Saving yourself from the real estate bubble

No one wants to go through the same experience we had in 1997. But to prevent a bubble, one must understand the underlying cause and derive measures to prevent it. A bubble forming in the market is not something immediate, but rather a collection of underlying causes that gradually develop and brew trouble over a certain period of time. In a bubble, rising prices encourage speculation, which further inflates demand until the market has reached its peak. 

In today’s market, the key factor pushing up prices is development cost, which has increased sharply. This is driven by a combination of rising construction and land costs. The costs of construction and labour are unlikely to come down, but the annual increase is still in a manageable range.

On the other hand, land costs in selected areas have increased at an uncontrollable rate driven by high demand from developers. Once a new record land price is achieved, sellers of other similar plots will raise their asking prices to the same level. 

Land cost is a major financial component for developments today and is the factor pushing up product prices higher than market affordability. In the past 10 years, land accounted for less than 20 per cent of total development cost, while today it has increased to more than 50 per cent. 

Today there is potential oversupply in some segments and some locations. Developers must exercise more caution when launching products and must conduct market and feasibility studies to ensure they are building the right product at the right price point and location to ensure there is real sustained demand.

Rising prices and off-plan purchases undoubtedly fuel speculative demand. When the market is on an upcycle, short-term investments from speculating on prices are attractive especially when the project offers low down payments. However, when the market and prices mature, buyers should avoid short-term speculation. It is also risky for developers if a large percentage of the units are sold to short-term speculators. Many developers have started to adopt higher down payments, which is a good sign and a measure to prevent a bubble. 

The general rule of thumb is that a household is considered to be able to afford a house and repay the mortgage if its monthly income is at least 2.5 times the mortgage payment. In cases where a household has a single mortgage it is not so much of a cause for concern as when one individual has multiple mortgages. Banking policies play a crucial role in preventing this concern.

Other risks lie in the ability to service loan payments. Many investors buy units to rent out and expect the rental income to pay off the mortgage. 

It is important for buyers to recognise that the rental market has not grown as fast as the sales market and there is a risk that rent may not cover the monthly instalments, or in the worst cases due to high competition in the rental market, the unit may take time to lease out. 

Whether the market is prone to a property bubble does not depend on one single cause or factor. It is a combination of interrelated variables – inflated prices, speculative demand and weak banking policies. 

All parties in the industry, from developers, investors and banks to property consultants all play a part in ensuring that appropriate preventive measures are implemented so that the market can enjoy sustainable growth.