Outlook 06: Full steam ahead

Lim Lay Ying


To understand where the Malaysian property market may be heading this year, let’s begin by examining three events that took place in 2005 as they provide clues to the likely course that will be taken.

One was the hike in retail petrol and diesel prices (on May 5, and then again on Aug 1) and the ensuing rise in food, transport and communications prices. Global oil prices, which rose to a high of US$70 (RM266) a barrel on Aug 30 because of Hurricane Katrina in the United States, weighed down on the already huge subsidies the Malaysian Government had to bear.

The domestic oil price hikes then triggered off a series of CPI inflation rate movements, pushing it to a six-year high of 3.7 per cent last August from January’s 2.4 per cent. This shocked the confidence of businesses and consumers, resulting in steep falls in the indices, particularly the Consumer Sentiments Index (CSI) tracked by the Malaysian Institute of Economic Research (MIER).

Rising inflation

While the Business Confidence Index (BCI) slipped by marginal 1.4 points from 104.1 in the first quarter of last year (Q1, 05) to 102.7 points in Q3, 05, the CSI suffered a major drop of 18.4 points to 102.5 from 120.9 points over the same period.

The growing anxiety among consumers was due to their concern that the rise in petrol prices and transport charges would lead to the higher cost of essential items. To the business community, the impact was on production costs and the likelihood of slimmer profit margins.

Despite assurances from the Government that petrol prices would be stable at least until April 2006, concerns of more increases later this year may be quite founded. The pressure is likely to come from the persistent high oil prices on the global front and the still huge amount of Government subsidies. This is pushing widespread speculation that utility tariffs (electricity and water) may even be adjusted upwards this year, in addition to further hikes in oil prices.

The currency factor

The second event - one that finally turned out to be a non-event for the property sector - was the depegging of the ringgit from the US dollar on July 21 last year.

Following the move to replace the peg with a “basket peg”, the ringgit strengthened to RM3.746 on Aug 2, but it did not stay there for long, weakening to RM3.809 on Dec 30. This means the ringgit in fact depreciated by 0.2 per cent from the previously fixed rate of RM3.80. This hints at the possibility that the new exchange-rate system will continue to be tightly managed against the dollar.

The more eventful part related to the currency factor, however, was the move by foreign investors to unwind their ringgit position in both equity and bond markets and their subsequent repatriation of profits and dividends. This occurred when their anticipation of a major ringgit exchange rate revaluation did not materialise.

Bearish equity market

Some RM50 billion worth of foreign speculative capital quit their ringgit assets and fled the country, causing a huge dent to the capital account (as at last October, the country suffered a deficit of RM17 billion). This triggered off a chain of events, which eventually resulted in a bearish equity market.

Real estate stocks were not spared, with the Property Index falling 26 per cent within the 12 months of 2005. After starting out at an impressive 712.29 points on Jan 3 and reaching a high of 738.47 points on Feb 17, the index ended the year at a low of 524.64 points on Dec 27.

While there is no statistical evidence, history has shown that there is a rather close correlation between the residential property market and the local bourse. When sentiments are weak in the stock market, it spills over into the residential property market, resulting in investors adopting a more cautious attitude towards property buying.

Rising interest rates

In addition to current economic and stock market concerns, what may spark off tougher times ahead for property developers this year is the third event. On Nov 3 last year, Bank Negara raised interest rates by 30 basis points - a move that hints at the possibility of more rate rises to come in the near future.

Although interest rates are still expected to remain low this year, any hike will ultimately mean property will be relatively less affordable. According to financial experts, every one percentage-point increase in interest will shrink house buyers’ affordability by an estimated eight per cent. This is based on the assumption that an 80 per cent margin of financing is obtained and repaid over 25 years.

Consumer confidence, which had already been shaken quite considerably by last year’s oil price and transport charge increases, may affect decisions on property purchases.

Residential: Still a safe bet

So, is this indicative of a softer market for residential properties in 2005? To some extent, the answer has to be “yes”. The sector will quite likely consolidate - albeit, only temporarily as it reacts to the current setback in consumer confidence stemming from inflationary pressures.

