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Monday, July 21, 2008

A frank assessment of property & construction

According to census only 5% of households in the country have a monthly income of RM10,000 or more. You would think the figure was a lot higher judging from the number of property launches over the last 2 years with condos, semis and bungalows selling for over RM1mil.

If you bought properties that are worth more than RM1mil, you’d better be living in them when they are completed.

The recent fuel price hike coupled with higher cost of living and inflation may require a sober assessment of the local property and construction sectors.

There are about 4 -5 million households in the country, so we are talking of just 200,000 to 250,000 households with income of more than RM10,000 a month.

A property purchase of RM1mil on a 30-70 deposit-loan ratio would be staring at a RM700,000 mortgage. That would be a monthly payment of RM7,000 - RM9,000. Even if you bring that down to RM400,000 it is still RM3,500-RM5,000 a month.

Hence one can safely conclude that it’s a market for rich folks and foreign buyers mainly. Rich folks being those who can put up all cash or 50% deposit hoping for a nice fillip in the near future.

According to the Masters Builders Association of Malaysia, building material cost for local contractors have risen by 25% on average since January this year. Following the recent electricity tariff hike, they should be looking at another 5%-10% hike in the coming months.

Coffee shop talk has it that contractors are already putting requests for price variations of a 30%-40% hike on the original contract.

Over the last few weeks more than 200 contractors have turned down letters of award for government projects. Some are asking for mutual termination.

Let’s look at some building material cost items:

Sand (washed)/t: 2006 24.00 / Q108 27.00 / June08 34.00

Readymix Concrete 40 M3: 2006 152.00 / Q108 186.80 / June08 234.00

Re-bar High Tensile/t: 2006 1,855.00 / Q108 3,169.00 / June 08 4,050.00

Property companies have been jumping on the super luxury market as the trend and sentiment were on their side. The huge success of casinos in Macau followed a very spectacular property boom in Singapore triggered by the IRs over the last 2 years. Hence some spillover effect is understandable.

Currently property prices in Asia-Pacific is still high but largely flat in recent months. The proverbial stuff has not hit the fan as yet. The wait and see attitude is masking grave dangers.

The big fallacy is to see property companies reporting enormous profits. Do bear in mind these are profits booked for the past 12 months.

Naturally developers would be the last people who would want to come out and sound the alarm bells. Many property companies in Asia-Pacific have delayed their IPOs over the last 6 months. These are the alarm bells.

We have to remember that property affordability and property speculation have a high correlation to local stock markets performance. In particular, it is more prevalent for Asia-Pacific because we tend to have a large portion of our GDP being listed, plus the fact that Asians prefer to do direct investments themselves.

Just look at the equity markets from 2005-2007 and note the markets’ performance. Now look at the markets’ performance over the last 6 months. The doldrum is only just working its way into the financial economy.

Looking ahead, we will still have firm commodity prices, high inflationary expectations and likely higher interest rates – all not exactly friendly to stocks or property markets. Enough said.

In fact the real demand in the market place is for properties between RM300,000 to RM700,000 which has been sorely lacking. Even semis in Balakong and Rawang are nearing the RM1mil in new launches. It all boils down to affordability, and that’s the affordable range.

If you had bought properties that are worth more than RM1mil, you’d better be living in them when they are completed.

Ask anyone in property about the price for concrete and steel bars, and you will get a good idea of the huge jumps in construction and material costs. All things being equal, higher material cost should mean that your existing property should be worth a lot more as the replacement cost has gone up significantly.

If you bought 12-24 months ago, technically speaking your house is worth a lot more based on higher building materials’ cost alone.

Why then is the property market flattening out? When things dictate that property prices should move higher, but it doesn’t, then something is very wrong. It’s an old adage but worth repeating here (for property and equity investors): If something that is supposed to go up doesn’t, it is very likely to go down.

Sub contractors are now more willing to give up on the jobs secured, even paying the penalties and giving the jobs back to the main con because cost of building materials have gone up so much that they will be making losses if they go ahead. Just look at the run up in billing estimates for the second Penang bridge and you will have a good idea what we are dealing with.

For the super luxury market, probably less than half will be tenanted if at all. One can expect more to come back onto the market place in the coming months even though the replacement cost for these properties are actually higher.

