Private home market: a bullish uptrend?

THE BUSINESS TIMES' WEALTH ROUNDTABLE

Genevieve Cua, BT Wealth Editor, asks analysts whether the uptick in residential property sentiment is here to stay.

Eli Lee is Senior Investment Analyst, OCBC Investment Research. He heads the real estate equities team. He was previously an associate at Wellington Management Company, covering Asian conglomerates in the Emerging Markets fixed income team. He is an avid freediver and book collector.

Desmond Sim is Head of Research for Singapore and South East Asia, CBRE. He is responsible for monitoring and analysing trends in the office and capital markets, and manages the firm's database and research publications. He is a big fan of indie music and team sports.

Derek Tan is a Senior Vice-President and Head of Property Research for Singapore, DBS Group Research. DBS Group Research, frequently ranked among the top research houses in Singapore, was ranked No 1 Real Estate Team in Asia in the latest Asiamoney Poll. The same poll ranked Derek as one of the top five Best Real Estate Analysts in Singapore. He is an avid foodie and enjoys trying new dishes.

SINGAPORE private residential property has been in the doldrums in the last few years, but a pick-up in sentiment is evident in recent months. How sustainable is this?

Genevieve Cua: What is your outlook for Singapore residential property over a five-year horizon in terms of demand, supply and rental prospects? What are the positive or negative underpinnings of your view?

Eli Lee: Our base case forecast is for Singapore residential prices to remain flat in 2017 and to appreciate 3 to 8 per cent in 2018. Our forecast is underpinned by the two fundamental realities of demand and supply in the Singapore market.

On the demand side, buying interest from prospective home owners and investors has been healthy, particularly as monetary liquidity in the system remains ample. Transaction volumes, both in the primary and secondary markets, have improved this year and sales performances at recent launches have been encouraging.

While one cannot be certain about the trajectory of housing measures ahead, there is a meaningful likelihood that the worst of regulatory headwinds is behind us, now that existing curbs have successfully stabilised the market and private home prices have fallen by double-digit percentages from the last peak.

On the supply side, the elephant in the room is the high rate of physical home completions in Singapore, including public housing, which has contributed to rising vacancy rates and falling rents since 2014. This physical over-supply will continue to be a headwind for the market in 2017, but we expect the situation to balance out in 2018 as completions fall from an average of 48,000 units per annum over 2014-2017 to around 30,000 units in 2018, which will drive a recovery in private home prices.

In terms of overall unsold developer inventories, the situation appears benign. As at end-June 2017, the total inventory of unsold private homes in Singapore stands at 15,000 units, significantly below the nine-year average of 31,000 units.

Penalties under the Qualifying Certificates (QC) rules, which require all units to be sold within two years after attaining Temporary Occupation Permit (TOP) status, do pose concerns for projects which remain unsold and will incentivise developers to sell units more quickly, but we do not foresee fire-sale scenarios due to the penalties' manageable impact on generally healthy balance sheets in the sector.

As these fundamental realities of demand and supply play out over time, we believe a recovery in the Singapore property market is on the cards.

Desmond Sim: The Singapore private residential property market appears to be at a turning point based on the latest 2Q 2017 data released by the URA; the quarterly decline in the property price index has slowed to minus 0.1 per cent after 16 consecutive quarters of decline, the longest downward streak compared to the 13 quarters of decline from 2001. The decline in the rental index is slowing as well, with vacancy rates unchanged from the previous quarter at 8.1 per cent.

The supply of inventory is gradually being absorbed with unsold units dropping for the sixth consecutive quarter, while pipeline supply is diminishing post-2018. On the other hand, demand is coming back strongly, with the number of resale transactions at its highest since 2013. These dynamics point to a recovery in property and rental prices over the next few years, moderated by calibrated land sales by the government, existing cooling measures, and a weak economic outlook.

In addition to these favourable fundamentals, the recovery in prices will be supported by a few more years of dovish monetary policy from the US Federal Reserve, a strong Singapore dollar, as well as proactive regulation from the government. However, global indices are at their all-time highs a decade after the global financial crisis, China is trying to reduce its outbound flows due to over-leverage, and sentiment is clouded by geopolitical tensions from North Korea. A deterioration in any of these factors, or a black swan event would have a destabilising effect on both foreign and local appetite in the property market.

Derek Tan: We are positive on the outlook and forecast the residential market to see a 6-10 per cent rise in prices by 2019, with multiple catalysts for residential prices to head higher.

