Fundamentals appear good for the mid- and mass market.

A MARKET WATCHER recently commented that stock markets have had so much bad news to digest in recent times that investors are desperate to feel good once again, even if it were for a brief period.

That seemed to be the case with property counters which rallied last month after having been amongst the laggards of late.

During the period of April 14 to 22, CapitaLand, Southeast Asia’s largest developer, soared 9.5 per cent to close at $6.91.

Not to be outdone, the region’s second largest developer, City Developments climbed 7 per cent to $12.30 while Keppel Land rose 5.6 per cent to $6.07.

The property sector has been inundated with negative news flow in recent months, the latest of which was the March 10 decision by Kuwait Finance House to withdraw from its decision in December to acquire Phase One of Goodwood Residence in Bukit Timah for $818.4 million (about $3,000 per square foot).

Some analysts point to the Kuwaiti fund pulling the plug on the deal as indicative of a market where asset prices are falling, especially in the high-end segment.

Hence, a number of brokers’ upgrade of the sector and a string of “buy” calls for the big property developers was a welcome sight for investors looking for a pick-up amidst the downcast on the property front.

Upon issuing 'buy' ratings for CapitaLand and City Developments at a target price of $7.27 and $16.30, respectively, Merrill Lynch noted that
“not only do these companies have the strength to ride through a weak cycle; they will also be in the best position to reap the benefits should the property market pick up again.”

Unquestionably, these developers have a healthy balance sheet owing to strong property sales and rental inflow. But the slow residential home market does put a question mark on whether the recent run on properties is sustainable in the foreseeable term.

A weak market

Truth be told, sentiment in the residential property market has deteriorated at an amazingly rapid rate. While expectations were rampant for capital growth in 2007, the market is now weighed down by increased new supply and lower transaction volumes.

Though March saw property developers launching 642 units – 57 per cent more than the 410 in January and the highest in seven months – only 50 per cent of the units in March were sold compared to 80 per cent in January. The figure reflects the current market situation with buyers remaining on the sidelines, seemingly justifying the decision of most developers to hold back property launches.

Nonetheless, in a somewhat surprising revelation, the 1Q08 flash estimate released by the Urban Redevelopment Authority (URA) last month showed a 4.2 per cent rise quarter-on-quarter (q-oq) in the property price index (PPI).

However, most analysts believe that the price growth registered were largely due to higher benchmark prices achieved for a handful of projects and is hardly evidence of strength in the sector.

“We believe that the figure is skewed by selected projects and that generally, residential prices in Singapore have started to fall,” said UBS Investment Research in its report dated April 16.

Further, the anemic demand for private property in the first quarter of this year saw only 795 uncompleted units sold, a far cry from the quarterly take up of 1,397 units in 4Q07 and 3,367 units in 3Q07. It represents the lowest number of new units sold in a single quarter since 1Q03 – when 322 units were sold during the worst of the SARS crisis – and even failed to surpass the 890 units transacted at the onset of the Asian Financial Crisis in 4Q07.

Asset prices to fall in luxury segment

The luxury residential segment is set to bear the brunt of weak market conditions with rents likely to have peaked before the year’s end, coupled with a general slowdown in sub-sale activity (units re-sold prior to completion). In a recent report on the residential property market, Nomura Equity Research predicted a correction in the value of luxury properties.

“We envisage average asset prices in this segment falling 32.3 per cent from the 2007 peak over (the period of) 2008-2010 – by 16.9 per cent in 2008, 10.3 per cent in 2009 and 9.3 per cent in 2010, as rental growth slows and yields are re-appraised.”

It added that while this would be a major correction, it is not an outright crash as the estimated 2010 average of $1,847 per square foot (psf) is slightly higher than the $1,811/psf in the 1996 peak and 22.4 per cent above the 2001 peak of $1,508/psf.

The key to capital value outlook is the forecast for rentals and hence yields, which is the income from a property measured as a percentage of its value. Luxury yields are at a historical low of 2.77 per cent, though mass market yields have risen on the back of strong rental growth.

Nomura’s analyst Tony Darwell expects average rentals for high-end property to peak this year – rising 5 per cent year-on year (y-o-y) to $3.64/psf. But as supply inthe luxury segment begins to enter the market, rents are expected to come off by 0.3 per cent y-o-y in 2009 and 15.7 per cent y-o-y in 2010.

During the boom of 2007, high-end properties were deemed by many foreign investors as being relatively cheap compared to Asia’s other developed markets such as Hong Kong and Tokyo. As developers outdid themselves in setting record prices for prime properties here, the huge increase in capital value has since closed the price gap so much so that Singapore properties are no longer perceived to be “cheap”.

