Churchouse Letter
February 2011         by Peter Churchouse

The Doctor’s Curse

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A price that one has to pay as a doctor, lawyer, accountant, or many other professions is the frequent requests for advice from friends and acquaintances, at cocktails parties, lunches, dinners and the like. Doc-tors, I am sure, find this particular facet of their life particularly irk-some. I also face requests for advice very frequently, although far re-moved from the medical profession, as to buying/selling/renting/financing property and stocks. But I don‘t find it irksome! The most frequent question is the simple one – “Should I be buying (selling) property in City XX right now?” In fact the real question they are asking is whether I think the property market is going up, down, or sideways.

This is also a favorite question of journalists in Asia. A suggestion that the underlying conditions are ripe for property to move up (or down) is almost always met by the question “How Much?” An answer suggesting, say possibly somewhere between 10% and 20%, does not satisfy our tenacious Asian reporter. As quick as a flash the comeback is “do you mean 10% or 20%?” – I usually respond to such naïve questions with an answer of immense but meaningless precision such as 16.83% or some such nonsense. Our intrepid reporter normally jots it down unquestioningly.


Quite frankly, in volatile Asian property markets, getting the direction of price moves right is cause for modest back pat-ting, and getting the forecast within 5% justifies breaking out the champagne.



Also, many people forget that property is not a homogeneous commodity and that property price indices do not carry the same degree of precision as stock indices.

Coming back to the original question of “Should I be buying (or selling) property right now?” I find myself usually delving into the questioner’s real motivation for the question. Is he looking at buying his first property as an owner occupier? Is the person an investor, with an existing portfolio of properties? Is it someone who owned his own apartment, sold when he thought prices were high (often finding them going much higher) and is now nervous about getting back into the market again? Is it someone whose objective is to buy with an objective of a fairly quick flip? Is it someone looking to build a long term portfolio for long term capital gain/rental income? Is it someone looking simply to diversify a little away from equities/bonds in a personal portfolio?

Sometimes I am afraid my answers may not satisfy the questioner who wants to hear a simple “yes” or “no”. My thinking on the subject is typically driven by my own top down views of the global and local economy, growth prospects, likely directions in liquidity, interest rates, cross border capital flows, household income and unemployment prospects. Then the very local issues of potential supply, vacancy rates, take-up and affordability feed into the equation. Next come issues of domestic policy stance of national governments and local/provincial governments – particularly important right now in Asia.

Tracing Potential Cause and Effect in Hard Asset Markets. Global Macro (Global Macro Factors: Global Growth Prospects, Likely Directions in Liquiditiy, Big Market Global Interest Rate Trends, Cross Border Capital Flows, Structural Changes in Employment Composition/Business) effects the Domestic Economy (Domestic Economy Factors: Local Economic Growth Prospects, Interest Rates, Unemployment Prospects, Household Income, Business Registrations and Investment, Domestic Liquidity), and the Domestic Economy at large influences Real Estate Specifics ( Real Estate Factors: New Supply Prospects, Vacancy Rates, Take-Up Rates, Affordability, Local Regulatory Changes, Changes in Tax Regime, Housing Policy, Recent Rental/Price Trends).

The Positive Carry Case

The sorts of things I tend to press upon first time buyers is to examine closely several important parts of the buy equation. These may seem obvious to many, but it is surprising how many people do not look at these issues. For example, consider the relative cost of buy vs rent. At present, in many markets even though residential property prices may have moved up sharply, the monthly outlay to service a mortgage for a modest entry level home is similar or even lower than the prevailing rental for that property. This “positive carry” situation can be a good indicator for the ‘buy’ rather than ‘rent’ case. This means that a buyer is building up equity in his property with every monthly repayment, rather than pay a similar amount of cash to a landlord.

There have been numerous times when the rent/buy equation is well out of whack, and I have made myself most unpopular in proclaiming that such conditions are unsustainable. There have been times in various markets when interest rates have been say 8% or more, and likely to head higher, with rental yields at 4% or less. In these circumstances the monthly rental is substantially lower than the monthly mortgage repayment. Such conditions seem to imply that the buyer/owner expects substantial capital gains that will more than offset the high monthly mortgage payments.

