City condo buyers must proceed with care

Atraffic light shines in just one of three colours. But Bangkok's condominium market has hundreds of intersections, and at any given time, some lights are green, some yellow, others red. So if you are shopping for a condominium, or already own one, or work in banking or real estate, it's worth trying to view the big picture, to judge how the city's traffic now flows.

As it happens, condo unit prices have risen continuously during the past five years, at an average annual rate of 9%.

This increase is especially significant because prices for townhouses and single detached houses have merely tracked inflation during the same period. That disparity has generated concern among some economists and real estate pundits about a potential bubble in condominium prices.

In theory, a prolonged period of easy money fuels apartment price rises. Low interest rates have given potential homebuyers higher purchasing power because they have lowered the cost of monthly mortgage payments.

So many former renters have opted to buy. If this is prolonged, however, the low interest-rate environment can pump up speculative demand, potentially risking a bubble.

Should we start worrying about a bubble? After all, overinflated asset prices can harm not only one's personal financial health but also that of the whole economy.

Still visible here and there on Bangkok's skyline are skeletons of several buildings taken off life support after the property market bubble burst in 1997. But instead of flying into a panic, we need to carefully evaluate the situation at hand.

Let's start with, "What exactly is a bubble?"

There is no standard definition, but it might reasonably be described as a situation where asset prices are disconnected from their fundamental value.

Fundamental value, in turn, is determined by three factors: supply, demand and realistic expectations about future prices.

In a bubble, rising prices induce speculation, which further inflates demand. The cycle continues until the bubble bursts. Owners rush to sell, causing prices to collapse.

As for condo prices, one way to assess fundamental value is to compare prices with historical rents. Rents reflect how much people value housing units for use without the benefit of future price appreciation.

The price-to-rent ratio, which is the property's purchase price divided by annual rent, is akin to the price-earnings ratio, or P/E ratio, that is the key to valuing shares in the stock market. The price you pay for a stock should reflect current corporate earnings and reasonable expectations about future earnings. The same is true for a home. A condo's price has reached bubble level when its price far exceeds what could be reasonably justified in terms of its rental income stream.

With the current condo price situation in mind, we at SCB Economic Intelligence Centre (EIC) went on the hunt for better data, surveying about 500 condos in the Bangkok area in April.

The results show that the price-to-rent ratio for a one-bedroom unit is now around 17.1.

The likely good news is that this ratio appears to be consistent with what theory suggests is appropriate based on interest rates, tax benefits for homeowners, depreciation and maintenance costs, and potential price appreciation. But without historical data on prices and rents that would allow us to compute a "bubble benchmark" ratio, namely from 1997, we cannot be completely certain. For now, the 17.1 ratio is a green light, but it needs to be closely watched.

Looking beyond prices however, there is some early yellow-light flashing on speculative buying. Current market conditions are encouraging players to buy condo purchase rights and sell units for profit without moving in. It typically takes only a 10% down payment to reserve a unit before construction. Assuming 10% price appreciation, that means a speculator can earn a return of up to 70% on the payment by flipping the unit before construction is completed in a few years. Developers are aware of this speculative buying, which encourages them to pump up their prices. This can set a vicious cycle in motion.

Another yellow signal comes from a look at household incomes. Housing unit purchases have grown faster than the growth in the number of households able to afford a house, based on data from the National Statistics Office's household socio-economic survey.

Half of the housing unit purchases are condos; a household is considered able to afford a house if its monthly income is at least 2.5 times the amount required to service mortgage payments, which is based on average housing unit prices and interest rates. So it appears that more and more people have been buying Bangkok condos for purposes other than using them as primary places of residence.

These two yellow signals are consistent with the EIC's study of data from the National Credit Bureau, which indicates the number of individuals in Bangkok having multiple mortgages rose significantly in 2012. The number of individuals having four or more mortgages _ a clear sign of speculation _ shot up more than 20% during the year.

Yet these people with four or more mortgages represented only about 1% of all people with housing loan accounts in Bangkok. This suggests that speculative activity in condos is still limited.

Given these signs of speculation, what do banks say about mortgage lending quality? Data from the Bank of Thailand on loan delinquency ratios among both developers and individuals have not shown any unusual acceleration so far. The BoT data do indicate that among buyers of new Bangkok condo units worth over 500,000 baht, the debt service coverage ratio (DSCR), defined as monthly income divided by debt-servicing expenditure, has declined slightly in the past three years. But even for low-income households, the DSCR is still above 2 _ the minimum lending rule among commercial banks.

So bank data show that businesses and households currently have little trouble paying off debts, which is not surprising. After all, the economy has been growing robustly; the job market is strong, and interest rates are low. But if growth slows, households might experience a cash-flow shock. This would increase delinquencies, hamper access to credit and hurt the economy. Also, the financial market turbulence and the resulting declines in stock prices could hurt consumer sentiment through negative wealth effects. That would probably lower the propensity to invest including purchases of real estate, which could leave supply unsold.

All in all, the case for a significant condo price bubble at present is weak, although there are some early signals of speculation. The situation is certainly not as bad as in Hong Kong where residential property prices have increased 120% since 2008, buoyed by a tide of incoming foreign capital. It has not yet warranted macro-prudential measures such as a requirement for banks to lower the loan-to-value (LTV) ratio from the current practice of 90% or a requirement that banks increase their reserves.

But vigilance is due, especially because interest rates might decline further. It's a good sign that banks have begun to exercise more caution in mortgage lending. In April, for example, commercial banks approved significantly fewer housing loan accounts than in the months previously.

What's especially needed is more data so that it is easier for everyone to spot a bubble before it starts to develop. This information needs to be collected by government agencies overseeing the property and financial sectors. These data series would help inform the public of the traffic lights so they could better navigate the condo market. Safe driving, everyone!


Dr Sutapa Amornvivat is chief economist and executive vice-president at the Economic Intelligence Centre, Siam Commercial Bank. She has international work experience at IMF, ING Group and Booz, Allen, Hamilton. She received a BA from Harvard and a PhD from MIT.
eic@scb.co.th EIC Online: www.scbeic.com

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Writer: Sutapa Amornvivat