Stock Picks – Property Sector – September 2010

TERRACE HOUSES SOLD FOR RM1M! BUYERS CAMP FOR 10 NIGHTS TO BUY A NEW HOUSE! HOMES BECOMING TOO COSTLY FOR THE AVERAGE MALAYSIAN! These are just some of the headlines that in no small way reflect a recent real estate phenomenon characterised by spiraling property prices and Malaysians’ thirst for newly launched houses. The aim of this report is to help investors understand the real estate environment we are living in, what is likely to happen in the future and how to profit from this ever-dynamic real estate sector.

The age of great volatility. Investors should recognise that there is a linked sequence of events that has led us to where we are today. The 1950s’ Baby Boomers have become more risk averse in their investments since 2003/04. As they approach retirement, they would divert a significant portion of their wealth into savings and traditionally perceived defensive asset classes such as real estate. As a result, the banks have been sitting on massive amounts of liquidity and have since been progressively loosening their credit expansion by lending generously to these baby boomers. Consequently, the collusion between demography and the banks has created a period of increased volatility in the real estate market in recent years by nurturing a ‘culture’ of speculation in the real sector. This helps to explain why the 2003/04 mass housing boom barely lasted for 2 years and how its swift collapse became the prelude to the 2007/08 high-end condos boom when liquidity was forced to seek a new home. The high-end condos boom, however, also did not last long and in the aftermath of its implosion in 2009, the system is still flush with liquidity. This money still needs to find a home and it can find no better abode today than the mid-to-high end landed properties, the last remaining residential asset class that has yet to experience a bubble since the Asian Financial Crisis.

A brewing real estate mania. Currently, the advent of the 1970s subtle baby boomers into the market in search of trade-up homes has coincided with the 1950s Baby Boomers who are still eagerly in search of real estate investment opportunities. With the twin demand coming from two groups of baby boomers, the coming boom in mid-to-high end residential properties, particularly landed ones, will turn out to be more than an ordinary upcycle. As has been demonstrated recently, banks will certainly be more than eager to fund and fuel the boom by encouraging the community and the financial system to leverage further and shift away from traditional financing to more speculative financing. Hence, euphoria may develop as a result.

2012, the year to watch out. As the euphoria grows, there is a risk that the use of speculative financing would become so widespread that the only way for the system to stay afloat is for property prices to keep going up similar to the recent subprime situation in the US. Alas, the constraints of demography imply that the demand mania may not be sustained post year 2012/13, thus restraining the upward trajectory in property prices. Then the entire financial system would become vulnerable to a collapse at the smallest trigger, such as the borrowers’ inability to honour their monthly mortgage obligations as the first large batch of deferred payment schemes begins to expire commencing 2011/12. Therefore, these dates strongly suggest that year 2012, or latest 2013, may mark the peak of what would perhaps be the country’s biggest residential real estate boom since the Asian Financial Crisis.

Upgrade to OVERWEIGHT (from Neutral). Despite the potential gloom post 2012/13, the phenomenal boom that immediately precedes it gives investors an excellent opportunity to profit from the trend. The winners in this phenomenal upcycle between 2009/10 and 2012/13 are clearly the mid-to-high end developers. However, their current valuations do not appear to be reflecting this as yet. We are upgrading the target prices of all midto- high end residential property developers under our coverage based on a higher P/NTA ratio assumption, while leaving our earnings forecasts unchanged for now. Since the mid-to-high end landed properties will likely to be the top performers of the sector, we value their potential P/NTA during this period based on 2.5σ above their respective historical mean, closer to the peak valuation they were trading at during the 2007 upcycle. Other developers with general exposure to the development of mid-to-high end residential properties have their P/NTA conservatively valued at about 1.5σ above their respective historical mean instead.

Below are the target price for property sector.

Source : OSK Research