Singapore Property Developers - Maybank Kim Eng 2017-05-29: Price Inflection Point, Upgrade To POSITIVE

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Singapore Property Developers Property Stocks Outlook CAPITALAND LIMITED C31.SI CITY DEVELOPMENTS LIMITED C09.SI UOL GROUP LIMITED U14.SI HO BEE LAND LIMITED H13.SI

Singapore Property - Price Inflection Point; U/G To POSITIVE

Turning POSITIVE on developers; UOL stays top pick 

• We turn POSITIVE on property developers, expecting catalysts from a potential rebound in property prices. 
• Strong home-buying interest could drive a sharp decline in unsold stock and allow developers to raise prices. Hence, we believe home prices can pick up even without further policy easing. And while the occupier market remains soft, keen interest in commercial assets has led to record prices in recent transactions. 
• We believe developers will increasingly be valued for their investment properties. We raise TPs by 12% and upgrade City Developments (CIT) and Ho Bee Land (HOBEE) to BUYs from HOLDs. With the largest local exposure in our coverage, UOL Group (UOL) remains our top pick as we deem it the best proxy for a price rebound in Singapore. Maintain HOLD on Capitaland Limited (CAPL). 
• Risks to our positive view include a surprise tightening of policy measures and a sharp spike in interest rates.

Prices can pick up, even without further easing 

• Take-up at property launches has been stronger-than-expected in recent months. Given ample liquidity, improving affordability and buoyant sentiment, we think home buying interest will continue. This could bring down unsold stock and allow developers to raise prices. 
• We lift our expectations from flat home prices to 3-4% annual increases for the next three years.

Developers will increasingly be valued for their investment properties 

• Despite a weak occupier market, keen interest in commercial properties has led to record prices in recent transactions. Hence, despite prospects of interest-rate hikes, we see scope for cap-rate compression during the year. 
• We raise our commercial-property valuations after lowering cap-rate assumptions by 0-50bps, which more accurately reflect the properties’ realisable value in the market today. 
• Moreover, elevated land prices imply high replacement costs for commercial properties. While the market has been fixated on a potential recovery in home prices, we think developers will increasingly be valued for their investment properties.

Mild rate upcycle manageable 

• While a rate-hike cycle has started, our Economics team expects a mild uptick in 3MSIBOR to 1.30%/1.60% by end-2017/18E. We believe this small 30bp increase will be manageable and should not lead to a sharp fall in property prices. 
• Furthermore, home buyers have already been stress-tested for normalised interest rates since the implementation of macro prudential measures such as a total debt-servicing ratio from 2013. 
• Interestingly, unlike the marginal uptick in 3MSIBOR, Singapore’s 10-year bond yields have corrected by over 30bps YTD to 2.1%. This has arguably enhanced the attractiveness of property yields.

1. Home prices can pick up, even without further easing 

1.1 Surprisingly strong upgraders’ demand 

• 1Q17 sales of 2,962 new private homes were more than double the number sold in 1Q16. Notably, take-up rates at new launches - The Clement Canopy, Grandeur Park Residences and Park Place Residences – were strong. Sentiment at the start of the year was further buoyed by a relaxation of cooling measures. We believe this is supported by strong household cash balances, improving affordability and healthy demand from HDB upgraders.
• Demand from HDB upgraders can be discerned from a growing share of new private-home buyers with HDB addresses. This is particularly evident in the midto mass markets, where elevated HDB resale prices have narrowed their price gaps with private homes. For example, the absolute price difference between an executive HDB flat and a new mass-market private condominium shrank from 129% in 2007 to 66% in 2016. Furthermore, an increasing number of HDB flats were sold at high prices. In 2016 alone, nearly 1,200 HDB flats were sold for above SGD700k. Assuming each of their sellers buys a new private property, these upgraders would have accounted for 15% of the 8,000 new private homes sold last year.
• We also notice an increasing number of HDB home owners renting out their HDB homes for investment income. For owners who have gone on to buy new private homes, their rental proceeds can be used to service a large part of their mortgages. Our calculations suggest that renting out a 4-room HDB flat in Clementi at SGD2,500 a month can help its owner service a SGD676k 30-year mortgage at a cost of 2.0%.

1.2 Strong household formation 

• Targets set in the government’s 2013 Population White Paper suggest that population growth in Singapore will slow to just 1.3% pa, less than half its 2.8% annual growth in the prior decade. This has generated concerns about a potential spike in vacancy rates as housing supply outpaces population growth. 
• But while vacancies did move higher in recent years, the magnitude of their increase was fairly moderate, due to surprisingly strong household formation.

1.3 Function of shrinking household sizes 

• We believe the strong household formation was brought about by a sharp fall in Singapore’s average household size. From 3.96 in 1995, households in Singapore shrank to an average of 3.5 persons in the decade before 2012. Between 2012 and 2016, they shrank further to an average of 3.35 persons. With household formation outpacing resident-population growth by 3.1x, the stronger-than-expected household formation quickly absorbed excess housing supply. 
• We believe rising single-hood and low fertility rates among married couples are key reasons behind this fall in household size and expect the trend to persist. As such, household formation is expected to remain healthy despite tepid population growth.

