Ravi Chandran
Is your buy-in to investment property the best way to beat inflation?
Left uninvested and at the current rate of 2% inflation in Singapore, your money will lose 25.99% of its value in 20 years. This means your S$100,000 today will only be worth S$74,008 in 2038. Everything is affected by inflation, including the cup of coffee you had today. With inflation, the same cup you had today will be quarter lesser in 20 years.
Inflation is the financial equivalent of high blood pressure. You don’t see it, you rarely feel it, but it will kill you if you let it. If we think back to past year even, the price of goods and services doesn’t seem to have changed that much.. We only identify with the danger of inflation when we look back at our previous lives as children.
So how best to beat inflation? Some say that besides diversifying your portfolio, an investment property is the best way to beat inflation.
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Yale economist and Nobel prize winner Robert Schiller in his book, Irrational Exuberance, says that over the very, very long-term property prices don’t beat inflation. In fact, by owning an investment property which you have not properly planned for, you may end up paying more than the actual worth of your property.
Having crunched the numbers, Shiller debates this topic openly and robustly. He says that, overall, the housing market doesn’t have a great long-term return. It barely outpaces inflation, in fact. He told USA Today: “If you look at the history of the housing market, it hasn’t been a good provider of capital gains. It is a provider of housing services…Capital gains have not even been positive. From 1890 to 1990, real inflation-corrected home prices were virtually unchanged.”
The Washington Post analyzed Shiller’s data and reported that, over the past 100 years, home prices have only grown at a compound annual rate of 0.3%, adjusted for inflation. The S&P 500, on the other hand, has had an annual return of 6.5%. That’s an awfully big difference.
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But does Shiller’s hypothesis hold true for a small, land-scarce country like Singapore? Let’s analyse.
Take for example, if you were to take a 20-year-mortgage loan for $2 million which offers you 2% for the first 3-years and 2.5 per cent thereafter, you will be paying over $512,000 just in interests alone.
This means that if your investment property is worth about $3 million today, you would have paid over $3.5 million for it over a 20-year-period.
So is it a good deal to put money down on an investment property?
The Government’s Private Residential Property Price Index shows that prices of private properties had almost doubled in the last 20 years.
The Government data suggests that although a private property may dip sharply over certain years, observed over a longer 20-year-period, it always appreciates. So the lesson really is if you are a short term investor in Singapore’s residential properties, don’t overestimate the returns on this investment.
In fact, no investment property can guarantee a perpetual positive return. And there is always the probability that your rental returns cannot cover all expenses related to your investment – expenses like loan repayment, management fee, property tax and maintenance and repair cost.
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While that single real estate asset might help protect you against inflation, a well-balanced stock and bond portfolio seems to be a better investment. But a lot of people’s portfolios are mostly made up of their home value. You wouldn’t put 80 percent of your portfolio in a bond simply to protect against inflation (unless maybe you were nearing retirement) so why would your home make up that same amount? That’s the argument against buying a home as an investment.
As Forbes contributor Jamie Hopkins says: “When making the decision it is important to understand that buying a home might not be a great financial investment and to not forgo all of your investable assets in order to purchase a home because you are really purchasing a right to housing and not a long-term investment designed to generate income.
“You might still be able to time the housing market just right and sell at a higher rate than Shiller’s data shows. But most experts agree: while housing is an investment, it’s not a great investment. So, if this is your only basis for buying a home, it’s probably not the best one.”
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