The conclusion I have sometimes drawn in such circumstances is that prices must come down, to bring the relationship between cost of capital and rental returns more closely in line.

In this regard I currently harbor some concerns about certain markets in China where property prices have continued to rise over sustained periods of time while rentals have remained flat or even trended down given huge supply coming on stream. For example, over the past 8 years in Beijing, rental yields for upper end residential property have fallen from around 14%+ to around 4% – 5%. Such a diverging trend between prices and rentals is unsustainable, particularly as interest rates are highly likely to rise from here. Something has to give. Either rents need to rise (how likely is that in an environment of substantial new supply coming on stream?), or prices need to fall. Nevertheless, such diverging trends can often persist for many years before finally coming unstuck.

Beijing Residential Property Market (1995-2010): Sharp Divergence between Rental and Price Index. Beijing Residential Price Index (Red line) increasingly diverges from Beijing Residential Rental Index (Blue Line).

Shanghai Residential Market (1995-2010). The Shanghai Residential Price Index (Red line) increasingly diverges from the Shanghai Residential Rental Index (Blue Line), especially after 2008.


I often suggest any first time buyer considers his ability to continue to service a mortgage if interest rates rise by say 200 basis points – 300 basis points. This is probably very relevant in many parts of the world today where interest rates are at or close to record low levels. I remember all too well how my first ever property mortgage payments doubled as interest rates soared with huge inflationary pressures in the late 1970‘s/early 1980‘s.

Positive/Negative Carry on Residential Mortgage Rates – as a Percentage of Annual Rental Income

Percentage By Which Rental Income Exceeds Total Mortgage Payment. Negative Carry: Rental Less Total than Mortgage Payment (Principle and Interest). Positive Carry: Rental Greater than Mortgage Payment.

Percentage By Which Annual Rental Yield Exceeds Annual Interest Payment. Assumptions: Figures are calculated based on a 70% mortgage over 20 years. For example, at 2.5% interest rate and 5% rental yield, rental income is 10.2% higher than total mortgage payment.


There is only one way that mortgage rates in most parts of Asia are going to go, and that is up!

Government Policy Initiatives in Property are More Important Now Than for Many Years

Potential government policy moves are far more relevant in the residential property purchase decision than we have seen in a long time. Governments in almost all major countries in Asia are under pressure to implement measures to slow down the advance of residential property prices. In most markets governments lay the blame for property price increases at the feet of so-called “speculators”. But what is a speculator and how is a speculator different from an investor? Being an investor is a socially worthy activity it seems in the cultural milleau, but being a speculator is distasteful, bordering on evil!

There is no question that in some parts of the region, a small cadre of buyers exists whose aim is to buy property with an objective to flip it on in short order (say within a few weeks) at a higher price.


“Property speculator” is viewed as a dirty word, but “investing” in property is still viewed as a socially worthy activity. What is the fundamental difference?



Although it is hard to measure, there is little evidence to suggest that such “flipper” transactions represent more than a few percentage points of all transactions. Then, people who buy a property and hold for potential capital gain over say 2 – 3 years are also labeled as “speculators” evil, antisocial folks! I see very little difference in this compared with an investment in stocks or bonds. The big difference is that the property buyer is probably taking more risk as he cannot guarantee that he can exit his investment in short order as can the equity or bond investor.

But in today‘s environment, buyers need to be aware that Asian governments are hell-bent on slowing (reversing?) current rises in residential property prices, and are likely to continue to introduce administrative and financial measures to that end.


The danger for most property buyers in Asia right now is that governments not only cool price increases but drive the price cycle into reverse. Fine tuning property markets to this extent is always going to be a risky process, with the danger being that natural economic events, or governments own measures cause a sharp downturn in asset prices. We have seen it before.



