum Swings Back. 1979/80, the Reagan/Thatcher years saw a swing towards deregulation, where excess returns went to capital, causing huge credit growth in housing, asset bubbles, widening income and wealth gaps and government deficits. In 2008/09 with Obama/Brown there was an increasing swing towards reregulation, which tends itself towards more strikes and union activisim, highly regulated trade and protectionism.

Source: Portwood Capital Limited

The UK was under an IMF program – yes, an IMF program in which its financial and monetary independence had been abrogated to the international body. Anyone wishing to pop across the Channel for either pleasure of business could legally take only GBP50 with them, and needed Bank of England approval to take any more. We tend to think of these kinds of situations as limited to the likes of Argentina, the Philippines, Indonesia or other such hapless victims of financial profligacy and bad management. Not Britain, leader of the free world! Britain was under a Labour government that owed its position in office to the unions.

The pendulum of economic power and balance had clearly swung too far in the direction of social and economic equality, to the point that the system had become not just merely inefficient but openly corrupt. While Britain’s case was particularly obvious, the situation was similar in many other western countries.

Something had to give, and it did – in 1979/1980. The catalyst for the swing of the pendulum to be reversed was the election of Margaret Thatcher as Prime Minister in the UK and Ronald Reagan as President of the USA. Quite quickly the powerful wings of the unions were clipped, most obvious abuses of the welfare systems were stopped and new regimes of economic and social practice and rules implemented. Central to the new regime was the opening up of international trade which ultimately became known as globalization. From economic returns being concentrated in the hands of labour, economic returns became focused over time on owners and employers of capital. From the early 1980’s until very recently, owners of capital and knowledge achieved greater financial rewards than labour. Within this pattern, not just owners of businesses stretched their economic lead but also families that simply owned their own home, or some investment assets, either property or shares. People who worked with capital (i.e. bankers, lawyers, accountants, consultants etc.) also benefited from the swing of economic returns from labour to capital.

Much of the discontent that is bubbling away in the western economies has much to do with the swing of the economic pendulum which has got to a point where capital is seen to be getting too big a share of economic spoils and labour is lagging behind. But at the same time all sections of society are being asked to pay the price of the recent financial sector and economic problems via higher taxes and austerity.

The swing of the economic pendulum has created a wider gap between rich and not so rich in a great many countries. Various measures of the Gini coefficient reflect this trend over the past generation quite clearly (The Gini coefficient measures the inequality of values of a data series – for example income. A measure of 0 shows perfect equality, where everyone earns exactly the same income. A value of 1 indicates that one person earns everything and the rest earn nothing. The higher the number the greater the degree of inequality).

Figures 2-6 show the Gini coefficients for a number of countries, with some showing data from the mid 1970’s – the period of labour dominance – to the present time.

Figure 2: Income Gini Coefficient Ranking

Income Gini Coefficient Ranking circa February 2012. Constituents listed from highest Gini coefficient to lowest: Brazil, Thailand, Hong Kong, Singapore, Malaysia, United States, Russia, China, Portugal, Japan, India, Indonesia, New Zealand, United Kingdom, Switzerland, France, Canada, Italy, South Korea, Netherlands, Australia, Denmark, Germany, and finally Sweden.

Source: The World Bank

First, just looking at the recent Gini coefficients for the major countries at figure 2, we can see that Asian countries dominate the top rankings in terms of income inequality with Thailand and Hong Kong at the top of the heap, and Singapore close behind. European countries generally are at the lower end of the inequality spectrum according to this data.

Figure 3: Non-European Income Gini Before and After Taxes and Transfers

Non-European Income Gini Before and After Taxes and Transfers from mid 1970s to late 2000s (United States, Canada, Australia, Japan, New Zealand).

Source: The World Bank

Figures 3-5 plot the Gini coefficients over time, some from the mid 1970’s to the present. The charts show changes in Gini over time on a pretax basis and on after tax basis. Several points can be made:

Figure 4: Gini Income Coefficient Change – European Countries Before and After Tax

Gini Income Coefficient Change - European Countries Before and After Tax and Transfers from mid 1970s to Late 2000s (Portugal, Netherlands, Denmark, Sweden).