However, the cautious stance towards buying property is likely to be more reflective of selective consumer demand, rather than the lack of it. Landed residential properties, after all, are still very resilient in the more established townships, with new launches in these places consistently recording strong take-up.

While pricing remains an important factor, the overriding criterion in determining demand still boils down to location - it is the less prime areas that will encounter greater volatility in price and demand whenever there is a change in economic conditions.

By most measures, the residential sector remains in a state of equilibrium. On the demand side, the sector has been resilient despite several potentially negative trends. Even in the luxury segment, building activity has generally responded well to changes in underlying demand.

The outlook for the sector - in particular the mid-upper market, remains favourable with the future risk of overbuilding appearing limited as developers become increasingly cautious of potentially slower absorption rates.

Nevertheless, there are many evolving demographic and social trends that will offer opportunities for developers and investors in 2006. These include:

Continued growth in the Malaysian economy

Based on the limited historical data on residential property transactions, the trend over the past decade has implied a strong correlation between GDP and the transacted values of residential property (see chart).

Hence, with the Malaysian economy expecting a growth of 5.5 per cent this year (2005 estimate: Five per cent) and a private consumption growth of seven per cent (2005 estimate: 7.5 per cent), the sector will likely continue to experience growth - albeit on a more moderate scale, than the year before.

Stable unemployment rate

The country’s unemployment rate has settled at around 3.5 per cent over the past four years, after reaching a high of 3.7 per cent in 2001. This year, it is forecast to ease to 3.4 per cent, making it comparable to the pre-crisis 1991-1997 average of 3.3 per cent.

High savings ratio

At about 36.4 per cent, this high ratio provides the comfort of financial security, unlike the mid-1980s recession when the savings rate was just 27 per cent.

Young demographic profile

The population age profile of Malaysians provides much impetus for a sustainable long-term need for housing. According to the Department of Statistics, the median age of the population in 2000 was just 23.6, with those below 50 years old representing 88 per cent of all the people in the country.

Of this, some 30 per cent were between 25 and 44 years old, which is the age group of first-time homebuyers, upgraders, and investors. Furthermore, more than 36 per cent of the population is below 15 years old, suggesting that future demand for residential properties will continue to be firm.

Continued trend towards urbanisation

The proportion of the urban population rose to 62 per cent in 2000 from 51 per cent in 1991, reflecting promising prospects for property development in States such as Kuala Lumpur, Selangor, Penang and Johor.

Lifestyle changes will support demand in urban areas providing social and recreational amenities for single people and empty nesters who want to trade down from their larger landed homes. The dissatisfaction with sub-urban sprawl and traffic congestion, combined with concerns of higher cost of commuting, should further provide a new set of opportunities.

Commercial offices:Opportunities in vibrant CBDs

The Securities Commission’s release of new guidelines on Jan 3, 2005 for the setting up of Real Estate Investment Trusts (REITs) to replace the old rules in force since the mid-1990s was a significant landmark for the commercial property sector. The rebranded property trusts successfully revived investor interest in commercial properties and transformed traditional approaches and perceptions of the portfolio.

Positive market reaction following the listing of the country’s maiden REIT - Axis REIT - on the Bursa Malaysia’s main board on Aug 3, 2005, raising more hopes in real estate among property companies.

The largest REIT to be listed so far is Starhill REIT, with a total asset value of RM1.15 billion. It made its debut on Dec 16, with a star-rated line-up of properties including the JW Marriot Hotel, Starhill Gallery and Lot 10 Shopping Centre - all located in the upscale Bintang Walk retail precinct in Kuala Lumpur.

The launch of UOA REIT followed on Dec 13, with UOA Asset Management Sdn Bhd hoping to raise RM170 million from the listing exercise. Listed on Dec 30, the fund has an aggregate value of RM323.9 million, which is approximately the size of Axis REIT’s gross asset value of about RM350 million (including its latest two proposed acquisitions).

More REITs this year

Last year, property developers and owners such as Sunway City Bhd, GuocoLand (M) Bhd, Landmarks Bhd, Meda Inc Bhd, Tradewinds Corp Bhd, and Naim Cendera Bhd of Sarawak publicly expressed their interest in making forays into REITs.

