Property (CIMB Research), ‘overweight’ maintained

2009 Property Market Report: Residential the shining star
* Maintain OVERWEIGHT. The key points we picked up from the recently released 2009 Property Market Report are 1) property transactions did take a hit as the economy turned down but the impact was far more muted than expected, 2) residential property prices bucked the economic downtrend and held firm, and 3) occupancy rates for commercial properties, particularly office space and hotels in the Klang Valley, were still weighed down by weak demand and increasing supply. Overall, the performance in 2009 reinforces our preference for property developers over property investment companies. We maintain our OVERWEIGHT stance on the property sector as underlying fundamentals are improving, particularly for residential properties. E&O remains our top pick in the sector while SP Setia is our preferred core holding. Key re-rating catalysts for the sector are a continued pick-up in launches and sales as well as a rebound in earnings.
* Residential transactions held up. In line with the 1.7% contraction in real GDP in 2009, the number of property transactions fell 1% to 337,830 while the value transacted fell a steeper 8% to RM81 billion. Of the big-3 property markets in Malaysia, Johor saw the biggest drop in the value of transactions at 24%, followed by Penang at 10%. The Klang Valley was the most resilient, with a fall of only 7%. By property type, residential properties surprisingly bucked the general trend with a 1% gain in transactions to RM42 billion. For 2010, we expect transaction value for the overall property sector as well as the residential segment to expand 10-15% to a new high.
*  House prices rose 1.5% in 2009. The residential property sector in Malaysia performed commendably in 2009. With the exceptions of the Klang Valley (Kuala Lumpur and Selangor) and the states of Pahang and Perlis, all states posted house price gains ranging from 0.5% to 8.5%. The overall price index for the country also rose 1.5%, which bucked the economy’s contraction, partly because the supply of homes inched up just 2.4% last year. This is the slowest growth since 1997 and a drastic slowdown from the 4% to 12% range seen since 2001. As we are projecting real GDP growth of 4.8% in 2010, overall house prices should also firm up by around 4% to 5% this year.
* Commercial occupancies softened. The 2009 performance of the commercial properties in the Klang Valley was mixed as the occupancy rate fell 0.9 percentage points to 83.7% for office space and 2.5 percentage points to 63.2% for hotels but improved a marginal 0.4 percentage points to 86.9% for retail space. The prospects for office space and hotels in the coming years will continue to be difficult due to substantial new supply. We are less concerned about the retail space market despite considerable new supply in the pipeline as the dynamics of the sector are more location and shopping mall specific and the sector is less homogeneous.
Transactions
The recently released 2009 Property Market Report (PMR) revealed a mixed picture.
In line with the 1.7% contraction or real GDP in 2009, the number of property transactions fell 1% to 337,830 while the value transacted fell a steeper 8% to RM81 billion. Of the big-three property markets in Malaysia, Johor saw the biggest drop in the value of transactions at 24%, followed by Penang at 10%. The Klang Valley was the most resilient, with a fall of only 7%. By property type, residential properties surprisingly bucked the general trend with a 1% gain in transactions to RM42 billion. The biggest drop in transaction value came from development properties or raw landbank, which fell 46% and accounted for 87% of the decline in value traded for the entire sector.


Residential
The residential property sector in Malaysia performed commendably in 2009. With the exceptions of the Klang Valley (Kuala Lumpur and Selangor) and the states of Pahang and Perlis, all states posted house price gains ranging from 0.5% to 8.5%. The overall price index for the country also rose 1.5%, which bucked the economy’s contraction. Even the other two major property markets posted healthy house price appreciation of 5.5% in the case of Johor and 4% in the case of Penang. Sabah was again one of the best-performing markets for residential properties. In fact, it was the top performer in terms of average price appreciation over the past 10 years (see Figure 7).




