A low interest rate environment, teamed with persistent high inflation and increased market volatility is the potent combination which has rocked the capital markets and unnerved investors in recent years. In such an environment, real estate has remained the all-weather asset class favoured by high net worth individuals for its stable returns on investment.
According to the Merrill Lynch Capgemini 2011 World Wealth Report, high net worth individuals in Asia Pacific (ex Japan) hold about a third of their assets in real estate investments, a number significantly higher than the global average of just under 20 per cent.
Most of these holdings are in residential real estate given strong fundamentals such as the robust housing demand from the growing middle class in Asia, as well as an active rental market in tier-one cities from professionals moving to and across Asia for work.
Against this landscape, many high-net worth individuals have made the decision to include substantial real estate holdings as part of a diversified portfolio.
Table 1: Correlation table of asset classes in Singapore’s market over a period of 10 years
|Real estate (Singapore Residential)||Global Stocks||Global Bonds||Global Commodities|
|Real estate (residential)||1.00||0.56||0.92||0.84|
Source: UOB Private Banking
Investors can also use real estate investment to increase their returns. Chart 1 shows how various asset classes (equities, bonds, commodities) and real estate have performed since end 1987.
On an absolute return basis, a dollar invested since end 1987 would have grown approximately 4.2 times if invested in commodities, 4.6 times if invested in Singapore residential property, 4.8 times if invested in global equities (dividends reinvested) and 5.2 times if invested in global bonds (coupons reinvested).
Although bonds seem to be the best performing asset class since the end of 1987 according to this analysis, this has to be qualified. Bonds are relatively less volatile, as can be seen from its 6.59 per cent per annum volatility (Table 2). They derive most of their returns from coupons distribution and benefit from a bull cycle of interest rate compression. Most investors would also expect the long-term return of equities to exceed that of bonds by a comfortable margin, given higher risks inherent in equities. However, in the analysis of asset classes of over 24 years, equities underperformed bonds. This implies that even a period of about 24 years is still not a sufficient for long-term normalised risk/returns to be achieved.
Table 2: The average risk and return of asset classes over a period of 24 years
|1988 to Q1 2012||Real estate (Singapore Residential)||Global Stocks||Global Bonds||Global Commodities|
|Return (% p.a.)||6.49%||6.69%||7.07%||6.09%|
|Risk (std dev % p.a.)||10.24%||16.42%||6.59%||23.62%|
Source: Bloomberg, UOB Private Banking
The advantage that real estate investments offer to investors is that such investments are typically leveraged. A 4.6 times return on investment can be magnified 2.5 times if a borrowing quantum of 60 per cent is assumed. On the flip side, the risks or volatility at 10.24 per cent per annum (as shown in Table 2) is not small. This is because property cycles do turn and they can be fast and sharp.
However, real estate price fluctuations can be cushioned by the economic benefits of rental yields. Using a conservative assumption of average real estate rental yield of 2-3 per cent per annum, will lift the returns characteristics of real estate investments.
The right investment mindset
Investors have to adopt the right investment mindset when it comes to investing. For any asset class, an investor must decide on his or her market entry or exit point, as well as the appropriate investment duration. A bond investor often has income distribution as the main consideration, and normally has a medium-term view. An investor who buys a stock often has a shorter time horizon and may sell off his investments relatively quickly when the market comes down or goes up.
However since real estate investments are less liquid, there is a tendency to hold on longer when prices turn south. Real estate investments may also be more difficult to sell and transaction costs tend to be higher. Therefore to make the most of real estate investment, a property investor should be prepared to take a longer term view in order to get the best returns on investment.
We conducted an analysis to find out if an investor buys a Singapore residential property at a certain point in time, how long he may have to wait before he makes a profit. Chart 2 covers the period from Q1 1975 to Q1 2012 and shows that the holding period has to be as long as 15 years for every rolling period return to be positive. For instance, if an investor happened to have bought a property at the peak, he would need to hold it for 15 years to break even. The largest increase of 781 per cent was recorded in the 15-year window of December 1979 – September 1994 and the smallest increase of 1.75 per cent was recorded in the 15-year window of September 1994 – June 2009.
A closer analysis of the property market in Singapore also shows that although residential property investments take 15 years to consistently register a positive return, office property had to be held for 30 years. Industrial and retail property had to be held for 16 and 31 years respectively to get the same result, further emphasising the long term nature of real estate investments.
The right investment mindset is critical. An investor has to consider carefully how long he or she will have to potentially hold on to this investment after buying it and what economic benefits can he or she derive from it during that time.
Clearly, a speculative investor mindset will not work. The holding period might be too long for a speculative investor to see through the down cycle. Such an investor may also find that spikes in interest rates may make loan servicing prohibitive. An investor with a speculative mindset might sell the real estate investment at the worst time possible and realise a loss instead of a gain.
The same rolling window analysis was run across other asset classes to include global equities (with dividends reinvested) and global bonds (with coupons reinvested), albeit through a shorter time frame as data was only available from 1987 onwards.
Global equities were able to give consistent positive returns over rolling seven years, while bonds yielded positive results over as short as three years, given the nature of coupon accrual and low volatility. Commodities, on the other hand, required rolling periods as long as 14 years in order to give consistent positive returns due to higher volatility and a lack of cash flows for reinvestment.
A case can then be built that if an investor holds a portfolio consisting of real estate and the other asset classes, with their differing cycles and correlation to each other, optimised returns at reduced risks can be achieved. This classic asset allocation model can help investors achieve increased total returns with lower risks.
This model can be further enhanced by tapping on the expertise of a real estate portfolio advisory team which can help source for suitable real estate investments not just in Singapore, but in major cities around the world.
Diversifying real estate investments globally
The return and risk profile of real estate investments can be optimised by investing in properties in different countries and territories. A correlation study done across residential real estate investments in different countries builds a case for diversifying holdings across geographical regions. Correlation statistics between prices from 1933 suggest that real estate investments in the West have lower correlation to similar investments in Asia. Low correlation affords diversification benefits as properties held in different markets move through their different cycles.
Table 3: Correlation table of investment returns from global cities from March 1993 till September 2011
|Singapore||New York||London||Hong Kong||Tokyo|
Source: UOB Private Banking
In the period lasting almost 20 years, London residential properties have outperformed the other cities while in Tokyo prices are still below where they were in 1993. Singapore came in second among the five cities reviewed. It will be interesting to see what will unfold in the next 20 years. It has been widely forecasted that the continued rapid urbanisation of the global population will result in a population concentration in large cities, particularly in Asia. This will provide strong support to property prices in Asian cities in the coming years.
The value of real estate portfolio advisory
However, evaluating and monitoring the value of properties across various markets can be challenging. In order to fully appreciate the value of real estate markets across various markets, investors need to understand the economic, political and regulatory developments in the various countries. A real estate portfolio advisory can help investors identify and seize investment opportunities by providing expert views and analysis of the various real estate markets across the world. UOB Private Banking has built this advisory service comprising Senior Client Advisors, in-house property loan specialists and external real estate consultancy firms to help clients source for property investment opportunities in Singapore and in major cities such as London, Australia, Japan and Bangkok. The advisory service also offers clients property financing solutions to enable them to seize such opportunities.
Real estate portfolio advisory can help investors further enhance the returns not just to their property investments and overall investment portfolio. By adding real estate to their investment portfolio, investors gain the benefits of diversification. Real estate investments can offer investors who have a long-term investment mindset, a relatively more stable return compared to other financial products which may be more sensitive to daily market fluctuations. It is also a tangible investment asset which can be passed down through the generations.