Property prices could rise 6-10 per cent in two years as volumes approach five-year peaks. Recent market indicators point towards a property market inflection in 2017 and an eventual rise in prices from 2018 onwards. In the first half of 2017, total property sales increased 46 per cent y-o-y. If the sales momentum continues, volumes will reach a five-year peak. In our analysis, we found that 94 per cent of home buyers in 1H17 are Singaporean households. A wildcard to a further acceleration in prices is when foreign buying returns, especially for homes in the Core Central Region.

Supporting a rise in the property prices, unsold inventories are at 16-year lows at 29,000 units. When compared against current transaction levels, we found that market absorption rate (ratio of unsold units and new sales) stands at 2.1 times and it is the tightest in the suburbs (Outside Central Region). Even if we were to include the more than 3,000 unlaunched new units from the recent government land sales (GLS) and en blocs, we believe the market can absorb them easily.

Winner takes all - S$14 billion in gross development value (GDV) up for grabs with a potential to reap more than S$1.4 billion in profits. Assuming developers achieve a 10 per cent profit margin on their projects, that could translate to an internal rate of return (IRR) of 9 per cent but returns could be as high as 40 per cent if pre-sales do well. As such, we expect developers to come out in force to bid for residential land and expect prices to continue inching higher in 2H17.

Genevieve: How sustainable is the current uptick in sentiment? Which segments of the residential property market are you most optimistic about and why?

Eli: We believe the current uptick in sentiment is sustainable, for three reasons.

First, residential rents will begin to recover in 2018. From 2014 to 2017, the increase in home completions exceeded the needs of Singapore's population growth, driving vacancy rates up by three percentage points from 5 per cent to 8 per cent. As a result, rents fell 13 per cent over the period.

This situation will reverse in 2018. Due to fewer launches in recent years, the annual rate of housing completions will decline by around 40 per cent over 2018 to 2020. This falls below the needs of population growth based on the government's projections, which will reduce vacancy rates and drive a rebound in rents.

Second, two major fears of real estate bears today - the risk of a recession and rising rates - are overwrought. With the global economy charting a reflationary path, the risk of a recession in Singapore over the near to medium term is low. The Chinese government has shown considerable success in engineering a soft-landing for its economy. In the major developed economies - the US, EU and Japan - signs of higher growth are being sustained by fundamen­tal improvements in the labour market and strengthen­ing household demand.

Central banks will likely remain cautious about rais­ing rates given the painstaking efforts taken to nurse the burgeoning recovery. With this in mind, the pace of rate hikes from the US Federal Reserve is expected to be measured, rising slowly from 1.25 per cent currently to 3.0 per cent in 2019. From historical analysis, the Singa­pore property market will take this in stride.

Third, a rising trend of collective sales tends to rein­force market fundamentals. After an en-bloc transaction, the process to vacate the original estate and complete the redevelopment typically takes four to seven years. Over this period, the physical stock of homes available for occupancy in Singapore is reduced. In the initial years of a rising collective sales cycle, more homes are taken out of the physical stock by en-bloc transactions than those added back in, exerting downward pressure on vacancy rates and boosting residential rents.

At the same time, those who sold their homes to developers through an en-bloc often enter the property market rapidly to re-establish their exposure, flush with new cash and borrowing headroom. Many also help fund home purchases for younger family members who may be subject to less stamp duties. This adds buyers into the market and increases demand.

In addition, developers typically launch new units for sale after one to two years. While there are usually more units in the redevelopment than in the original estate, they will be sold at significantly higher prices per square foot, which tend to drive up property valuations in the area.

As at mid-September 2017, total collective sales in Sin­gapore have hit S$3.1 billion, already far surpassing the S$1.0 billion in 2016, and we expect this trend to continue.

We are most optimistic about the high-end residen­tial segment which - being the most dependent on for­eign demand - has suffered the brunt of existing curbs, particularly the additional buyer's stamp duties (ABSD) which imposed 10 per cent and subsequently 15 per cent upfront duties on foreigner home purchases.

As a result, the premium of high-end median psf prices over the mass-market is now 62 per cent - near a 10-year low and more than one standard deviation below the average level of 85 per cent. Given that the deepest relative value can be found in this segment, we expect high-end home prices to outperform those in mid-tier and mass-market as the market recovers ahead.