Figure 5: Gini Income Coefficient Over Time – Core Europe Before and After Tax

Gini Income Coefficient Over Time - Core European Countries Before and After Taxes and Transfers from mid 1970s to late 2000s (Germany, France, United Kingdom, Italy).

Source: The World Bank

  1. There are very few examples of the Gini coefficient trending down over this period, i.e. income inequality becoming less. Clearly there has been a trend of growing income inequality over the past 30 – 40 years, which has coincided with a period of declining union influence in the western economies, growing globalization, and growing economic returns accruing to owners of capital (including owners of hard assets such as property).

    Figure 6: Countries Showing Reduced Gini Income Coefficient (%) After Taxes and Transfers

    Countries that Show Reduced Gini Income Coefficient (%) After Taxes include: United Kingdom -6.18%, Canada -7.97%, Portugal 14.28%, Italy -18.08%, Japan -25.69%, France -29.44%.

    Soure: The Central Intelligence Agency (CIA) Gini Index

  3. Gini coefficients are considerably lower (i.e. show greater equality of income) when adjusted for tax and transfers, demonstrating that taxes and transfers do tend to produce greater equality of income, as might be expected.

    Figure 7: Countries Showing Increased Gini Income Coefficient (%) After Taxes and Transfers

    Countries that Showed Increased Gini Income Coefficient (%) After Taxes include: Germany +2.72%, Australia +8.53%, New Zealand +10.25%, Netherlands +11.79%, Sweden +12.66%.

    Source: The Central Intelligence Agency (CIA) Gini Index

  5. Figures 6 – 8 plot the change in the pretax and post-tax Gini coefficient for our universe. In only 2 cases (Japan and Netherlands) did the Gini remain flat over the period considered (pretax). In all other cases, the Gini increased by 11.5% to almost 35% in the case of the UK on a pretax basis, demonstrating rising inequality of incomes.

    Figure 8: Countries Showing Similar Gini Income Coefficients (%) Before and After Taxes and Transfers

    The two countries which had GINI income coefficient remain largely the same before and after tax were the United States and Denmark.

    Source: The Central Intelligence Agency (CIA) Gini Index

  7. When we consider the change in Gini over time on a pretax basis vs a post-tax basis the analysis shows that for 4 countries of our sample the Gini grew greater in percentage terms after tax than on a pretax basis. This shows that income inequality actually widened on an after tax basis for about half of our sample universe over this period compared to the pretax basis (Figures 6 – 8).

Figure 9: Top 1% Income Share Sample

A sample of the share that the top 1 percent of income earners make from 1920-2010 for the following countries: United States, United Kingdom, Canada and Australia.

Source: World Top Incomes Database

Analysis of data for the US demonstrates that the increase in the Gini coefficient there between 1967 and 2003 is due to relatively greater income gains for upper income earners. It is NOT due to income losses of lower income earners. Long term data for the US also shows that the share of total income of the top 1% earners remained quite constant for the period from the 1950’s to the mid 1980’s (roughly the period of our “high returns to labour” era) at around 8% – 9% of total income rising thereafter to around 17% of total income in 2005.

Figure 10: Comparison of Wealth Gini and Income Gini

Comparison of Wealth Gini and Income Gini (Australia, Brazil, Canada, China, Denmark, France, Germany, Hong Kong, India, Indonesia, Italy, Japan, Malaysia, Netherlands, New Zealand, Portugal, Russia, Singapore, South Korea, Sweden, Switzerland, Thailand, United Kingdom, United States).

Source: The World Bank

Wealth Inequality is Much Greater Than Income Inequality

While the above analysis refers to income inequality, the wealth Gini coefficient considers the inequality of wealth not just that of the income. Figure 10 shows the Wealth Gini for members of our sample group. In all cases, the wealth Gini is considerably higher than the income Gini, demonstrating a much greater degree of inequality of wealth than income. This measure reflects ownership of assets such as property.

What we can conclude from this is that the change in economic and social policies that were heralded by changes in key governments in the late 1970’s/early 1980’s have brought increases in income disparities across most of the western world (and many other areas also), which have benefited the great bulk of middle income earners and even more so for the upper income earners. Owners of capital have proved big beneficiaries of this process, both in the income stakes and also through ownership of assets such as property, pension plans and other investments.

