Cash, Flats and Valuation

HDB

COV

CPF

Letters you need to know (and understand) when you buy a resale flat.

On Monday, 10 Mar, Minister for National Development announced a new rule that would (hopefully) eradicate the scourge of Cash over Valuation (or COV) in resale HDB transactions.
Khaw had previously explained why he could not abolish COV:

"It is simple... COV is the difference between (a) price of flat as agreed between buyer and seller and (b) the valuation of the flat given by a professional valuer. (b) is done by an objective professional. (a) is between buyer and seller.

The question was who would set the price if the COV was abolished? Thus it would seem, that COV was here to stay. A previous attempt to legislate it away just drove it underground. There was still COV, just hidden.

But Khaw announced a new process on Monday. Instead of getting a valuation first, and then negotiate on the COV, in the new process (from Monday 10 Mar), the buyer and seller would now settle on the price before getting a valuation. That way there would be no negotiation about COV.

What's the problem?

BUT... there may still be COV, of sorts. If the buyer and seller agrees on say $400k and the valuation subsequently comes in at $380k, that means the buyer can get a loan for up to $380k, but he would have to top up the shortfall with $20k in cash.

The problem with the new approach is that it adds uncertainty to the process. You may not be explicitly negotiating on the COV, but if your offer is too high, you had inadvertently agreed to a COV. Even if you had intended to bid high to secure the flat, if the valuation is lower than you estimated, you had inadvertently committed to a higher COV than you intended.

How was the process previously?

In the previous process, the valuation assures you of the cost that can be covered with the loan and the CPF. Say the valuation is $380k, and you have $80k in your CPF ordinary account, you need a load for $300k. Base on this, you can decide if you want to pay off your loan in 10 years, 15 years, 20 years or whatever. You also know how much CPF contribution goes into your ordinary account and whether that means you can service a 10, 15, 20, 25 or whatever loan tenure.

All this can be computed and worked out either ahead of time or very quickly after. The valuation is known. Your CPF balance is known. Your CPF contribution is known. And if COV is required, you know how much savings you have and how much you can scrape together if need be.

There was certainty. You would only over-extend yourself if you were reckless or over-estimated your resources.

What is the result of the new process

The new process may have some good effects.

Firstly, buyers would be more cautious, more prudent. As the valuation is not confirmed, all the buyers will have is some inkling of what the valuation might be. The buyer could be advised by the property agent, obtained an indicative valuation from the Bank, or check HDB's website on recent transacted prices. However, if the best estimate is $400k, the buyer may want to discount some of that in case the eventual valuation is lower.

This means that there would be a built-in mechanism to keep prices from being too exuberant. Maybe.

Secondly... Actually, there is only one possible advantage to the new process. I can't think of another.

And that "advantage" is fully dependent on market sentiment. If every buyer is being prudent, or the overall market sentiment is bearish, and cautious, then yes, a buyer can afford to be prudent and reasonably expect to secure a deal. However, if the market is "irrationally exuberent", or simply optimistic (rational or not), then being prudent will not get you the flat you want.

Other effects would also be situation-dependent, and possibly negative (generally).

If buyers are more prudent, it may well mean that sellers won't enter the market... Until buyers start taking risks, and start offering more, and risk over-extending themselves.

Valuations may be pressured to rise or meet the negotiated price. This could be a policy decision. One way to "remove" the COV is to value the flat exactly as it is negotiated. Khaw could give a directive to HDB valuers: value the flat equal to the negotiated price, or not more than x% below it. This would effectively contain COV to x% of the selling price. If this were the plan, it would not be long before buyers and sellers (and agents) realise this, and soon, transacted price would rise stratospherically. There would be no "brake" on the price, if valuation chases price.

If valuations are to continue to serve as brakes on prices, their effectiveness may be dubious in a bullish market. Currently the market has cooled. Sentiments are contained. But if there is another bull market, a sellers' market, we can expect all this to change. When one seller puts his flat on the market and 20 buyers are interested, the buyers will bid up the price, regardless of the valuation. COV will again be there, just not directly negotiated. Moreover, as ST Opinion Editor, Chua Mui Hoong pointed out, the HDB data will only show "transacted price" not valuation. Thus if transaction for a 4-rm flat was $500k, you do not know if the valuation was $500k, $490k, or even $400k. Hidden COV can still get you if you depend on the official HDB data. The recent transacted price listing in an exuberant market will contribute to the exuberence.

Certainly valuations in the past were ineffective in containing prices when market sentiment were irrationally exuberant. Would this new process, with a later valuation help to contain prices? Is that the point of of this new procedure? To contain prices? I seriously doubt it.

The SG Govt and prudent players in the market (real estate agents) are aware of the danger of a "bubbly" market, or runaway prices. A crash would eventually result, and the bigger the bubble, the more disastrous the bursting of the bubble. The market (and Singapore) is best served by a steady, controlled, rational rise, backed by market fundamentals. Irrational exuberence is short term.

The price of resale flats has two components. The concern has always been COV, as that is the key cost to the buyer, the most germane opportunity cost, the pressure point, the "pain" point. But, the official valuation, which allows loans and CPF to be used is another component; the relatively painless component.

But it is NOT painless. It only feels painless in the present, but it postpones pain to the future. Paying a $300k loan over 20-25 years will mean that total payment with interest could come up to almost double the price. As this would be paid mostly, or solely with CPF, it is less savings for retirement. But people generally discount future costs.