So a buyer of residential property in many parts of Asia has to weigh up the following factors:

  • The Basic underlying fundamentals of supply, employment, wages, are generally positive in most markets – parts of China are a clear exception.
  • Banks are flush with liquidity, mortgage finance is generally quite readily available.
  • Interest rates are at or close to record lows.
  • But interest rates are clearly likely to trend upwards, even if they have not already, running the risk of creating a dislocation in the yield/cost of capital equation and increasing mortgage service costs – possibly substantially.
  • In some markets foreign buyers are a force in the local market, lending weight to upward price momentum.
  • There is positive carry – or close to it – in many markets. Rental yields and cost of capital are not significantly out of alignment.
  • The major fly in the ointment right now is government policy objectives to cool residential markets, with the risks that policies could tip the balance of prices into reverse. This has not happened as yet, but the risk is there.

In this environment I have to conclude that the forces are lining up against the short term property flippers, but it is hard to conclude that buyers with the objective of own use, or long term hold for rental income and long term capital gain are going to come seriously unstuck.



Forces of rising rates and policy measures are likely to at least slow the rate of price appreciation in the coming year or two, with an increased risk that such measures could in fact tip the scales in the opposition direction, even though the government policy measures are not necessarily aimed to create such an outcome.


In this environment I have to conclude that on balance, residential property sales volumes in most parts of Asia will likely remain robust but probably lower than in the recent past. Average residential prices will probably edge to the upside, but again at a much slower pace than in the past 18 months or so.



Major property developers in markets such as Hong Kong, Singapore, Bangkok, Kuala Lumpur, Taipei and most major cities in China will likely be able to sell pretty much all they target to sell at prices that are probably higher than expected when the sites were first bought a number of years ago.

Shares of major property developers in most markets are in “Goldilocks” territory in terms of earnings multiples, (not too hot, not too cold) but are trading often at sizable discounts to Net Asset Value (NAV).

Property Sector Overview by Market Leaders circa February 2011. Hong Kong Developers: Sun Hung Kai Ltd, Cheung Kong Ltd, Henderson Land Ltd. Hong Kong Investors: Wharf Holdings Ltd, HK Land Holdings Ltd, Hysan Development Co Ltd. China: China Overseas & Land Investments, China Resources Land Ltd, Guangzhou R&F Properties Co Ltd. Singapore Developers: CapitaLand Ltd, City Developments, Keppel Land Ltd. Japan: Mitsubishi Estate Co Ltd, Mitsubishi Fudosan Co Ltd, Sumitomo Realty & Development Co Ltd. Australia: Westfield, Stockland, GPT Group. Chart includes constituents' Share Price, Market Capitalisations (by US$ MM), Earning Per Share (EPS), Price-Earnings Ratio (PE), Price to Book Value (P/BV), Net Asset Value, Premium to Net Asset Value, Debt to Equity Ratio, and Dividend Yield.

China Property: Discount to NAV (May 2003 - November 2010). China Property Average: -25%, Peak at 44%, Trough at -64%.


Within the region as a whole the shares of major China property companies listed in Hong Kong are trading at the lower end of their historical valuation ranges with a good number trading at single digit multiples and most trading at 20% to 50% discounts to NAV. The stream of policy measures aimed at cooling residential property markets has increased the risks associated with investing in property stocks, the result being reasonable valuations. The great majority of listed China developers have achieved or exceeded their sales targets for 2010. They face the risk that further cooling measures may be introduced that might possibly lead to a pull-back in residential prices, and not just a slowdown in the rate of price growth.

Any sign or indication of easing of property cooling measures may prove a catalyst for a significant rebound to the upside for these China property developer shares.

Let the Head Rule the Heart in Matters of Property Investment: The Resort Property Ownership Temptation

We have all traveled to delightful places around the world during our holidays, and fallen in love with seductive properties in idyllic locations. Tuscany, the Dordogne, Algarve, Aspen, Courcheval, Phuket, Koh Samui, Whistler, any number of Greek Islands, even counties of Hampshire and Oxfordshire in the UK – the list goes on.

Time and again I have looked at buying property in such locations, and thankfully, on return to home base, a reality check kicks in and nothing gets done. You may have bought such property yourself. Even if not, I am sure you have seen many people you know buy holiday properties in such idyllic resorts and holiday destinations.