The merry-go-round has stopped for super luxury items. Just witness the property markets in Singapore, Hong Kong, Thailand, Indonesia, China and even Australia.

The only sub-sector that may hold up well might be commercial buildings but that’s largely due to under-investment the few years following the Asian financial crisis of 1997.

As things stand today, just in Selangor alone there are already 140 abandoned projects from the previous cycle, involving the 47,000 odd units worth RM2bil. The huge cost run up will increase the likelihood of more new abandoned projects.

We Asians tend to view property investments differently. We tend to do it with minimal discussions with friends or relatives, as if its a crime to let others know that we are buying properties.

Maybe people will think we are rich, or too rich. In the end we end up discussing property investments with property agents, and reading tomes from property magazines. Just note the number of new property magazines launched over the last 2 years. After all, this is probably the most important financial decision we make in our lives.

The probable consequences in coming months

· Properties having sold 100% off the plan will see some of the developers starting to lose money if they are less than halfway through their projects as they may not have secured the building materials cost budgeting.

· Some smaller developers will be hit even harder and there will be more abandoned projects. Better to run than to continue the project. Developers cannot really go back and ask buyers to pony up another 30% to their purchase price, or can they?

· A substantial portion of the economic vibrancy in Asia-Pacific over the last 3 years has been due to strong property prices. A similar contraction effect will happen if things slow substantially in the property and construction side.

· Luxury properties will see at least a 15%-20% easing in the coming months even though the holding power is stronger. 15%-20% is about the loss that speculators are willing to take going forward.

· Real affordability is between RM300,000 to RM700,000. Anything above that is a different market, but they will still be affected. Completed units will have to be left empty or be rented at cut-rate prices. Maybe we can rent a RM1.5mil house in a gated community at RM3,000 ? who knows.

· Affordability is a function of outlook on inflationary expectations as well, and that’s not looking good

· Government construction projects will have to be revised higher to be viable or else the successful bidder will just walk away, even with penalties. Construction spending will rise in the coming budget but not in actual number of projects. Just accommodating the higher costs alone will move the budget a lot higher.

· Developers who sold 100% off the plan over the last 12 months may now be looking at making losses just to complete the projects.

· Coming months: a slowing US economy; higher inflationary expectations; commodity prices to stay firm; global equities under pressure.

· Rental market is a lot better in Hong Kong and India, showing a preference to defer property purchase. Expect that trend to be replicated in Singapore and Malaysia as well.

· While Asia-Pacific has weathered the US sub prime implosion well enough, the recent Vietnam implosion has rattled some feathers of regional developers.

· Be prepared for margins destruction, projects disruptions and scrapped/deferred projects.

Things we need to do now

· Lower your leverage and borrowing substantially, even if it means making some loss.

· By lowering your leverage, you are basically making it available at a future point in time to capitalise on probable better opportunities in stocks and property.

· Re-evaluate your property portfolio, be careful if there are yet to be completed properties you have bought.

· Be very wary of buying from smaller developers as the risk quantum has increased substantially.

· The state and federal government should start imposing adequate “capital requirements” for existing projects and new projects. Don’t wait till they abandon the projects. It is a lot harder to revive once abandoned.

· Think about the potential jobs constriction within the property and construction market place and plan your policies to mitigate those effects on the broader economy.

· Even developers with overseas projects may not be immune unless the rise in material cost has been factored in fully. Even if they were factored in, a 50% jump in cost may make many of these projects unviable. Only places such as the Middle East countries swishing in petrodollars can maintain the aggressive infra spending plans over the next 1-3 years.

· The economy may hold up a lot better than the general population as oil and gas receipts and plantation receipts will be positive. Generally speaking the general public’s wallets does not have a high correlation to oil or CPO prices, if there is even a correlation at all.

· Authorities should only allow build-and-sell developers over the next 3 years. As consumers, buying from the secondary market place would be a much better option than off the plan.

· A three-year contract in the Middle East with lucrative terms on a construction related job should look a lot better now.

· The government should defer the big projects which may not be the priority now. Instead it should spend more on Klang Valley’s transportation system.

By The Star (by S.Dali) (Article posted on 20 July'08)

S Dali is a pseudonym. He is an ex analyst/fund manager and active blogger. ( who says he is too young, too old, too sarcastic, too dark, too funny, too charismatic, too poor, too Cantonese, too Malaysian, too frank, ...too bad ..

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