Globalisation of Labour and Capital is Central to Income and Wealth Gap Widening

Globalisation has played a vital part in the swing of returns from labour to capital. Globalization has produced considerable competition for labour, particularly in the lower skill sectors and manufacturing as countries such as China, India and other emerging markets have entered the global manufacturing and exporting environment. Reduction of trade barriers of many kinds have allowed production of manufactured goods to migrate to these emerging markets.

Increased globalisation of manufacturing capability and effectively labour markets has produced globalization of capital flows. Those factories in China have been funded to a significant extent by foreign capital, and as those companies have grown and prospered, a great many have listed on local and foreign stock exchanges. Do you remember “Big Bang”? This was the capital markets phenomenon that took effect when the UK liberalized its financial services sector. Within a year or two virtually every medium to large sized bank, stock brokerage and investment bank in the UK popped up with offices in Hong Kong and Singapore as well as other markets. The US financial services industry, which had been very inward looking also started embarking on a drive offshore that eventually saw them if not dominating then certainly becoming major players in the financial services sectors of some of the major financial markets around the world.

The global migration of capital led to very substantial benefits for “knowledge” industries and services, and has added its weight to the trend of greater inequality of income. The lawyers, accountants, bankers, marketers, headhunters have been the stewards of globalization of the educated classes. Not only has globalization made competition for labour at the lower end of the reward spectrum more fierce for these groups in the western world, but it has provided an abundance of well paid opportunities to those from the west with degrees and a willingness to take their skills around the world. The word “expatriate” has gained real meaning over the past generation. Wall Street is heavily populated today with British, Europeans, and Asians, just as the City of London finds its pubs and restaurants filled with American and European accents. This phenomenon is found also in the other core financial capitals of Hong Kong, Singapore, Tokyo, Frankfurt, Paris and Sydney. And no doubt will be similar in Shanghai the moment the Chinese see fit to make their currency and capital markets open to the world.

Globalisation of industry and capital has hurt the income growth prospects of the manual occupations in the west but has enhanced earning and wealth opportunities for the university educated sectors of western society. In recent years this process has been increasingly accessed by the educated elites from emerging countries such as China and India also.

Data for the US show that just under 40% of high school dropouts in the US have a job, while more than 72% of those holding a bachelor’s degree or higher are in employment. The unemployment rate amongst the graduates now stands at 4.2% vs. 13.1% for high school dropouts.

Recently I spent almost two weeks in Europe, more for pleasure than for business. A former American colleague once very dismissively described Europe as nothing more than a giant amusement park. What struck me during this visit was the steady stream of invective being poured onto anyone who had the remotest connection to the financial industry in the UK and Europe. Banker bashing really has taken on an even bigger dimension than seems to be the case in the US. Possibly the timing of my visit, somewhere in the middle of bonus season for the banks was unfortunate.

“Buy to Let” Property Owners Taking a Bashing in UK Media

Another symbol of the “bash the middle classes” syndrome that is gaining momentum that I noticed recently is a flurry of shrill newspaper articles slugging “buy to let” property owners in the UK. I find this quite incomprehensible. According to this school of thought anyone who buys a property that they do not occupy, and rents it out to tenants for a rental income are labeled “scum of the earth” and other such pleasant titles by this brand of political misfits. What is so socially reprehensible about renting out a property? These same complainants are probably working in an office or factory that is rented by the occupying company. So it is OK for the owner of an office to rent it out for people to undertake a business, but it is not OK for an owner to rent out an apartment or house for someone to live in. This line of logic escapes me. If someone out there can fill me in on what I am missing here, please feel free to do so.

My own view is that the owner of a residential property who rents it out is doing the world a favour – he/she is providing a place for someone to live. Moreover he/she is probably lessening the risk that he/she will become a burden on the state in future years as hopefully his property will continue to provide a rental income that the owner can use to support his livelihood in the future.

