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Office, retail recovery may boost shophouse segment

Growth of CBD co-working space may siphon office space demand from shophouses, but small firms still like them.

The conservation shophouse market has seen several high-priced transactions in the past six months and is expected to continue attracting buying interest given limited supply and interest in this asset class by foreign buyers as well as property funds.

THE private residential market enjoyed the limelight in 2017 with sales increasing and prices bottoming out. The revival of the en bloc market also fuelled the optimism as developers shored up land banks in anticipation of price increases amid a shrinking unsold inventory.

Although the residential market looks promising, the current exuberance has also drawn repeated warnings from the government which has raised the spectre of possible additional cooling measures which may increase acquisition costs and lower the overall investment return.

In addition, with the punitive additional buyer's stamp duty (ABSD) still in place, are there any other real estate investment opportunities with attractive cashflow and potential capital appreciation to generate return?

We believe there will be exciting opportunities in the shophouse segment in the coming years. Fuelled by demand from high net worth individuals (HNWIs), family offices and boutique family funds, shophouse transaction values and volumes rose in 2017. With recovery on the cards for both the office and retail markets in 2018, shophouses are well poised to reap the benefits from rental growth in these sectors.

What are shophouses?

Built between the 1840s and 1960s, shophouses are typically narrow, long terraced houses with varied facades, creating an attractive unified streetscape. They are mementos of Singapore's historical and cultural heritage.

Typically two to three storeys tall with floor sizes ranging from 1,000 to 1,500 sq ft, shophouses are attractive to small-to-medium businesses that seek an "exclusive and exotic" feel coupled with a strong identity. These include new startups, businesses in the creative industries, and food and beverage (F&B) outlets.

Due to their historic significance, many shophouses are placed under conservation status, with the strictest conservation guidelines placed on shophouses located in historic settlements in Chinatown, Tanjong Pagar, Boat Quay, Kampung Glam and Little India. For example, shophouses in historic districts have to be fully retained and restored, so no rear extension is allowed and only internal asset enhancement is permitted. According to the Urban Redevelopment Authority, there are over 6,500 conserved shophouses located all over Singapore.

Shophouse sub-markets

Shophouse clusters can be classified into two main submarkets. CBD shophouses are located in areas such as Chinatown, Tanjong Pagar, Upper Circular and Boat Quay, while the rest are located outside the CBD in areas such as Kampong Glam, Little India, Balestier, Geylang, Joo Chiat and Tiong Bahru.

Most CBD shophouses are located in historic districts and governed by strict conservation guidelines. Such conservation shophouses are usually deemed as core assets due to their central locations, historic values and stable cashflows. Intrinsic values can be raised through asset enhancement initiatives, such as lift installation or refurbishment. Boutique real estate funds, family offices and HNWIs are often on the lookout for such opportunities in this submarket.

Shophouses located outside of the CBD are governed by less strict conservation guidelines. Investors can further increase their value by enhancing the rear extension or through a complete redevelopment.

Not all shophouses are conserved and may be completely redeveloped. For example, Macly Capital acquired a row of single-storey shophouses at Telok Kurau for S$35.5 million, and outline planning permission has been granted to redevelop the site into a mixed development with seven commercial shops and 46 residential units, according to media reports.

Notably, Kampung Glam could be an upcoming hotspot for shophouses. It lies just on the fringe of the CBD and is poised to benefit from the rejuvenation of the vicinity given the completions of the Duo and South Beach integrated developments as well as the Downtown Line. The expected increase in pedestrian footfall should add more vibrancy to the area, underpinning rental growth there.

Furthermore, Kampong Glam has been designated to undergo a digital makeover, as part of the government's initiative to transform the retail sector. A slew of initiatives could be in the works, such as Wi-Fi hotspots, e-commerce strategies and data analytics for merchants.

Anecdotally, HNWIs have been quietly picking up these units. Units with current F&B approved use are highly sought after as the authorities have stopped giving out any new F&B licenses in the area due to concerns over traffic congestion.

Shophouse demand rising

Unlike the private residential market which remains encumbered by heavy acquisition taxes such as the ABSD and seller's stamp duty (SSD), the shophouse market has been largely shaped by market forces.

For shophouses, there is a goods and services tax (GST) of 7 per cent, but shrewd investors are able to circumvent the GST payment by purchasing through a GST-registered company.

However, for shophouses which have an attached residential quarter, ABSD is still payable for the residential quarter. Investors will have to pay ABSD on the residential portion and GST for the commercial portion.

Demand for shophouses have picked up in 2017, with 148 shophouse deals concluded, an increase of 38.4 per cent over 2016. Nonetheless, this remains substantially below volumes seen between 2010 and 2012, when on average, around 280 units were transacted annually.

A price gap between buyers and sellers has led to limited activity in the shophouse market. The current stock of shophouses is tightly held by funds or HNWIs who are in no hurry to sell unless a sufficiently high premium is offered.

Nevertheless, opportunistic deals such as adjoining units of shophouses occasionally come onto the market as current owners look to redistribute funds or cash out after a long investment cycle.

The median price for shophouses peaked at S$3,824 psf (on land area) in 2014, and has since fallen 13.7 per cent to S$3,301 psf in 2017. The fall in prices can be attributed to a pull-back in demand after the implementation of the total debt servicing ratio (TDSR) framework which surfaced affordability concerns in the market.

Still, savvy investors have managed to reap a tidy profit in the shophouse segment despite the market slowdown.

For example, a freehold shophouse unit in the Chinatown/Tanjong Pagar area was bought in 2013 for S$6.2 million. Subsequently, the unit was resold in 2017 for S$9.1 million, representing a profit of 47 per cent over four years. This is testament to the capital appreciation potential and value stability of shophouses.

Rental performance

Overall shophouse rents are strongly correlated with office and retail rents.

Though overall office rents have started to recover in 2017, retail rents remain soft. As such, shophouse rents have been sliding for the past three years.

CBD shophouse rents have held up better due to their central location which attracts relatively higher footfall. The trend is flight to quality as retailers favour localities with strong pedestrian footfall.

CBD shophouse rents fell only 6.1 per cent over three years, compared to outside-CBD shophouse rents which fell by 9.9 per cent over the same time period.

The underlying demand for shophouses however remains strong, given the scarcity and potential for capital appreciation. In addition, foreign demand for Singapore properties is expected to rise, given the glowing prospects for investing in Singapore real estate.

According to the Emerging Trends in Real Estate Asia Pacific 2018 report by Urban Land Institute and PricewaterhouseCoopers, Singapore property has gone from near the bottom in investment prospects within the Asia-Pacific region to third place.

Additionally, the shophouse market remains unencumbered by cooling measures and is expected to attract significant foreign interest in 2018.

The expected recovery in the office and retail markets will further bolster the appeal of the shophouse market given its flexibility of use.

Grade A office rents tracked by Cushman & Wakefield Research is expected to increase by 10 per cent in 2018, after rising 6.6 per cent in 2017.

Though the fast expansion of co-working space in the CBD may siphon off some office space demand from the shophouse market, small businesses which prefer the privacy and visible frontage may still be attracted to this segment as an alternative to office buildings.

Furthermore, with improving retail sales and higher tourist arrivals amid a more positive economic outlook, retail rents are poised to stabilise and recover in 2018. This will bode well for shophouses, and prices could reach greater heights in the years to come.

  • Ms Li is head of research and Mr Wong is senior manager of research at Cushman & Wakefield Singapore

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