The question policy-makers should be asking is, "is it acceptable for people to squander their retirement savings for a home?"

A possible answer to that question is that it's not a problem. A $150k flat bought in 2000 can be sold for $$350k in 15 years. The flat is an investment, and the amount you pay for it, will be recovered over time.

Which is true. But also deceptive.

Some critics have called the HDB flat market a "Ponzi" scheme of sorts. There are some similarities - early investors come in cheap. Late-coming investors pay a premium and pay-off the early investors. It sort of seems like a Ponzi scheme.

But that can be said of say Apple stocks. If you bought Apple stocks in 1990, you would have got it cheap. If you tried to buy in in 2005, you might be buying the stocks of someone who bought it in 1990 cheap.

But again, while it is true that the value of the flat has risen, the problem is that all property has risen and if the flat is your home, we have the problem of being asset rich and cash poor.


$600k flat with $20k CPF or $300k flat with $200k CPF

The question policy makers should be asking is, is it better for Singaporeans to be living in a $600k flat, with $20k in their CPF, or living in a $300k flat with $200k in their CPF at the start of their retirement? Certainly in terms of absolute cash value, $600k + $20k is better than $300k plus $200k. But when $600k is illiquid, then the answer may well be "no".

Solving the COV problem is a populist move. Solving the overall price of the flat is a bigger problem, and a more politically dangerous problem. Does the government dare to solve it?

Why is it a dangerous problem? Because it cuts to the heart of the Singapore Dream.

Or the Singapore Way.

The dream that the government (PAP) has "sold" Singaporeans is, you can buy a HDB flat at a subsidised price, and over time, it would be worth hundreds of thousands, and maybe for some, millions of dollars.

But the problem now is asset-rich, but cash-poor retirees. To be fair, there were many ways how retirees got to this situation. Some live in homes bought by their parents or grandparents. They inherited the property. They did not have to pay for the property, but they are cash-poor for various other reasons.

But many retirees or near retirees are facing or will be facing a severely depleted CPF account at retirement BECAUSE of their over-commitment to HDB flats, usually resale flats (where prices are not controlled) or even new flats direct from HDB (where prices and eligibility are controlled, but flat size (and cost) is up to the buyer. The Minimum Sum policy is at best ameliorative. It is also inelegant, clumsy, and hated.

The SG government has also been advising buyers to be prudent and buy what they can afford. However, what the government considers affordable for a given income, and what buyers (in that income bracket) actually believe they can afford are probably not aligned.

Buyers tend to buy the biggest flat they can afford. Because when prices eventually go up, it would be worth a lot more. However, they fail to realise that when their flats are eventually worth 3 times more than what they paid, they are unable to realise their "investment" because they would still need a place to stay, and any new place they want to buy would also cost about what they are able to sell their flats for. Unless they downgrade to a smaller flat.

Which is another reason to buy the biggest flat you can afford when you are younger. If you buy a 3-room flat, you don't have much options to downgrade. If you have a 5-room flat, you have more options.

Or they buy again from HDB. Their second bite of the cherry. The government doesn't like to provide a second bite of the cherry, but they are realising that they have to.

With new flats, the prices are controlled by HDB who strive to provide a concession or subsidised price. The subsidy is obvious as resale flats of the same size in the same area may be 50% to 150% higher (approximately, on average).

However, with resale flat, the prices are determined by "market forces". And valuation is based on "market forces". And if you examine this "market forces", you realise that it is on a self-referencing loop. In MS Excel, it would be called a "circular reference error".

The market "price" is partly influenced by the valuation, and the valuation is based on prices of recent transactions, which were guided/influenced by... valuation!

And what is the pressure to raise prices of resale flats? COV? only during "irrational exuberence". The rest of the time, the normal times, and at all time, the pressure to raise prices are due to... CPF.

How to contain HDB resale prices? Do the unpopular.

Allow CPF to be used for resale flats purchase up to X% of a BTO flat of similar size in the area. Say you want to buy a 4-rm resale flat in Ang Mo Kio. A recently transacted price is say $400k. HDB's nearest BTO 4-rm flat is $300k. If the policy is set that CPF can only be used up to 120% of a comparable direct HDB sale flat (i.e. BTO), the buyer can only use CPF to finance the purchase of the resale flat up to $360k.

This in effect becomes the valuation.

BUT, you might say, there is still circular referencing, because the HDB BTO prices are "market-subsidised", so there is reference to market prices (i.e. resale transactions) which is then discounted.

Yes. but if the market-subsidy discount is equal to the resale "premium" (the 20% of the 120% in the above example), the circular referencing should eventually equalise. This is not quite good, because it would be a stagnant market (I will leave the question of "not good for whom?" unanswered. You can try to answer it for yourself.)

So when the market has stabilised/equalised, the policy or formula can be tweaked. Allowing a higher resale premium (say 125%) will allow resale prices to rise. And this will allow market-subsidised prices to rise in turn, which will then allow resale prices to rise in turn, until the market subsidy discount is re-equalised allowing the BTO-Resale to reach equilibrium again.

So why is this a politically dangerous move? Because it would put a brake on resale flat prices, and people have been expecting their flats values to rise and keep rising. Clearly this is unsustainable. And people have realised this.

Secondly, and more insidiously, this clearly shows that the prices of resale flats and BTO flats have been artificially inflated because of CPF, and HDB policies. There is no market forces that is not created or artificially sustained.

And this is why it will probably not be done.