The owner of rented property is not on a sinecure here. As anyone who has embarked on this form of investment well knows the risks and management headaches can be substantial. Owners often get hit with property taxes (that may rise substantially), may run the risk of higher interest costs and swings in rental incomes. The owner can be caught up in a constant round of maintenance and upgrades, all costing money, and can experience voids when there is no occupant for the apartment, but still many costs not to mention the rapacious fees that many so called “professional” property managers/agents charge in the U.K. for doing mostly very little.

We contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle.
– Winston Churchill

To the extent that landlords have purchased properties with little or no equity, just as have great many owner occupiers, and run into financial difficulties, they will stand to lose everything they have worked for. Unlike in the US where owners can cut their losses and walk away from a property with “under-water” mortgage, in the UK the owners are liable for the mortgage all the way. They will likely end up being a victim of the greed that has impacted very large numbers of subprime/Alt A mortgage holders in most parts of the western world, experiencing default and foreclosure on their properties.

Recession and Austerity is Bringing Waves of New Taxes – Protect Yourself!

Apart from the banker bashing I was made very much aware of a very disturbing and substantial undercurrent of moves to increase taxation in just about any form imaginable, not just in the usual headline tax targets of profits, incomes and goods and services taxes. European governments, up against the wall to cut debt/GDP ratios are dreaming up ever more complex, creative and minute ways to tax just about everything that moves, and for anything that does not move, impose a stamp duty! The European Commission has been trying to introduce a financial transaction tax “to make the financial sector pay its fair share”. The socialization of great mountains of debt by governments and international organizations since the global financial crisis makes this inevitable. But nonetheless I am unaware of any country that has taxed its way to economic growth and prosperity for its people.

While the rumblings of discontent growing in the western world and given forceful expression through banker bashing or such avenues as the “occupy” movement are perhaps a manifestation of discontent surrounding widening income and wealth disparities it is worth taking pause to consider the causes just a little more deeply.

Easy to Point the Finger — More Difficult to Pinpoint Actual Causes

It is simply too easy to bash Wall Street. Everyone loves a scapegoat. Yes, there are reasons to be critical of the behaviour of parts of the financial services sector. But it can be argued that the current financial mess has its roots to a large extent in government policies, and those of quasi government agencies such as central banks, housing agencies and other organizations charged with providing tax backed goodies for voters.

The roots of the US housing crisis go back to the last great recession of the 1930’s when about 10% of US housing stock was in default. To prevent a total meltdown of the housing market and the financial system, the US government stepped in to the mortgage markets via the Federal Housing Administration (FHA) and the Home Owner’s Loan Corporation (HOLC) to both buy up mortgages in default, and repackage them into much longer dated loans. The FHA was given the task of insuring the loans against future default risk, which meant that private sector institutions would be far more willing to accept such long term loans for their portfolios.

(A very lucid and concise history of the US housing credit markets can be found in Raghuram Rajan’s very readable book “Fault Lines” published in 2010)

30-Year Conventional Mortgage Rate (MORTG) from 1970-2012. Shaded areas indicated US recessions. Source: Board of Governors of the Federal Reserve System.

As the initial crisis calmed, the Federal National Mortgage Association – later named Fannie Mae – was created to pull in longer term finance for the housing mortgage industry. Fannie Mae basically bought in mortgage pools and financed them through the issue of longer term bonds sold to investors such as pension funds, insurance companies and other yield seeking investors.

The Government National Mortgage AssociationGinnie Mae – appeared in 1968 in response to rising interest rates and institutional based blockages in the mortgage markets that sprang up at the time. Under the new arrangement, Fannie Mae was effectively privatized as the provider of long term mortgage finance (and hence removed from the government’s direct balance sheet – very convenient!), and Ginnie Mae acted to insure, package and securitise mortgages for Fannie Mae to fund. The Federal Home Loan Mortgage Corporation (Freddie Mac) was formed to securitise home loan mortgage made by the thrift industry.

Although Fannie and Freddie were not formally government owned agencies but actually privately held, they did in fact have “community duties” to uphold, and with the implicit backing from the Treasury, were viewed by the investing public as having the US Federal government underwriting them as financial organizations.

