A city of two tales - revisited

There are clouds on the horizon for both Singapore's office and residential markets.

Mon, Jan 10, 2011
The Business Times

By Joseph Chong

TWO years ago, in the midst of the greatest financial crisis since the Great Depression, I contributed a piece forecasting the performance of the residential and office property markets (BT, Dec 10, 2008, 'A city of two tales'). In essence, the prediction was that the residential market will recover briskly and outperform the office market. That has come about.

Indeed, times are currently buoyant for the property market. Although conditions are expected to be good over the next 6-12 months, we need to look beyond 2011 to ascertain whether the current boom is an investment opportunity or the top of a cliff. As always, we need to invoke the old saw: demand and supply.

First, let's look at the overall global demand picture. Currently, the global demand picture looks encouraging. Leading economic data such as the Purchasing Managers Indices show continued moderate expansion in almost every major economy. This is expected to continue over the next 12 months because of unprecedented low interest rates and quantitative easing (QE) of some kind in the US, Europe and Japan. In response, equity markets around the world have risen fairly sharply over the past couple of months.

There has been much media ado about QE but it is in essence nothing special because it is an extreme extension of what central banks do on a daily basis. Central banks raise or reduce interest rates by manipulating the level of money circulating in the economy (money supply). Increasing money supply aggressively enough will lead interest rates to fall to zero.

Although interest rates cannot fall below zero, central bankers can achieve the effects of negative interest rates by printing money and buying assets such as debt issued by the government. The US Fed is doing this because there is a risk of deflation in the US. GDP growth is anaemic, core inflation has fallen to about 0 per cent and labour is in huge surplus with about seven million spare workers.

Indeed, according to the Taylor Rule, the appropriate Fed funds rate ought to be a negative number. The Taylor Rule is used by the US Fed to estimate the appropriate short-term interest rate for the economy.

Deflation is bad for stocks, as falling prices depress profits. The Fed and other central banks shooting for higher inflation is akin to granting stock market investors a put option - hence, the global rally in stocks. Nonetheless, there will be a comeuppance from the extremely low interest rates currently - but that is another story.

In short, global growth will probably revert to 2005-2006 (pre-crisis but pre-bubble) levels, but the shift is towards China, Asia-Pacific and other emerging countries away from the US. Ironically, however, stock markets in developed countries where growth is slower will probably do better than emerging countries in next 12 months. This is because developed countries are in easing mode due to disinflation whilst emerging countries need to tighten policy because of inflation.

Office market

In the past few months, quite a few property 'consultants' have been issuing bullish reports about the office market, predicting a sustainable rebound. I see the same data and hear the same government policy actions but I arrive at quite a different conclusion. Maybe it is because I have no office rentals or sales to broker.

The crux of the matter is the vacancy rate. Until the data signal that this is on the turnaround, rentals and capital values will stagnate with a downward bias over the next two years. Unfortunately, the data and policy actions signal that the rise in the vacancy rate has more to go.

From data published by the Singapore Department of Statistics, the labour force has grown at an annualised rate of about 4 per cent over the past 11 years. During this period, the service sector has grown even faster - by about 4.5 per cent annually. This was driven by the policy to allow the population and labour force to grow aggressively in 2005-2007. However, according to URA data, the demand for office space in Singapore has grown at an annualised rate of less than 2 per cent in the same period - demand for office space lagged employment growth considerably during the same period. The reason for this is most probably the changes in IT technology, allowing companies to economise on office space.

I expect the trend of more efficient usage to continue but continue to project a demand of 2 per cent per annum for the long term - about 120,000 square metres per annum. Again, this is probably unreasonably optimistic given the need to curb the labour force growth over the next few years.

Assuming an optimistic annual demand of 120,000 sq m, supply of completed properties will still swamp demand every year until 2013, according to URA data. 339,000 sq m is expected to be completed in 2011 - nearly three times annual demand. The cumulative surplus is expected to push the vacancy rate past 17 per cent by 2013 - roughly one in six buildings will be empty. It is to be noted that the vacancy rate was 16 per cent when the office market bottomed in 4Q 2004, when Raffles Place rentals bottomed at $5 psf/month.

