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Thursday, 27 March 2008

Nomura Remain Bearish On SG Property Market.

Residential property

SINGAPORE

Our view
We retain our Bearish stance on Singapore’s residential sector, with the market moving swiftly from a state of denial to acknowledging the realities on the ground. We see asset prices being driven down further by the marginal speculative sellers, amid low transaction volumes and rising unsold pre-sale inventories.

Anchor themes
Residential rents are likely to remain firm in the short term, given the low vacancy, though rising new supply is likely to cap rental gains from 2H08F — we forecast vacancy will rise from 5.7% at end-2007F to 8.2% at end-2010F.

Luxury residential prices have risen too fast relative to rental expectations. We see the marginal speculative seller in the pre-sale market as the catalyst for asset price declines in the luxury sector of 16.9% in 2008F and 10.3% in 2009F, with the mass market not immune from asset price declines amid rising new supply.

Eye on the storm
􀁣 Luxury asset prices to fall by 32% over 2008-10F
Sentiment in the market has deteriorated rapidly — asset prices look to
have fallen by about 5% over the first two months of the year, with falls
of up to 15% in some non-prime locations. We see asset prices being
driven lower by the marginal speculative sellers, amid low transaction
volumes and higher unsold pre-sale inventories. Overall fundamentals
aren’t supportive, on higher expected new supply and re-assessed
rental expectations. Luxury should bear the brunt of falls in asset prices,
though mass residential looks unlikely to escape completely.

􀁤 Unnerving sound of supply: 12,231 units pa over 2008-11F
We assume supply will remain modest in 2008F (8,364 units), but
completions should rise markedly thereafter, to 12,867 units in 2009F
and 15,043 units in 2010F, with the average at 12,231 units pa over
2008-11F. We note that over the course of 2007, the volume of new
supply forecast for 2008-11F rose by 10,829 units.

􀁥 Demand remains firm: 9,064 units pa over 2008-11F
Our demand forecasts are broadly intact, with 2008-11F private sector
demand averaging 9,064 units pa, though with this demand slightly
skewed to 2010-11F, when the integrated resorts open. We expect
vacancy to fall to a low of 5.1% this year, but rise to 6.4% in 2009F,
before stabilising at around 8-9% over 2010-11F. We expect rents to
peak this year, and ease by 10.3% y-y in 2009F and 15.7% y-y in 2010F.

􀁦 Withdrawal of pre-sale speculators?
With asset values likely to correct further over 2008-10F, we see
speculators becoming net sellers, weighing on pre-sale launch prices.
Smaller players are likely to initially trade price for volumes in 2008F,
with the larger players possibly having to follow suit — and as construction costs rise ever higher, this may well create a potential
downside surprise for margins and NAVs.


Capital values
Eye on the storm
Singapore’s residential market is moving quickly from a state of denial to now acknowledging the realities of falling asset prices. The exchange of SMS messages shown below highlights the rapid recent deterioration in the residential market.

In early March, an agent noted below to a prospective vendor for a unit in District 9: “The market for sale has gone quiet for now. Please advise if you still want to ask at $2400psf. Buyer sentiments are at the $1900-2000 range. In the next few weeks, price is expected to dip another 20% as some urgent sales by weak speculators of projects are being caveated and will become apparent to the market”

Two weeks later the same agent advised:
“They (buyers) are now looking below $2000psf. Market expectation lowered as more owners lower price. At the moment sentiments are weak, especially after the pull out of a fund from the purchase of a high end project. So now most buyers on a wait and see mentality. Unless its a genuine fire or urgent sale the interest level is not so high”

In what we see as something of an under-statement, an agent recently candidly summarised the current market:

“To be honest the market is very slow”
We see asset prices being driven lower by the marginal speculative sellers, amid low transaction volumes and higher unsold pre-sale inventories. Fundamentals aren’t supportive, on higher new supply and re-assessed rental expectations.

The 10 March decision by the Kuwait Finance House (referred to above by the agent) to withdraw from its decision made in mid-December to acquire Phase One of Goodwood Residence (comprising 97 out of 210 units) for S$818.4mn (about S$3,000/psf) in Bukit Timah is indicative of a market where asset prices are falling.

Analysis of sub-sale activity (units re-sold prior to completion) and caveats lodged in key residential developments suggest that asset prices have already fallen by about 5% over the first two months of the year, with falls of up to 15% in non-prime locations such as Sentosa Cove. This analysis highlights the broadening of the correction in asset prices, and is a natural extension of recent analysis by estate agencies that the decline in asset prices has been selective.

Sentiment in the market has deteriorated rapidly. While rampant expectations for capital growth in 2007 are now being checked by global economic concerns, the longer-term reality is that the domestic residential market will remain weighed down by increased new supply and unrealistically low yields. As launches are deferred amid weak demand, we see the prospects for a build-up of unsold inventory adding further
downward pressure to pre-sale asking prices.

