More Skin In the Game

By TAN Kee Wee
(MediaCorp 938LIVE’s Money Talks, Monday, 13 September 2010, 7.20 am, 9.20 am, and 7.20 pm)

Recent measures taken by the Singapore government to curb property speculation have made many investors unhappy. One of these measures is to increase the down payment for second properties from 20 to 30%.

This may be a good thing because it forces investors to put in a bigger stake, or what we call “skin in the game”, in their investments.

In many countries, the average down payment is 10 to 20%. During the boom years in the US, zero down payment was possible. This reflected lenders’ optimism about property prices.

There is another reason for the small down payment. Historically, most home owners do not default because of the moral obligation attached. Unfortunately in the US, this moral obligation was recently undermined.

According to recent research, led by Professor Luigi Zingales of the Chicago Booth School of Business, US homeowners will not default if the negative equity in their homes is 10% or less.

But once it reaches 15%, the tendency is to default. The term used is “strategic default”. This is possible in the US because in many states, lenders find it difficult to go after the defaulters.

This is now a big issue in the US. One out of every five homeowners who defaulted in recent months chose to default even though they could pay. This is bad for the market because it drags down prices further.

Can this happen in Singapore? “Yes and No”. “No” because the law here will come after you with guns blazing. “Yes” because the behavior of today’s investors is very different.

If defaults appear, it will come from those who could evade the law, and those who could pack up and return to their home countries.

Based on the research done by Professor Zingales, let’s calculate the level Singapore property prices must fall before defaults appear.

Most recent investors bought their properties with a 20% down payment. So, for a S$1 million property, the down payment would be $200,000, and the mortgage would be $800,000.

If the strategic default point is 15% below the mortgage, the value of the house must fall below $680,000 before homeowners start to default. At $680,000, the property would have dropped 32% from its original value of $1,000,000.

A 32% drop in prices is a lot. But it is possible. During the Asian currency crisis, Singapore property prices fell 45% within two years.

Of course, it is grossly unfair to say that many non-Singaporeans will default. But with 20% of all properties in the past ten years bought by non-Singaporeans, a small proportion of them can move the market.

This behavior is not far-fetched. Default is a rational option if the guest worker has lost his job, and his property is under water. That was precisely what many guest workers did in Dubai last year. They drove their luxury cars to the airport, took the flights home, and left all their problems behind.

The Dubai authorities can’t do much, once these guest workers have disappeared among the millions in their home countries.

So the latest 30% down payment rule is good because prices must fall even more before defaults appear. It increases the homeowner’s “skin in the game”. Ideally, the best “skin in the game” is to make homeowners love Singapore and its delicious foods so much that they will stay no matter what.

So when it comes to the crunch, between financial freedom in their home countries and eating Chicken Rice in Singapore, they will choose the exquisite tasting jelly-like skin in the Chicken Rice.