1.4 Buoyed by recent policy relaxation 

• The improvement in home buying sentiment early this year was further buoyed by the government’s surprise review of cooling measures on 10 Mar. Park Place Residences sold out every unit launched in that immediate weekend, at a median price of SGD1,800 psf. This was 6% higher than the SGD1,700 psf achieved by a comparable project, Katong Regency, during its launch in Apr 2012.
• Consequently, developer sales in March rose to 1,780 units, their highest since 2013. The buoyant sentiment has continued into the current quarter, with Seaside Residences selling more than 400 units during its recent launch, bringing total new home sales to over 1,500 units in May. 
• As home buyers’ confidence has been reinforced by the government’s seeming willingness to relent and relax, we now see buying resilience, even without further policy easing.

1.5 Further supports: healthy affordability & household cash balances 

• Traditional affordability metrics suggest that mass-market private homes in Singapore have reached an affordable level. At a home price-to-income ratio of 4.5x and mortgage servicing ratio of 16%, affordability has vastly improved from its previous peaks in 1996, 2007 and 2013. Given this, we believe the government will be less preoccupied with keeping housing affordable. Unlike other countries that are still struggling with runaway home prices, Singapore’s pre-emptive moves have successfully cooled its property market. 
• A record SGD403b cash pile on household balance sheets also points to buying capacity.

1.6 Drawdown of unsold inventories should allow for ASP hikes 

• Unsold inventory has been falling in recent years, with the 21k unsold homes at end-2016 representing only half of the 40k units during the market’s last peak in 2011. If the sales strength continues, tapering land supply could soon deplete unsold inventories. 
• Assuming 10k of new-home sales and 7k of new supply from Government Land Sales and private land deals, we reckon that unsold inventories could fall by about 3k units each year. This could lead to a favourable shift in the inventory-to-sales ratio and give developers scope to raise prices.

1.7 Supply: slower housing starts 

• With a significant deceleration in housing starts in the past two years, we think peak supply should also be behind us. This should help restore balance in the occupier market. Furthermore, a resurgent en-bloc market can both alleviate oversupply - as older homes get demolished - and add to demand - as displaced home owners hunt for new homes. 
• The impending redevelopment of Shunfu Ville and Raintree Gardens, the two largest en-bloc deals last year, will lead to the demolition of 533 housing units. If more deals are struck, demolitions could quickly tilt the demand-supply balance. 
• Two former HUDC projects, Rio Casa and Eunosville, are up for sale and could potentially remove another 600+ units from the system.

1.8 No reason for sharp increases in land supply 

• One of the contributors to the current supply glut has been the government’s determination to address the basic housing needs of Singaporeans. A combination of low home building and high population growth led to undersupply in the years leading up to the global financial crisis. The housing shortfall was most acute in 2009, when there were 48k more households living in HDB homes than units available. 
• We believe this undersupply has been addressed as the 1.0m resident households residing in public housing roughly equal the number of HDB housing units today. Given this, we don’t think the government will be in a hurry to release more land for housing.

1.9 Less wary of cost pressures 

• Earlier, we also feared that developers’ margins would be squeezed by elevated land prices in a tepid home market. But with home prices approaching an inflection point, this is less of a concern now. 
• Assuming a developer tenders for a piece of land with a 10% EBIT margin in mind, we estimate that home prices will need to fall by 3% pa for the developer to lose money over a typical 4-year development period. But if home prices climb by 3% pa instead, the developer could book a “healthy” 20% margin, if the project is launched during its fourth year.

2. Developers will increasingly be valued for their investment properties 

2.1 Cap rates narrowed in recent deals 

• Defying weakness in the occupier market, commercial properties have transacted at record prices in the past year. This has led to a mismatch between the cap rates used by valuers of property companies and rates used in physical-market transactions. 
• Offices in Singapore are typically held on the books of property companies at cap rates of 3.75-4.25% and 5.00-5.75% for retail malls. These are higher than the low 3% in most office transactions in the past year. For example, Capitaland Commercial Trust’s (CCT SP, Current Price SGD1.69, Rating: BUY, Target Price SGD1.81) recent sale of a 50% stake in One George Street to insurer FWD Group was transacted at a cap rate of just 3.2%. 
• In the retail market, Jurong Point, a 658k sf suburban mall, was recently sold at SGD2.2b or a tight cap rate of 4.2%. With such keen interest, we think the impending sale of Asia Square Tower 2 could also be transacted at high prices and reinforce tight cap rates for office buildings. A similar trend may also pan out in the retail market, assuming the Marina Bay Sands retail mall is put up for sale next year.