Very often we have seen people end up being stuck with their properties, (liquidity is often very poor in such locations) dealing with seemingly intractable management, staff and maintenance problems, coming to terms with obscure local tax rules that always seem designed to trip up the naïve foreign buyers. Many think that they will be able to rent out the property for part of the year. Sometimes correct, but often not.

Agents in such locations will point to endless properties “worth” $X million dollars/Euro/pounds etc., but if one actually digs in and asks the agent to identify second-hand properties that have ACTUALLY been sold, the answer is often zero or no more than a handful in the past six months. Small low priced houses and apartments aimed at the local market may be selling quite well, but the upper end properties aimed at the foreign market is often a very different kettle of fish.


Property purchase in resort locations is very often a risky proposition fraught with difficulties of management, maintenance, changes in holiday fashion, unfamiliar taxes, poor liquidity in the secondary sales market, subject to weather and other natural events. Be prepared for a long struggle to sell the property when the time comes to exit.



Not too long ago, I was speaking with a friend who has been operating a seasonal business in a popular resort, doing a little better than breaking even over the course of the visitor season. My friend rents high quality residential properties for the visitor season (a few months) from local owners, committing to a rental many months before the visitor season cranks up. My friend then sets about attracting visitors/holidaymakers to stay in the premises on a weekly basis over the peak season, providing additional services such as local transport, housekeeping, meals, guiding services etc.

The model to me is fraught with risk.

Firstly, the resort/tourism business is notoriously flakey, volatile and very sensitive to immediate economic, political events and natural disasters, weather disruptions.

Second, fashion plays a major part in the success or otherwise of many resort type destinations, and the clientele can change from year to year — Russians seem to be taking over many resort destinations around the world these days, bringing with them problems that are peculiar to the culture.

Third, the model involves making a commitment to pay a rent for the property a very long time prior to having any guarantee of being able to sell the space on during the season.

Fourth, committing to staff and other services also adds to the risk.

The issue my friends are considering is to buy one or two of these properties in the resort destination rather than renting from a local landlord, with the objective of creating a long term income into their retirement.

All my senses tell me that this is probably a bad idea!

The asking prices of resort properties like this are high relative to potential rental income, often producing a rental yield of around 2.5% or so. Given the risk of actually running properties like this for the season, this yield seems way too low to me. Risk/reward is out of whack.

Running this business is seriously hard work, and going into the retirement zone of life, one has to question the ability and desire to continue to work so hard.

Tying up large amounts of scarce capital in potentially very risky, illiquid assets for people who may need speedy access to that capital for day to day living does not seem to make a lot of sense.

In the past my friend has been quite shrewd by buying some smaller, very rentable properties in and around London, and has access through certain relationships to buy further properties of this type. The track record of existing properties has been very good with minimum initial rental yields of 5%, virtually zero tenant voids and access to very reasonably priced management service. Properties are generally quite low maintenance.

To me it seems to make a great deal more sense for a family in these circumstances to apply their property based resources to their existing urban property strategy rather than take on the much greater risks associated with the resort property acquisitions. By all means continue to run the resort business by renting properties for the lifestyle reasons that appeal. This does not involve tying up a lot of capital.

There is going to come a time when the ability or desire to run such a business will dwindle. Having so much capital tied up at that point in potentially very illiquid, risky and low return assets is not a great position to be in.

The Suit and Tie Theory of Investment Property

Personally, I have always preferred to own properties in cities, preferably inner cities. Cities such as London, New York, San Francisco, Hong Kong, Singapore, and Sydney will likely always function as employment magnets. They are likely to continue to be focal points for higher end service industries, and highly paid employees. As such they are often also magnets for foreign investment into the local property market. There is generally good demand for rental of property and the ability to sell, even in difficult times, is much greater than in small towns and particularly resort/holiday areas. London is probably the global standout location for attracting foreign capital to its property markets.


As one bright spark put it to me recently – “I only buy property in cities where people don a suit and tie to go to work”
I could not have put it better!