It is interesting that house prices in Selangor have underperformed the national average based on the 10-year average appreciation. Its performance is, in fact, the worst after Johor. Johor’s poor performance is not a surprise given the massive glut and availability of huge landbank for development. We suspect that the weakness in house price gains in Selangor resulted from intense competition among the developers and the prevalence of high-rise developments where prices have been relatively stagnant in the past 10 years. The price performance for high-rises in Kuala Lumpur is the second worst performance by residential-type properties in Klang Valley. It is the greater scarcity of land in the Federal Territory that has kept appreciation higher than that for high-rises in Selangor (see Figure 9).
Over the past decade, landed properties have fared much better than high-rises in the Klang Valley, which only began to catch up in recent years when condo prices in the KLCC and Mont’ Kiara areas rose substantially. Another interesting point is that the strongest gains were racked up by the most expensive properties in the Klang Valley, i.e. bungalows and semi-Ds. This indicates a widening gap between affordable properties (terrace houses and apartments) and upscale properties. Also worth pointing out is that terrace houses in Kuala Lumpur have appreciated more in percentage terms than even bungalows and semi-Ds in Selangor.
In terms of supply, the supply of completed residential properties in 2009 increased at the slowest pace since 1997. This is a positive trend for prices. The supply of newly completed residential properties in Malaysia rose only 2.4% in 2009, a drastic slowdown from the 4% to 12% range seen since 2001. New supply in the Klang Valley in 2009 was only 1.9%, lower than Johor’s 2.1% and Penang’s 4.3%. Within the Klang Valley, Selangor’s supply growth was higher at 2% compared to Kuala Lumpur’s pedestrian 1.3%, which was the lowest in the country. The three states with the highest growth in supply in 2009 were Sabah at 4.5%, and Sarawak and Penang at 4.3%. Their strong supply growth somewhat corresponds with their strong house price appreciation in recent years, which could have attracted more development.
In terms of unsold stock in Malaysia, the total fell a significant 14% in 2009 to 65,406 units. Selangor and Johor saw a drop in overhang but Kuala Lumpur and Penang recorded a bigger overhang. While the overhang to needs ratio for properties in Kuala Lumpur appears to be high at 100% compared with the national average of 51%, we are not overly concerned as the authorities have been trying to increase the population in the Kuala Lumpur city area to liven it up at night and during weekends. The proliferation of condominiums in KLCC and Mont’Kiara should help increase the population in Kuala Lumpur and accelerate population growth. In terms of the overhang to total stock, Kuala Lumpur’s ratio is 1.7%, lower than Johor’s 2% but slightly higher than the national average of 1.5%. More importantly, the overall ratio for the Klang Valley is only 1.1%, much lower than the national average. We envisage a trend where residents in Selangor are increasingly attracted to quality high-rise residential products in strategic locations in Kuala Lumpur.
Office space
Overall occupancy rates for office space in the Klang Valley softened last year for the second year in a row. The drop could be due to the weakened economic environment. Office space occupancy in Kuala Lumpur and Selangor slipped as new supply totalling 4.2 million sq ft outpaced demand growth of 2.5 million sq ft. Supply growth may have moderated from 4.6 million sq ft in 2008 and 5.4 million sq ft in 2007 but remains high in absolute terms. Overall occupancy for the Klang Valley slipped 0.9 percentage points to 83.7% in 2009, after falling 1 percentage points to 84.6% in 2008. In line with the fall in occupancy rates, rental rates also came under pressure (see Figure 13). Newly completed office buildings are taking longer to fill and building owners have had to lower rates to attract tenants. Occupancy rates in the Klang Valley are among the lowest in the country, better than only Johor and Penang (see Figure 14).
Retail space
The Klang Valley market for retail space fared better than the office market as there was a marginal contraction in supply, which lifted occupancies by 0.4 percentage points to 86.9%.
Kuala Lumpur’s occupancy rate edged a marginal 0.1 percentage points lower to 83.9% while Selangor’s occupancy rate improved 0.9 percentage points to 89.4%. In terms of supply, Kuala Lumpur’s supply shrank 1% while Selangor’s supply eked out a 0.4% growth.
Demand, on the other hand, dipped 1.2% in Kuala Lumpur but grew a relatively brisk 1.4% in Selangor. Unlike the office space market in the Klang Valley, retail space fared better in terms of occupancy rates compared with its peers in other states. In fact, occupancy rate in Selangor in 2009 was the second highest in the country and was far better than the two worst markets, which were again Johor and Penang.
Hotels
The average occupancy rate for hotels in the Klang Valley pulled back 2.5 percentage points to 63.2% in 2009, continuing 2008’s 5.9 percentage points collapse to 65.7%. The occupancy rate in Kuala Lumpur fell from 68.8% to 65.9% while in Selangor, it dropped from 57.2% to 57.2%. Although the total supply of rooms in the Klang Valley dipped 0.8% to 43,789, demand was even weaker, falling 3.4%. This is unexpected given the 7% rise in tourist arrivals to 23.6 million in 2009, the highest ever (see Figure 20). One reason could be that Klang Valley hotels cater largely to business travellers rather than tourists.



Outlook
Residential property prospects good
We are not surprised that total transaction value fell in 2009 as there is a strong correlation between property transactions and the broad economy. When the 1997/8 Asian financial crisis struck, the value of property transactions plunged 48% in 1998. It took seven years before transaction values in Malaysia surpassed the 1997 high of RM53 billion. That said, the contraction in volume and value of properties transacted in 2009 was lower than our 20% to 30% expectations. As the global financial crisis appears to have a much more muted impact on the property sector than expected, we believe the rebound in 2010 will be more moderate and unlike 1999’s 23% to 30% surge. We expect transaction value growth for the overall property sector as well as the residential property segment to be closer to the 10-year average of 10% to 15%.
We also expect residential property prices to firm up in 2010. Historically, the prices of residential properties in Malaysia and the Klang Valley moved in tandem with the economy but with a slight lag. During the 1997/8 Asian crisis, property prices pulled back more than the economy. We were partially right in our prediction last year that residential property prices in 2009 would fall less than the economy’s contraction as the overall Malaysia house price index actually increased 1.5% while real GDP fell 1.7%. But overall house prices in the Klang Valley performed in line with the economy and also declined 1.7%. As we are projecting real GDP growth of 4.8% in 2010, overall house prices should also appreciate 4% to 5% this year.