In addition, following CIMB’s tie-up with Mapletree Capital Management Pte Ltd (a unit of Singapore’s State-owned investment company Temasek Holdings Pte) to set up a REIT fund, Maybank Bhd announced similar intentions to do so with CapitaLand Group, which is currently operating the largest REIT in Singapore.

The Malaysian Government too has decided to create a Bumiputera REIT with a fund size of RM2 billion (as announced in Budget 2006). Aimed at enhancing Bumiputera participation in the commercial property sector, Yayasan Amanah Hartanah Bumiputera will be chaired by the Prime Minister.

REITs - a temporary safety valve

There is no doubt that the markets for REITs are here to stay. First, the market infrastructure for the investment vehicle is seen to be better established than before. Second, investors are getting more knowledgeable and receptive of the REIT market and becoming more active than ever before.

The advent of this public capital market is likely to provide a safety valve for keeping excessive development of non-residential properties in check. However, it may not completely shield some types of properties or locations from possible overbuilding.

The inherent problems associated with developing real estate, such as the long construction lag which force developers to build for forecasted demand - indeed, a moving and very volatile target - can result in localised overbuilding. This is particularly applicable to commercial properties in high-growth markets, where forecast may be over-optimistic or demand may suddenly shift.

Demand for investment-grade offices

However, the overall outlook for commercial real estate remains favourable. Central business district (CBD) offices offer the best prospects for growth. On the other hand, investors and developers must be more selective about investments in suburban office properties.

For the former, thriving downtown areas still offer the brightest opportunities. A scarcity of investment-grade properties warrants new construction in some office markets. Driven by strong demand and rising rents, new office space construction will shift into high gear this year, increasing the risk of building activity getting ahead of demand.

Suburban commercial properties - in particular the single-tenant, built-to-suit office properties - are likely to sustain current rents and capital values. Speculative projects, especially those targeted at the retail investors’ market, will face increasingly greater risks as financing costs rise.

Commercial - retail: Demand-side risks

Despite strong construction, retail real estate in certain markets has managed to register respectable returns and high occupancies. The sector clearly owes its recent success to the penchant of the Malaysian young urban consumer to spend rather freely.

However, retail spending this year may face the possibility of slower growth for several reasons:

• Rising cost of consumer durables, stemming from higher petrol, transport and communications costs and utility tariffs;

• Rising interest rates, which will also eat into the consumer’s take-home income; and

• Volatile stock market which could eliminate the “wealth effect” on retail spending.

In addition to these demand-side risks, another issue that may possibly dampen the outlook for the retail sector somewhat is the huge amount of retail space that is being built and added to an already overbuilt market in some areas.

Much of the recent wave of new construction has been funded by those centres that so far have been performing exceptionally well, where there are long queues among interested retailers. This will cause many older centres to suffer from rapid obsolescence. In particular, those with wrong formats, dated appearance, deteriorating locations and poorly performing tenants will be the casualties. Overall, retail real estate will face the greatest risks from all fronts, compared with other property types.

Hotels and serviced apartments:A value play

The fundamentals that drive investment performance in the hotel sector have never been as strong as they have been until recently. The demand for rooms has been much greater than expected, with the sector appearing on track to continue to make profits through increases in average daily room rates and operating efficiencies.

Across markets, hotels - especially the luxury and upscale ones - have been investing significant amounts of capital to refurbish both their guest amenities and rooms. Without a major recession, this category of hotels in most markets will continue to perform well in the near future.

Serviced apartment investments, especially those managed by well-reputed apartment operators, will continue to perform well. Those in premium locations of high-growth markets may also benefit as high-quality locations and land become scarcer.

Industrial: More of an enabler

The outlook for the industrial sector is expected to be mixed, depending on the product type and location. Warehouse properties and distribution centres in areas well-served by a good network of roads and highways and easily accessible to both airports and seaports, and market centres, will remain popular and command attractive rents.

For as long as the country’s economy maintains its growth path, demand for industrial properties can be sustained at a reasonably healthy level this year.


Lim Lay Ying is managing director of Research Inc. (Asia), specialising in market research and consultancy for all facets of real estate development. Access past articles and more at www.researchinc.com.my. Contact: 03-2092 4966.