Rising Income Disparities Led Successive Regimes to Promote/Subsidize Home Ownership for Lower Income Families

And here is where the problems really started! In the early 1990’s, in the wake of the recession at the time and more than 10 years since Ronald Reagan had entered the White House, it was becoming increasingly clear that income disparities were rising, and that lower income sectors were experiencing flat, or even falling incomes. An obvious and quick fix to this problem was to promote home ownership for lower income households, using the so-called private agencies such as Fannie and Freddie to pay the bills – all off the government’s balance sheet of course. These organizations were caught between a rock and a hard place – refuse to bend to the will of the political masters, and their organizations would likely be shut down or re-shaped, or go along with the plans and take on much more financial risk. They predictably chose the latter.

Of course promoting low income housing is an easy sell to the voters. Just about everyone benefits from easy credit – low income households get to own their own home, something that might have been impossible in normal private sector credit markets. The mortgage sourcing institutions gain, the bankers gain, the lawyers and the accountants love it. Pension funds and insurance companies get a steady stream of apparently low risk paper for their portfolios. What is there not to love?

Fannie and Freddie grew to enthusiastically embrace this regime. In time, the Clinton administration openly encouraged the private sector financial institutions to find creative methods of making home ownership even more available. In effect, the political machine was inviting the private sector to devise financial tools to make home ownership a reality for everyone who wanted it, regardless of whether they could afford it or not. Asking bankers to dream up creative financial instruments and sell them on is like leading ants to a honey pot.

On top of this, the politicians of the Clinton administration reduced down payments required for insured mortgages and dramatically reduced the premiums payable for mortgage insurance. The housing floodgates were well and truly opened.

In this respect it is perhaps just a bit unfair to lay ALL the blame for the 2007/2008 financial crisis at the feet of bankers.

The whole housing crisis was essentially underpinned by a flawed social policy, aimed at winning the votes of the lower income parts of society. One might even argue that this was a cynical political process.

Yes, the Clinton administration started the ball rolling but following right after the Bush administration pushed the boat out even further, raising the mandate for low income lending even higher in its efforts to create an “ownership society”.

While the intent of addressing a growing income and wealth gap through homeownership may have been laudable, the execution was far from it. The appeal of home ownership was certainly clear to voters who probably rewarded politicians with their votes for such platforms. It is also probably true that provision of easy and cheap credit created its own demand, demand that would not have probably been there under a regime of purely private sector financing and “normal” credit extension.

As we have seen time and time again, major government financial and economic initiatives tend to end up with very substantial unintended consequences.

In summary it is probably fair to say that the housing crisis in the US was in fact created by flawed social policies, and aided and abetted by an avaricious financial sector, but lapped up by a voting public who believed they were getting something for nothing.

Although the US financial markets scaled new heights of financial engineering and creativity, the easy credit conditions traveled far and wide in the western world, producing similar effects in markets such as the UK, Spain, Ireland Australia and New Zealand. Asian markets largely escaped the patterns of credit excess during the post 2000 era mainly because Asia was still recovering from its own wild excesses of the mid 1990’s. Asia simply did not have time to get itself into too much trouble this time around.

Impact And Consequences For Asia

The socio-political pendulum is indeed swinging back from its zenith, bringing with it cries for greater equality in the spoils of economic growth. The highly paid bankers are the symbol of the excesses of a system that created ever wider disparities in income and wealth inequality. It remains to be seen whether the plethora of newly minted taxes, fees, charges and duties will in fact reduce income and wealth disparities. The work above shows that income disparities as measured by the Gini coefficient on an after tax basis are in fact lower than on a pretax basis BUT taxation has not always reduced the spread or growth of income inequality. Our review here shows that the growth in the Gini coefficient over our study period has been HIGHER on an after tax basis than on a pretax basis for almost half of the countries reviewed.

How is this all going to play out in Asia? Asian countries are not going through the overt cult of banker bashing that is so prevalent in the west. Nor are its economies suffering from massive public sector debt burdens, forced austerity programs and pressures to ramp up taxes to pay for the debt mountains. But there is less obvious swinging of the social-political pendulum back towards a more central position, just as is occurring in the west.

Still, Asia does have its own wealth and income gap problems. Gini coefficients in the region are quite high in many instances. While less obvious than in the west, there are growing mutterings of concern in many parts of the region about income and wealth disparities. Those voices are probably loudest in China where income inequality comes in many guises and is providing several sources of rising discontent and potentially nasty political consequences.