In fact, figures compiled by real estate consultancy Jones Lang LaSalle showed that capital values of luxury homes in Singapore is now only 2.1 per cent lower than those in Hong Kong, compared to 24.6 per cent just a year ago. Indeed, bargain-hunting for luxury properties in Singapore has a much hollow ring to it than in the past.

Mass market

The URA’s 1Q08 flash estimate pointed to decent q-o-q growth in property prices but while analysts contend that the thin volume of property transactions points to a market on the wane, it is worth noting that mass market properties led the way in home prices.

While it consistently trailed prime regions during the boom period, properties in the mass market segment posted a 4.8 per cent growth q-o-q compared to the 4.4 per cent in the core central region. Compared to the anticipated decline in prices in the high-end segment from here on, some believe that the mass market will continue to grow in 2008.

“While overall PPI appears to be approaching peak, we estimate that
prices in the mass markets are still below the previous peak of 1996. We see further upside potential in asset prices to come from this segment this year,” noted CIMB-GK property analyst Donald Chua.

The mass-market has been boosted primarily by demand from en-bloc sellers and HDB upgraders. DBS Group research noted that the strong demand in the HDB resale market, arising from insufficient supply of new HDB flats available for immediate occupancy, may further prompt HDB owners to cash in and upgrade to private property in the mass market.

“I don’t know whether it will strengthen but looking at the overall market, the fundamentals currently appear good in the middle and mass market,” affirms Dr Chua Yang Liang, head of research for Southeast Asia for real estate consultants Jones Lang LaSalle.

Mass market yields have also risen on strong rental growth as the tight vacancy in the luxury segment saw demand redirected to the mass market segment. But with fresh supply due over the next two years – 63 per cent of which are focused in the prime districts of 9,10 and 11 – those displaced to the mass-market would likely return to the prime locations and thus soften mass-market rental and asset prices.

Nomura Equity Research anticipates mass residential prices to peak this year before falling 10.3 per cent in 2009 and 10.1 per cent in 2010.


Supply side to dominate henceforth

The specter of an oversupply in the property market in the medium term looms as project completions are expected to be significant in 2009 and 2010. The URA estimates that 56,516 units are scheduled for completion over 2008 to 2011 – 8,364 units in 2008, 12,867 in 2009, 13,493 in 2010 and 18,509 in 2011.

Over the past decade or so, the average annual increase in occupied units has been at around the 8,000 mark. Most analysts are expecting the figure to remain firm, with demand slightly skewed to 2010 when the Integrated Resorts (IR) and the Marina Bay Financial Centre (MBFC) open.

While demand seems to be exceeding vacancy at the moment, it is difficult to
assume that the take-up rate will increase sharply to meet supply given the uncertainty of the extent of the global slowdown and the fall-out in the financial services sector. Experts have estimated that the tight vacancy rate of about 5 per cent in 2008 would ease considerably in the range of 8 to 9 percent by 2010.

Dr Chua feels that while the majority of the units to be built have already been acquired, home-owners may have to contend with a weaker rental market.

“Actually, most of these units due in 2010 have already been pre-sold but I think the new supply will affect the leasing market where owners could find a problem when looking to lease their properties.”

Macro-environment a major factor

By nature, the property market is mainly sentiment driven and the bearish prognosis of the state of affairs in the US and a weakened financial market has not helped lift sagging spirits.

While some commentators have cited domestic factors such as strong income growth and low interest rates as potential demand drivers for the property market, they may not be enough to allay immediate worries of a global slowdown led by the US.

Dr Chua believes that the macro-environment needs to improve for the property market to regain its momentum. “I think external factors would be a major catalyst; the feel-good factor has to return to the stock market, to oil prices and the whole sub-prime crisis.”

Kim Eng Securities’ property analyst Wilson Liew notes that buyer response at upcoming property launches may provide some indication as to whether sentiment has improved.

“In the short-term, we’ll have to see what the take-up rate is like at new launches, especially for marquee projects like the Marina Bay Suites,” he says. Others have gone as far to predict that property developers may offer discounts in the second half of the year to stimulate demand. While that may be a possibility with the smaller players who may forsake price for volume, it might not materialise with the bigger boys who possess stronger balance sheets and thus holding power.

Several question marks are still to be answered with regards to the property sector. While investors wait in anticipation for its comeback, they might yet have to digest a few more bitter pills before the gloom is lifted.

This article was recently published in Smart Investor magazine and is reproduced here as part of a special collaboration between the magazine and NextInsight.

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