Perils of having a non-market housing segment

By Phang Sock Yong, David Lee, Alan Cheong, Phoon Kok-fai And Karol Wee, Published The Straits Times, 17 Aug 2013

THERE have been many suggestions on how to restructure the Housing Board pricing and resale system in order to make home ownership more affordable for first-time buyers.

In November last year, the Singapore Democratic Party proposed a non-market segment, priced at building costs only but with the requirement to sell back to the HDB. The rationale underlying this proposal is that housing should not be a means of investment for capital gains.

The SDP proposal for a non-market segment is supported by chief executive Ku Swee Yong of real estate agency International Property Advisor, who suggests in an April article on IPSCommons website that not only a segment, but all new BTO flats be "priced at four times the salary of the household with the requirement to sell flats back to the HDB only after the minimum occupation period, at price that is pegged to inflation and GDP growth." BTO refers to Build-to-Order subsidised flats by HDB.

In a similar vein, research fellow Tan Meng Wah has proposed that new flats be sold at costs-based prices minus land value, with the HDB "claiming the pre-determined land value from the capital gain" when the home owner sells his flat. "In the event if the capital gain is less than the land value, the shortfall will borne by the HDB."

Other proposals to reduce the value of the HDB flat so as to make it more affordable include: extending the minimum occupation period; the HDB to reduce the term of mortgage loans in its computation of the debt-service ratio from 30 years to 15 to 20 years; and for the HDB to shorten the leases for BTO flats.

Many of the above proposals represent a movement away from market norms of pricing and resource allocation for the HDB sector, with the justification of improving housing price affordability.

Retreating to the non-market policies of the 1960s and 1970s involves trade-offs and requires careful consideration of effects.

The following are some of the potential costs involved:

- The home ownership affordability problem affects new entrants and households wishing to upgrade - a smaller proportion of the population as compared to existing owners.

In making changes to the existing system, there is a need to avoid making changes which could potentially have adverse impacts on housing asset values and retirement wealth of a majority of the population. Policymakers should aim to stabilise housing prices and not bring about a sudden decline in prices.

- The proposals for a segment of new BTO flats to be sold back to the HDB, or for all new BTO flats to be eventually sold back to the HDB at some predetermined price or with the shortfall to be borne by the HDB, introduces a number of issues.

If market prices for housing appreciate at rates higher than predetermined prices, home owners in this new segment will be unable to benefit as much from this asset appreciation - one of the primary benefits of Singapore's home ownership programme.

New entrants at the point of entry will then have to make a decision as to which segment of the market would yield better returns in the long run. If expectations are for higher rates of house price appreciation in the market segment, the preferred option would be to enter the market segment, with the non-market segment viewed as an "inferior" investment vehicle.

This would cause prices in the HDB resale market to appreciate even more. If sentiments are less certain, the pre-determined price of the non-market segment provides a floor, which could create a moral hazard problem leading to over-consumption and over-investment.

- Moreover, in a situation where HDB market resale prices are higher than the non-market pre-determined price, households opting for the non-market segment may face a mobility problem when the minimum occupation period is over.

The gap between the pre-determined price and market prices may render the household with no viable options in the resale market. Using 1981 household data, one study by Professor Phang Sock Yong showed that HDB restrictions prevailing then led to considerable distortions in housing tenure, consumption and location decisions, such that the value of the consumer surplus derived from the housing stock had been less than achievable from a freer market.

In particular, commuting distances and commuting times were significantly higher as compared to private housing residents. As such, the desire to impose a cap on investment returns on subsidised HDB housing by introducing restrictions can result in increased housing market inefficiencies and increases in commuting costs.

- Proposals for flats to be sold back to the HDB at pre-determined prices will be extremely challenging to implement in practice. In addition to being the biggest developer, the HDB will need to tie up financial resources to become the biggest buyer (and seller) in the housing sector.

Housing is a multi-dimensional product and home owners pour varying amounts into investment in housing quality. Locational prices of various attributes would also have shifted in the interim between launch and resale.

The proposed pre-determined prices upon resale to the HDB will thus not be reflective of market prices or reflect variations in market demand.

If an entire segment of the housing sector is subject to non-market prices as proposed, the valuable role that market prices play in the allocation of resources would have been sacrificed in the process. This is reminiscent of the inefficiencies of socialist cities during an era when land and housing markets were not allowed to operate.

Alan Cheong is with Savills, a global real estate services provider, while the other writers are with the Singapore Management University. This is an excerpt of a paper presented at the Singapore Economic Review Conference 2013 on Aug 7.