More on Affordability

A friend, Brandon Sedloff of GLG Group, brought my attention to an article in the Wall Street Journal quoting work by Demographia, a US based public policy consultancy. The Demographia works suggests Hong Kong‘s housing market is one of the most unaffordable in the world. I have quoted work from Demographia in the past on the affordability rankings it establishes for mainly for US cities but also for many other cities around the world. The work does serve as a consistent benchmark insofar as it measures average or median house price in a location against average or median household income.

While such work does provide a broad framework for comparison, it is potentially very misleading to accept the rankings without some question.

Housing Affordability in Larger Metropolitan Markets. Constituents: Hong Kong; Vancouver; Melbourne; London; San Francisco; San Jose; CA; Auckland; San Diego, CA; Christchurch; Newcastle & Tyne; Edinburgh; Liverpool and Merseyside; Toronto, ON; Belfast; Quebec, QC; Houston, TX; Las Vegas, NV; Atlanta, GA; Saginaw, MI.

Averages Can Hide Big Ranges in Price and Income Distribution

Firstly, the use of an average or a median figure can mask huge ranges in the distribution of the data. For example, although the average house price in a city such as London may be say £300,000, that average can be significantly distorted by substantial numbers of houses sold at prices of £3 million or above. Such wide ranges of prices often do not occur in many smaller cities that the Demographia covers.

The fact that the median, or average is say £300,000 also tells us that there are a great many properties sold at prices way below the average or median.


The first time buyer is hardly likely to be looking to buy a house at the “average” price for that location—he is probably targeting property priced in the lowest decile or quintile of that market.



From a social or policy point of view, the concern on house prices may typically focus on the entry level housing, the first rung on the housing ladder for say a young couple or family. Quite frankly anyone just climbing on to the house ownership ladder is hardly likely to be looking to buy a property that is the “average” or “median” price.

Such buyers are likely to be looking at properties in the cheapest decile or quintile of the market. Such properties may be half or even less than the average or median, depending on the city.

The buyer of the “average” priced house is probably someone upgrading from a cheaper property, not a first time buyer.

Affordability assessment should perhaps therefore focus more specifically on this entry level part of the market rather than the “average” property.

Mortgage Interest Rates Have a Big Impact on Affordability, and are Widely Different Across Markets

Second, the Demographia work does not take account of the impact of interest rates on affordability. Interest rates have a huge impact on monthly mortgage repayments and therefore the ability of a family to afford a particular property. For example, some 60% of mortgages in Hong Kong are being taken out based on the local interbank rate, which results in a mortgage rate of around 1%. The balance is taken out based on the bank “prime rate”, producing a typical mortgage rate of about 2.5%. Mortgage rates in most western countries are currently in the range of 4% to 7%, dramatically affecting affordability. The Demographia work does not reflect these differences.

Tax Levels Affect Ability to Afford Housing

Third, is the issue of taxation. Households buying property do so on an after tax basis. The more income tax people pay, the less they have to service a mortgage on their property purchase. In markets like Hong Kong and Singapore income taxes are around 15% – 20%, compared with more like 35% – 40% plus in many western societies. Moreover most western societies impose massive VAT/GST on purchase of goods and services. These are typically 15% – 20% and more. Singapore has a modest VAT of about 5%, while Hong Kong has no VAT, no tax on dividends, no estate duty, and no capital gains tax. Other Asian markets also have low or no such taxes.
The tax regimes in cities like Singapore and Hong Kong are much friendlier than most western societies, and have a significant positive impact on housing affordability.


Our own calculations show that a “professional” looking to buy an upper middle end property in London or New York would have to earn some 40% – 50% more gross income than a similar professional in Hong Kong or Singapore to have an equal disposable in-come after monthly mortgage payment and tax payments.



It is certainly true that the rise in housing prices in markets like Hong Kong and Singapore are a potentially worrying trend and have certainly worsened housing affordability. Governments are acting to head off the rise in asset prices and slow the worsening affordability trends, particularly for lower end, entry level housing. Our affordability analysis (shown in our recent report) indicates that approximately 55% – 60% of households in Hong Kong can afford to service a mortgage on an entry level apartment. The figure for Singapore is even better at around 75%.

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