Asset price outlook

We see the luxury residential market bearing the brunt of the changed realities in the market, and we envisage average asset prices in this segment falling 32.3% from the 2007 peak over 2008-10F — by 16.9% in 2008F, 10.3% in 2009F and 9.3% in 2010F, as rental growth slows and yields are re-appraised. This amounts to a major correction in luxury asset prices, though not a crash, with a 2010F average of S$1,847/psf,
marginally higher than the S$1,811/psf in the 1996 peak and 22.4% above the 2001 peak of S$1,508/psf.

Note: the forecasts above are averages. We expect greater falls for pre-sale units in selected developments and markets, with Sentosa Island and fringe CBD/fringe prime locations likely to bear the brunt of lower asset prices.

Mass residential prices appear on a firmer footing, supported by rental growth and prevailing yields. However, the advent of new supply and the resultant increase in rental availability in prime locations is likely to see demand that was once displaced to “non-core mass market” locations returning to prime districts, hurting non-core rents and ultimately mass market prices. As a result, we anticipate mass residential prices
remaining flat in 2008F (+0.5%), but as the new supply is completed in the prime districts, we expect prices to fall 10.3% in 2009F and 10.1% in 2010F — with prices to fall 19.4% from the 2008 peak.

However, as asset prices are known to overshoot rationale expectations, the risk is that in the current economic climate, asset price falls may overshoot on the downside, especially if developers defer launches, potentially increasing the overhang of unsold inventory, and/or cut prices to clear stock.

Rental / yield outlook

The key to our capital value outlook, and the sustainability or otherwise of current asset prices, is our outlook for rentals, and hence yields. We maintain our forecast for demand of about 9,000 units pa over 2008-10F, and expect average rentals to peak in 2008F, rising 5.0% y-y to S$3.64/psf pm, following rises of 14.1% y-y in 2006 and 41.2% y-y in 2007. We had previously pencilled in growth of 26.5% for 2007 and
18.2% for 2008F, and anticipated rentals would peak in 2009F (at S$4.00/psf pm).

Luxury yields are currently at a historical low of 2.77%, whereas mass market yields have risen on strong rental growth as demand has been displaced from core locales. While we expect real interest rates in Singapore to fall (mainly as a result of higher inflation rather than lower interest rates), we do not envisage these monetary conditions sustaining the historically low yields in the luxury market. As a result, we expect yields to rise from 2.77% currently to 3.00-3.50% over 2008-11F.
With supply on the rise, we expect rents to ease by 10.3% y-y in 2009F and 15.7% y-y in 2010F. Despite the declines, mass residential rents will still be 25.2% higher than 2003 trough levels.

Unnerving sound of supply

6,513 units in 2007

We estimate 6,513 units were completed in 2007 (source: URA, Nomura), versus average annual completion over the past 10 years of 9,062. However, due to demolitions as a consequence of en bloc transactions, we estimate the net increase in the private residential housing stock was only 1,448 units.

12,231 units pa over 2008-11F
The URA estimates that 56,516 units are scheduled for completion over 2008-11F. While we expect some slippage in project completions, we still expect total supply of 48,924 units. We assume supply will remain modest in 2008F (8,364 units), but should rise markedly thereafter, to 12,867 units in 2009F (below the URA’s estimate of 13,493 units) and 15,043 units in 2010F (URA: 18,509 units), well above our demand assumption of about 9,000 units pa.


Changing supply forecasts: 10,834 more units for 2008-11F
While an increase in new completions is increasingly being factored into the market, the key is the significant change in the volume of expected supply, compared with forecasts that were being made six to 12 months ago. Over the course of 2007, the volume of new supply expected to be completed over 2008-11F has increased from 45,687 to 56,516 units, an increase of 10,829 units, broadly equivalent to an additional year of new supply (see the exhibit below for details).


Tight construction market contributing to slippage

The increased volume of construction activity in Singapore, both for residential and non-residential projects, as well as the increase in commodity prices, has contributed to a marked pick-up in construction costs. According to the tender price index, construction costs in Singapore were up 23.2% y-y in 4Q07 (the residential tender price index was up 28.9% y-y). We estimate total construction costs plus interest comprise about 15-20% of the total cost for luxury developments and 25-40% of total costs for mass residential projects, with the key remaining cost being for land.

While rising construction costs are unlikely to have an immediate impact on developer margins, given the high level of pre-sales and fixed price contracts, margin pressure beyond our current forecast period is likely, with the lower achieved prices and higher input costs hurting NAVs. Given the interplay between costs and margins, it is perhaps more plausible to conclude that if the tight construction market starts to impact completions, such delays are more likely to impact the mass market rather than the
luxury sector, supporting our view of greater supply risks in the luxury sector

We already assume natural project slippage in new completions. We have analysed past URA data for two-year forward forecasts (for units under construction) over the six years covering 1999-2004. The URA’s forecast of 48,182 units was above the actual level of 46,178 units, a slippage rate of 4.3%.

New supply mainly in prime locales

The volume of new supply is focused very much on the prime districts of 9, 10 and 11 (broadly defined by the URA as the Central region) — these areas have been the focus of most of the en bloc activity in the past 24 months.

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