Desmond: On the back of recovering demand and diminishing supply, the current uptick in sentiment should be sustainable barring any external events, with the greatest optimism surrounding the luxury segment. With prices having adjusted to more acceptable levels, demand has revived in this segment since 2016, while the supply of luxury homes will fall beyond 2017. Luxury residential prices have remained relatively stable and will continue to remain so. Developers of luxury developments have deep pockets and have the financial muscle to keep prices stable.

Adding to that, the limited supply of new luxury pro­jects has upped the premium on luxury prices. With a strong growth story, Singapore's luxury market is still bang for the buck, and will continue to attract foreign investors from Hong Kong, China, and Indonesia who see the value of Singapore's luxury residential market.

Derek: We believe that we are only at the early stage of the current property market upcycle. Next year, we expect to see close to 3,000 displaced households from the en-bloc sites looking to purchase a new home and they will drive transactions in the secondary market.

For a more sustainable recovery, we will need to see an improvement from the HDB resale market which will then drive higher transaction volumes and eventually prices. The current price to income ratio of close to six times and strong household balance sheets will drive increase in home prices.

We believe that the luxury end of the residential market (homes in the Core Central Region) offers good value especially when the number of foreigners has not returned in a big way to the Singapore market. In addi­tion, relative pricing in the luxury end of the market (Core Central Region) is still at a 34 per cent difference to homes in the suburbs (Outside Central Region) against a 10-year mean of close to 50 per cent.

Genevieve: Please share with us the developer stocks on which you have the highest conviction "overweight" or "buy" rating, and why.

Eli: In the Singapore developer space, our top buy-rated stock picks are City Developments Ltd and UOL Group Ltd.

Both developers enjoy substantial exposure in terms of domestic land-bank and have excellent track records in the Singapore residential space. As a result, they stand to benefit significantly from the upturn in the residential market.

Admirably, the management teams in both com­panies have also exercised considerable discipline in acquiring land at accretive prices through the property down-cycle. For example, back in October 2016, UOL completed an en-bloc acquisition at Raintree Gardens at around S$800 per square foot - a significantly lower price per square foot than subsequent prices paid for nearby sites in the Bidadari estate locality at government land tenders.

Both developers also hold firm balance sheets with healthy gearing ratios. Despite slower home sales in recent years hanging over earnings over the near term, they benefit from significant recurring income derived from their sizeable portfolios of commercial and hotel assets. These income streams help anchor their dividend payments, currently in the range of 1 to 2 per cent yield, which shareholders can enjoy as they hold for long-term price appreciation.

Derek: City Developments (CDL) and UOL Group are our preferred picks given their relatively higher exposure in the residential sectors.

We remain buyers of CDL despite the recent share price rally, on expectations that CDL's share price remains on an upward trajectory supported by positive catalysts coming from good sales momentum in 2017. We maintain our "buy" call on CDL with a higher target price of S$12.63 based on a parity to RNAV (15 per cent discount previously) or an implied 1.2 times P/NAV.

With the Singapore property market in the nascent stages of recovery, CDL is largely seen as a proxy for Sin­gapore residential market and has historically traded up to 1.2 to 1.3 times P/NAV.

While CDL is largely the preferred stock of those who have gradually turned positive on the Singapore mar­ket, we believe that further upside surprises will come on the back of: (i) better than projected sell-through rates at remaining unsold and unlaunched inventories in Singapore; and (ii) stronger than projected sales at its international portfolio, mainly in the UK. Our estimates are generally higher than consensus on the back of our positive stance towards the group's ability to drive good sales across its projects.

The key risk to our view is a decline in residential prices in Singapore. As CDL is a proxy for Singapore's residential market, a deteriorating operating environ­ment will cap share price performance.

UOL's valuations are still attractive. We maintain our "buy" rating as it is trading at an attractive valuation of about 0.7 times P/NAV, which is at the lower end of its historical range. The successful launches of recently purchased land sites in the en-bloc market will be re-rating catalysts. We have lifted our target price to S$8.73 based on a narrower 20 per cent discount to RNAV of S$10.90.

UOL reported a 4 per cent rise in earnings to S$80.3 million, in line with expectations. Management believes the Singapore property market has stabilised, and UOL has been more aggressive in landbanking than the other large cap developers. Key positives from the results were: (i) revenue growth from all divisions, and (ii) stable portfolio occupancy rates. The group has recently acquired more landbank, offering longer term income visibility.

The downside risk to our projections is if residen­tial sales are slower than expected, or if commercial properties and hotel operations are impacted by slower-than-projected growth in rental/room rates. W