2.2 Lowering cap-rate assumptions 

• To better reflect the realisable value of properties held by developers in the market today, we cut our conservative cap-rate assumptions by 0-50bps for FY17, to 3.25-4.00% for offices and 4.75-5.00% for retail assets. We note that unlike the 3.75% cap rate used by Singapore REITs’ valuers for Marina Bay Financial Centre, Hongkong Land (HKL SP, Not Rated) has already adopted a tighter 3.5% for its one-third stake in this Singapore property.

2.3 Elevated land prices imply high replacement costs 

• Furthermore, elevated land prices imply high replacement costs for commercial properties. In Nov 2016, a commercial land parcel at Central Boulevard was sold at a record SGD2.57b or SGD1,689 psf GFA. We estimate that the developer can only break even at SDG2,800 psf for an office building. This reinforces our expectations of higher valuations for commercial properties. 
• While the market has been fixated on a potential recovery in home prices for developers, we think that they could increasingly be valued for their investment properties.

3. Mild rate-hike cycle manageable 

3.1 Interest-rate cycle: mild & manageable 

• While recent rate hikes in the US have kick-started a new rate-raising cycle, our Economics team expects a mild pick-up in 3MSIBOR to 1.30%/1.60% by end- 2017/18E. Although this could add 30bps to annual borrowing costs, we reckon that the increase would be manageable and is unlikely to spark a sharp fall in property prices. Assuming a 60bp increase in mortgage costs for a 30-year SGD1m loan, we estimate an increase of just 8% in monthly mortgage servicing.
• Moreover, the increase in mortgage costs should be less for loans with shorter tenures.

3.2 Better market stability from prudential measures 

• Furthermore, the implementation of macro prudential measures in recent years has led to better market stability. Under the total debt-servicing ratio framework, home buyers have already been stress-tested to a normalised mortgage rate of 3.5%. Unless income falls off the cliff, we think a potential rate hike of 60bps to about 2.6% should remain manageable for home owners.
• Furthermore, higher cash down payments and lower LTV limits for non-first-time home buyers implies that the pain from rate hikes should be even lower.

3.3 Past rate hikes not that damaging for property prices 

• In past cycles, higher short-term interest rates did not materially hurt property prices. In fact, in three of the past five upcycles, 3MSIBOR increases were accompanied by higher home prices, as the higher interest rates also reflected economic strength. 
• Today’s pick-up in interest rates is similarly charted by a stronger economy with our Economics team raising GDP expectations to 3% (from 2.5%) for this year.

3.4 Differentiating long- from short-term rate hikes 

• Although more persistent rate hikes could end up affecting property demand, we believe the impact from higher long- and short-term rates is different. While higher short-term rates raise borrowing costs and erode property income, higher long-term rates tend to raise the bar for competing yield assets like properties.
• Interestingly, unlike the marginal uptick in 3MSIBOR, Singapore’s 10-year bond yields have corrected by over 30bps YTD to 2.1%. This has arguably enhanced the attractiveness of property yields.

4 Raising Forecasts 

4.1 Higher ASP assumptions 

• As of 1Q17, Private-home prices have corrected by 11.6% from their last peak in 3Q13. As we now believe strong buying interest could bring down unsold stock and lead to higher home prices even without further policy easing, we raise our expectations from flat home prices to 3-4% annual increases for the next three years. 
• We believe such price hikes will be politically palatable, since they are in line with long-term price growth. With the potential for a cumulative price hike of 10% over the next three years, we are now less worried about margin squeezes from elevated land prices. 
• We continue to prefer developers with mid-to-mass market exposure due to faster inventory turnover in this segment. While high-end prices could pick up from smaller supply and their relative value vis-à-vis overseas markets, we think the magnitude of any rebound could be capped by a weak rental market and the additional buyers’ stamp duty levied on foreign home buyers.

4.2 Raising TPs; UOL stays as our top pick 

• We update our RNAV estimates for property developers for their latest disclosures; and raise residential ASPs and capital values for their commercial properties. We also cut discount rates for Singapore commercial properties to 10% from 20%, to account for the keen buying interest and a bottoming cycle.
• Our revised RNAV discount of 11% for bellwether CDL is 0.4SD above its 10-year mean. While we believe developer stocks are unlikely to return to premium valuations anytime soon, we see scope for a narrowing of RNAV discounts, from keen interest in the sector. With the euphoria over the first policy easing over, we see recent stock corrections as good entry opportunities.

5. Risks: 

Policy tightening. 

• We believe the market has interpreted the latest fine-tuning of property-cooling measures as a reversal of the government’s tightening stance since 2009. As such, any policy-tightening shock could quickly reverse sentiment and hurt demand for property.

Interest-rate spikes. 

• While we think mild increases in short-term rates will be manageable for property demand, any sharp increases would bump up financing costs. A significant pick-up in risk-free rates for longer-tenure government bonds could also raise the bar for yield instruments like property.

Economic weakness. 

• Economic weakness could affect the absorption of real estate and lift vacancy rates. Job losses would also affect buyers’ ability to service mortgages.

Derrick Heng CFA Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2017-05-29

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