Saturday, August 7, 2010

Reflection on hot issue: Malaysia housing bubble?.....Part I

I saw a few articles being published on the Star Online today. Since the topic is quite related to what I have been writing, I am going to piggy back on it.

The first article is making a hue and cry(CPCB) that we are in a speculative market.

(The Star)SINCE the last quarter of 2009, property prices have not gone up incrementally. They have escalated, especially for landed units. In certain locations, prices may be unsustainable.

Up to the first quarter of this year, intermediate two-storey houses in a popular part of Petaling Jaya were transacting at about RM650,000.

Yesterday morning, an agent said the company had sold several houses facing T-junctions (which are not popular units among buyers) in the same township. These were 2 1/2-storey houses. One was sold for slightly more than RM1mil, among the highest he has ever seen in that location for a house located opposite a T-junction while another was sold for RM950,000, the lowest among the three.

Even at RM950,000, he felt that it was rather high. He is also rather concerned about valuations these days. “I like this property business. I want it to grow. But not this way!” he said.

In certain locations, especially in gated and guarded communities, it has come to a point where valuers are reluctant to put a value on a property.

How do you pin a value on a house when next month the price will be different? Prices are simply moving too fast.

Due to pressure, the valuer may have to value it. If the previous transaction was RM1.6mil, he may then reluctantly value the next one at RM1.63mil. The result is that the price of houses in that gated and guarded development becomes increasingly higher. It eventually becomes a speculator’s market, not a buy-to-stay market.

The second article was trying to put a perspective of valuing the property based on P/E ratio(20 times PE and 4% ROI is okay).

(The Star)Calculation of P/E ratio for a property investment evaluation is pretty straight forward. For a house that yields a rental income of RM1,000 per month, that works out to be RM12,000 per year. With the house valued at RM240,000 that derives to a P/E ratio of 20 times. Based on my experience, this rate seems to be the valuation point of landed properties in the Klang Valley. To be more accurate, some would deduct direct expenses to derive at the net rental income less expense. Rates lower than these could either entail a bargain or a low valuation placed by investors, while rates above would translate as either a premium, or over valuation by investors.

We can also calculate the annual Return on Investment (ROI), simply by dividing the annual rental against the investment value, and this derives to 5%. This is actually the inverse of the P/E ratio, whereby 1 divided by 20 gives 0.05 or 5%.

What this means is that at 5% annual ROI, it will take 20 years (at current rate excluding inflation and other factors) to recoup the investment.

The P/E ratio can also be used if you are evaluating to sell your property (besides having a market price evaluation). For instance, if you had purchased a RM240,000 property, and three years down the road the rental has increased to RM18,000 per annum. Assuming the property P/E ratio remains, then the property should have a valuation of RM360,000 (RM18,000 X 20). This represents a three year cumulative average growth rate (CAGR) of 22.5% which can form a benchmark.

Prelude. Why people are attracted to property market?

The answer is obvious, you can make fast and easy money. How? Let me find you a real life case study.

I am sure that everyone loves SP Setia. They are more solid than gold. This was one of the comments when the project was first launched. It was around RM 700,000 in 2008for 2.5 storey terrace house - 20 x 70.

This is the latest happening when the project completed. Wow many units available-lah but still expensive!

Let's say the guy manage to push it out for about RM 800 k with original cost of RM 700 k. So what kind of return is he getting?

Let's assumed he managed to secure a rock bottom loan of BLR - 2.3% during 2008, he funding cost was around 2.9% for 2 years.

Husband and wife have a combined gross income of RM 8,000. So the bank was offering 90% margin, so his downpayment was RM 70,000(his capital).

Let's say based on 2.9% p.a. interest, he served bank interest of RM 35,960 and forget about the exit penalty for early settlement.

Now he pocketed a tidy profit of RM 64,040.

So his return of investment is 64,040/70,000 = 91%.

Whalao.....this return is damn so good-lor.

This is the magic of LEVERAGING, especially with very low funding costs.

Let's say he just managed to push it out at RM 750,000.

His profit was only RM 14,040 - BUT - ROI is 14,040/70,000 x 100 = 20%. Still not so bad.

He was patience enough, the property price jumps from original RM 700 k to RM 1 million in 3 more months.

The potential profit is even more fantastic, RM 264,040 or ROI of 377% over a period of 2 years.

Now do you understand how great is the temptation to get into this asset class?

Almost guarantee "no lose money", high margin from bank, SP Setia price for new launches getting higher = very high return, surely beats Warren Buffet's returns, can retire in 5 years time(flip for 3-4 times enough-lor). So what are you waiting for?

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