  1. For example, the more developed coastal regions enjoy much higher incomes and economic opportunity than most cities in the centre or west of the country. Beijing has long been adopting policies to encourage more investment in these areas in an attempt to redress the development/income imbalances.
  2. The Hukou system of residency is another source of considerable discontent and imposes significant income/wealth differentials on certain sections of society. In simple terms, the Hukou system means that migrant workers from the countryside to the large cities may not be permitted to reside permanently in the cities where they work, but instead only have a “licence” to live in their home town or village. This ensures these migrant workers are not allowed to own homes, educate families, or receive social services in the cities they work in.
  3. Local governments across China are hugely reliant on land sales for income to run their municipalities – provide roads, public transport, schools, services and so on. For some cities land sales account for as much as 65% of total municipal revenues. Given this pressure on revenues, some governments resort to forcing people from their land and sell it for private sector development. In the past year there has been an estimated 100,000 “incidents” (i.e. protests, riots, disturbances) across China, with the great bulk of these having forcible removal from land as the core reason.
  4. All of this comes on top of a very natural tendency in a developing nation such as China to experience rising inequality of income through rapidly rising demand for an educated workforce to run new businesses and services in both the public and private sectors. The Chinese government in the past couple of years has mandated massive wage increases (in percentage terms) for factory workers in many parts of the more developed coastal regions. While this has been met in many cases, it has also led to the closure of thousands of factories in areas such as Guangdong Province (immediately to the north of Hong Kong) and the relocation of thousands more to other lower cost cities in China or out of the country altogether to other Asian countries such as Vietnam, Thailand, Malaysia, Indonesia, Bangladesh and India.

Higher Gini coefficients are perhaps to be expected in high growth emerging economies moving from a primarily agricultural base to industrial and service based economies. Hong Kong and Singapore are far from developing nations, ranking very much as service based economies, but carry a Gini coefficient at the high end of the range of developed countries. In both cases, the government has substantial accumulated wealth that is invested or held as a “rainy day” reserve.

Figure 11: Hong Kong Private Domestic Average Price (sqm) by Class from 1984-2011

Hong Kong Private Domestic Average Price (sqm) by Class from 1984-2011. Classes: Less than 40 sqm, 40-69.9 sqm, 70-99.9 sqm, 100-159.9 sqm, 160 and above sqm. Data shows a widening price gap between high end and mass market housing.

Figure 12: Singapore Property Price Index, Private Residential (Q4 1993=100)

Singapore Property Price Index, Private Residential from 1993-2012.  Q4 1993 has been baselined to 100.

Figure 13: Hong Kong Private Domestic Price Index, All Classes (1999=100)

Hong Kong Private Domestic Price Index, All Classes from 1993-2011. 1999 has been baselined to 100.

Figure 14: China Second-hand House Price Index, Shanghai

China Second-hand House Price Index in Shanghai from 1993-2011

Figure 15: Australia Price Index of Established Houses, Weighted

Australia Price Index of Established Houses, Weighted, from 2003-2011.

Figure 16: New Zealand

New Zealand Housing Index from 1993-2011

Figure 17: US Purchase-only House Price Index, Seasonally Adjusted

US Purchase-only House Price Index, Seasonally Adjusted, from 1993-2011

Figure 18: UK Average House Price (in British Pounds)

UK Average House Price (in British Pounds) from 1993-2011

Figure 19: Centaline Hong Kong Residential Index Overall

Centaline Hong Kong Residential Index Overall from 1994-2011.

Housing in most countries is the single highest cost item in the household budgets, particularly at the lower end of the income scale. As such, high and rising housing costs exacerbate the impacts on a high Gini coefficient. Rapidly rising housing costs throughout the region and its impacts particularly on lower income and middle income groups have been behind a wave of policy initiatives aimed at curbing housing prices over the past 1-2 years.