Although the affordability index for Malaysian residential properties has slipped a bit due to the drop in per capita income in 2009 and the recent hike in interest rates, it remains close to its best ever (see Figure 23). This is because house prices in Malaysia as well as the major property markets including the Klang Valley, Johor and Penang, have lagged behind income growth (see Figure 24). The lag became more pronounced after the Asian crisis.

Property developers have been doing brisk trade in recent months. SP Setia recently revised its FY2010/10 sales target from RM1.6 billion to RM2 billion while Mah Sing sold over RM500 million worth of properties in 1Q2010, more than half of its full-year target in a quarter of the time. Buyers also appear to have shrugged off concerns over the 5% real property gains tax announced in October 2009 as SP Setia’s monthly sales since then have been robust. Property sentiment appears to have been buoyed by the economic and stockmarket rebound. Property buyers also seem to be more concerned about potential inflationary pressures and are searching for inflation hedges.
Commercial property prospects mixed
The prospects for commercial properties, however, are less rosy due to the substantial amount of supply coming onstream. This is particularly true for office space and hotels, as evidenced by the weakening occupancy rates even in 2009. In the Klang Valley, the future supply to existing stock ratio is the highest for hotels at 54% and the lowest for industrial properties at 11%. The future supply to existing stock ratios for residential, shophouse, office and retail properties range from 21% to 26%. As retail occupancy rates in the Klang Valley are relatively healthy and property specific, we are not perturbed by the considerable new supply. The successful major malls such as Suria KLCC, Megamall, Sunway Pyramid, 1Utama and Sungai Wang have their own specific niches that can easily be defended. However, the office space market is more homogeneous and the new supply will put a cap on rental rates and capital appreciation. We are most concerned about the Johor retail and office space markets as there is massive new supply in the offing.
Valuation and recommendation
The key points we picked up from the recently released 2009 Property Market Report are 1) property transactions did take a hit as the economy turned down but the impact was far more muted than expected, 2) residential property prices bucked the economic downtrend and held firm, and 3) occupancy rates for commercial properties, particularly office space and hotels in the Klang Valley, were still weighed down by weak demand and increasing supply. Overall, the performance in 2009 reinforces our preference for property developers over property investment companies. Developers stand to benefit from the healthy residential property sector and rising house prices. Property investment companies will be weighed down by weakness in rental rates due to relatively high vacancy rates and substantial new supply.
We continue to OVERWEIGHT the property sector, particularly the developers. KLCC Prop remains our sole Underperform recommendation as the stock is a property investment company and will benefit the least from the strong pickup in demand for launches and rising residential prices. Moreover, the dividend yield offered by KLCC Prop of 4% to 5% trails far behind those of REITs (see Figure 27). The performance of property stocks YTD has been lethargic as they have been dragged down by investors’ fear of rising interest rates and the new accounting policy IFRIC 15 which requires developers to recognise profits on development properties upon delivery of vacant possession rather than the progressive recognition currently practised.
The price weakness contradicts the underlying performance of developers, which has been very encouraging. It also goes against the traditional outperformance that property stocks enjoy in stockmarket upswings. We view the weakness in prices of property stocks as a buying opportunity. We value most property companies based on RNAV instead of earnings and the new accounting policy will have little impact on our target prices. Key re-rating catalysts for the sector are a continued pick-up in launches and sales as well as a rebound in earnings.



We maintain our earnings forecasts and OUTPERFORM recommendations for all the property developers. Valuations of property stocks remain undemanding. The six property companies under our coverage are trading at an average 38% discount to RNAV and only 7% premium over NTA. E&O remains our top pick in the property for its liquidity and beta. The stock, however, has been a disappointing underperformer this year as both domestic and foreign investors remain lukewarm on property stocks.
Curiously, the worst-performing stocks under our coverage include E&O and Hunza Prop, both of which have significant exposure to the robust Penang property market and recently made cash calls. Investors appear to be more comfortable with private placements as Mah Sing undertook one but its share price is one of the best performers YTD. SP Setia continues to be our core holding in the sector for its size and management. The company is actively scouting for landbank domestically and regionally and has the balance sheet to acquire strategically located sizeable land from the government.