The current bounce in offices is thus likely to be a technical one - an opportunity to sell and not to buy. Indeed, policy makers appear to have learnt the lesson from 2007 from the recent government tenders. The generous land sales for offices recently will ensure no shortage beyond 2013 and that any rental increases will be muted. The office sector looks like a poor long term investment. Perhaps, that is why savvy major office landlord CDL has been a net seller of office buildings.

Residential market

Demand in the residential property market will be dominated by the need to control inflation in Singapore - in the near and long term. In the near term, the Singapore dollar has been allowed to appreciate fairly sharply. Most of the appreciation has been against main export markets and competitors. This is not good for the manufacturing sector which was already moderating.

Longer term, inflation needs to be curbed because of excessive demand creation (overcrowding) in the aftermath of the 'go for growth' policy of 2005-2007. The population was allowed to balloon beyond the pace at which infrastructure could be built. Among other things, this caused property prices to rise far beyond economic fundamentals. Population growth needs to be curbed whilst enough hospitals, train lines, homes etc are being built. This structural correction will have to take its course over the next few years. The sharp increase in COE prices is the most immediate manifestation of the pain of this correction as overcrowding of roads needs to be resolved. The pain in residential properties is yet to come.

The same logic of this structural adjustment will have a negative impact on the residential property market where buyers have been too optimistic about future demand, whilst the government sells residential land and builds new HDB flats at a pace far above the level of expected future demand, in order to correct the earlier undersupply.

According to URA data, an additional 8,100 new private homes on average has been occupied every year since 1995. However, given the curbs by the government on population growth to alleviate the overcrowding, demand in the next few years will probably be below this historical number. Indeed, the most current URA data show that despite the economic rebound, we have already fallen to 8,100 already. The government has been quicker to curb housing demand than expected.

Assuming we stay at 1.2 million foreigners and a historical growth rate of 1.5 per cent in the resident population, demand for dwellings going forward from growth in the resident population will be about 55,000/3.5=15,714 per annum. 3.5 is the median household size.

Now, let's look at supply. According to the latest URA data, 6,714 units under construction will be completed in 2011. In 2013, 11,621 units under construction will be completed with 7,091 under planning. Given the spate of new launches in 2010, we should see a substantial portion of this 7,091 under planning being constructed and completed. Hence, we should assume that around 18,000 units will be completed in 2013.

We see a similar picture for 2014, where we could expect about 15,000 units to be completed. In both 2013 and 2014, completed supply is far greater than the historical demand of 8,100 units. The vacancy rate could rise as much as 4 per cent over a 12-month period when all the completed homes hit the market in 2013 and 2014.

Nevertheless, the main pressure of oversupply from 2013 will come from HDB. HDB has ramped up its BTO programme to more than 20,000 units annually over the next few years! We expect about 12,000 BTO units will be completed in 2013 and about 20,000 in 2014. HDB and the private sector combined will deliver some 30,000 in 2013 and 35,000 units in 2014 - far in excess of the required 15,714 units projected from resident population growth.

We expect an oversupply of completed dwellings by 2013. The fall in rentals and the impact on capital values could be significant in 2013 unless demand surges significantly. During the Asian financial crisis of 1997, the vacancy rate climbed by 4 per cent in 12 months - pushing capital values down by 40 per cent. We could see a similar fall in 2013 and 2014.

Maybe this is why residential property stocks such as Allgreen Properties are trading at more than 20 per cent discount to published NTA - up from a 10 per cent discount a year ago. Despite growing its NTA, the stock has underperformed the STI by some 10 per cent over the past one year.

The writer is CEO of financial adviser New Independent. He welcomes feedback at [e-mail]. This article is for information only. Readers should seek independent advice

This article was first published in The Business Times.