This is particularly the case in markets such as Hong Kong and Singapore where housing is expensive in absolute terms. High housing costs make wide income inequality all the more a source of considerable social discontent. Both Singapore and Hong Kong have very well developed housing policies that aim to provide accommodation for the less well off. In the case of Hong Kong approximately 50% of the population lives in publicly provided housing either as subsidized rental accommodation or as subsidized home ownership schemes. In Singapore an even greater percentage of housing is provided by the state, typically north of 80%. High housing costs are very much on the top of the political agenda in Hong Kong.

These subsidized housing schemes seem to implicitly recognize the income gaps in these societies and address this through provision of low cost housing. Many other countries in Asia also implicitly address income gaps through provision of housing in various ways. In Malaysia, for example, it has long been the practice that any developer building a private sector housing estate must provide a certain percentage of lower cost housing units to be held specifically for the Bumiputra population (ethnic Malaysians). China has embarked on a nationwide program of building “affordable” housing in response to the rapidly rising cost of housing in the nation generally, and worsening affordability. Thailand has a major program of subsidized housing provision in the capital Bangkok.

While most Asian countries are in a better position than many western countries in terms of public sector finances, we must remember that it has not always been so, and may not be so again at some point in the future. It is perfectly possible that some combination of events including mismanagement and corruption could drive public sector finances in Asian countries into a similar state of affairs. Such circumstances would likely result in a flurry of tax raising, benefit cuts, job cuts, and general austerity, self-imposed or imposed from outside. Asian countries are not well endowed generally with social services, pension benefits in any event. This makes it all the more necessary for households to provide their own economic backstops.

Property Ownership as a Source of Long Term Household Security

I see home ownership, for owner occupation and also property ownership as an investment to let as an integral part of that household economic backstop. Don’t listen to the “loony left” bleating on about the supposed social evil of the “buy to let” landlord. In simple terms, a property or two bought early in one’s working career can provide a hugely important income source or supplement in later life. I would encourage anyone who can to firstly buy his or hers’ own home as soon as possible. It is always tough to find that deposit, and fund that mortgage, but it is usually worth it, even if it means living in a less salubrious environment than one might wish for. A home mortgage is the one form of finance that you can get for 20 years or more, meaning less risk of refinancing that comes with borrowing for most other forms of investment.

The first home that we bought was a basement flat in north London, with a small garden. It was a decorative disaster when we bought, and we spent several months of evenings and weekends stripping and renovating the place to a livable standard. It was small, and certainly less than luxurious, but it was affordable and ours. Because repayments were well within our means, it was not a disaster when interest rates went through the roof a couple of years later in the early 1980’s.

The apartment provided a steady stream of income for about 25 years after we moved to Asia to work. The 90% mortgage was well and truly paid off, and the little flat provided an annual rental income that was 125% of the entire purchase price of the apartment when bought in 1978.

A family that makes a few investments of this nature may well find itself able to provide a very respectable “pension” plan for retirement. Yes, ownership of real estate has its risks and is certainly not hassle free. Most mortgage markets in the world involve taking a floating rate mortgage, and we have all seen what can happen to interest rates and monthly repayment schedules if interest rates spike up. Property is a cyclical business – property prices can go down as well as up. But over the medium to long term, property prices have typically kept up with or exceeded inflation in most countries. There will inevitably be periods of rental voids in between tenancies. There will be maintenance and renovation costs. That early morning call from the tenant with the news that the cooker/fridge/air conditioning unit etc has gone on the blink. There will likely be legal fees and agents fees from time to time.

Figure 20:

Investing Directly in Residential Property
Pros Cons
+ Relatively straight-forward, easy process. Large lump sums.

Bricks and mortar, can be seen, touched. May require significant maintenance costs while sitting empty.
+ Good inflation hedge. May take time to sell.
+ Low interest rate/environment. Can become costly if interest rates rise.
+ Can add value through renovation/ redevelopment. Requires a lot of attention and work to ensure tenancy and good maintenance.
+ Generates relatively steady cash flows. Some high dividend stocks also produce good cash flows.
+ All decisions – good or bad – taken by the investor landlord. Takes a degree of active management and time/energy.
Investing in Commercial REITs
Pros Cons
+ Requires little attention for long term investments. Its value can be volatile short term – fluctuates with markets.
+ Can invest smaller sums to build up capital. Investing in stocks may be difficult and costly for some retail investors.
+ Generates relatively steady cash flows via dividend payments. Cannot be touched, seen
+ Can be easily sold. It is NOT managed and decided by investors.
+ Does not require maintenance costs. Price may not always be in line with assets values.
+ Does not requires additional redevelopment costs. Possibility of dilution as REIT raises capital to grow.
+ Good inflation hedge.

Source: Portwood Capital

Buying early in life, and having debt free property when one wants to step off the fast lane of employment can make for a very comfortable income stream and asset backing into the latter part of one’s life. Even in markets such as the UK and USA, where average property prices may be 30% off their recent peaks in many parts of the country, properties acquired say in the mid 1990’s are likely to be valued still well north of their original purchase price, and still able to produce decent rental incomes. In fact in the US, multi-family homes are seeing rental increases as many households have been forced by foreclosure into the rental market.

In markets such as Hong Kong and Singapore, recent moves to curb lending to housing markets have produced perhaps the unintended consequence of boosting the demand for rental properties, underpinning rental values and as a result to some extent prices.

Ownership of commercial property (office, shops, industrial) can also prove attractive. There can often be reduced hassle factor with commercial property as the tenant will typically fit out the property to his own requirements, and be responsible for its maintenance. Often such tenants will stay in the premises for many years, lessening the income disruption of frequent voids and changes of tenancy.

The issue with commercial property may be one of scale and liquidity – such properties can often be large upfront lump sum investments, and financing terms may not be quite as friendly as for residential properties. Besides selling a commercial property investment can be a slower process. If one is not able to rustle up the larger amount of cash to make that investment in commercial property, investment in a well-run REIT may give you a similar exposure. REITs typically provide tax breaks that investing in other stocks do not, and the legal underpinning of REITs requires the REIT to payout 90% or more of its net income to you the shareholder. In some jurisdictions REITs are not permitted to have gearing higher than a certain level, thus hopefully lessening financial risk. In theory, the value of REIT shares should move in line with the underlying property values, but in reality sometimes can trade at a premium or a discount to underlying asset value.

The investor has a large array of commercial property REITs to choose from. Most of them tend to focus on the local market and while in the developed markets like US, Europe and Australia they tend to be specialized on one subsector—such as retail only or office only—in the newer REIT markets, such as the UK or Asia they are often diversified across office, industrial retail and other sectors.

Figure 21: Dividend Yield for the Top REITs in Asia

Dividend Yield (%) Dividend Yield (%)
Top Japan REITs Top Singapore REITs
Nippon Building Fund Inc 3.79% CapitaMall Trust 5.22%
Japan Real Estate IC 4.07% Ascendas REIT 6.60%
Japan Retail Fund IC 5.57% CapitaCommercial Trust 6.02%
United Urban IC 5.94% Suntec 8.00%
Mori Trust Sogo REIT 5.07% Mapletree Logistics Trust 7.07%
Top Australia and New Zealand REITs Top Hong Kong REITs
Westfield Retail Trust 6.57% The Link REIT 4.22%
Stockland 7.59% Champion REIT 6.21%
CFS Retail Property Trust 7.48% Yuexiu REIT 6.26%
Commonwealth Property Office Fund 5.79% Sunlight REIT 7.22%
Investa Office Fund 6.39% Prosperity REIT 6.41%

Source: Bloomberg

Our August and September 2011 pieces entitled “Risk off the Table – A Window for Asian REITs” and “Reducing Risk – A Window for Asian REITs Part II” contains more detail on the benefits and characteristics of REIT investing in Asia

We find it is possible to build a portfolio of REITs across the region that will give an attractive blended dividend yield of 6% – 6.5% with a relatively low risk profile both in earnings terms and in terms of stock price performance. Modest earnings growth is possible in many cases in the short to medium term, and highly likely over the longer term.

Typically REITs have a lower Beta that many other sectors, mostly below 1 and often well below, so they enjoy potentially lower stock price volatility.

This portfolio would comprise a good many companies (See Figure 21) that investors should be comfortable owning for the long term given the quality of managements involved, quality of assets and ability to provide long term sustained competitive advantage within their particular markets.

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