TIMES are hard for the property market with softening capital and rental values and dwindling transactions. Although conditions are expected to be poor over the next 6-12 months, we need to look beyond 2009 to ascertain whether the current slump is an investment opportunity. As always, we need to invoke the old saw: demand and supply.
Currently, the demand picture looks bad. Almost every country and industry has been affected by the aftermath of the credit and economic crisis. The bankruptcy of Lehman Brothers was the tipping point. Unbelievably, the Bush administration allowed the US$700 billion sub-prime problem to morph into a global economic disaster wiping out several trillion dollars of wealth globally.
Coincident economic data such as the Purchasing Managers Indices shows contraction in almost every major economy. However, recessions do not last forever. Since the Great Depression of the 1930s, policymakers and economists have learnt much in dealing with recessions. The first step is already in place - no more bankruptcies of banks, no more Lehmans. The second step is being done - flood the system with cheap money, lots of it. Borrow it from the market and if the market allows it, print it.
The markets responded favourably to the announcement by the US Federal Reserve that it will be purchasing US$800 billion worth of securitised housing, consumer and small business loans. The market for these securities has been frozen with little issuance post-Lehman. Without credit, auto purchases in the US have fallen off the precipice.
The Fed purchases will essentially be made by printing money - quantitative easing. The effect of the announcement was a dramatic drop in mortgage rates, while causing a sell-off in the US dollar. In normal times, quantitative easing eventually leads to hyperinflation - for example, Latin America in the 1980s. It is, however, a very effective tool when combating depression and deflation, which is the major threat.
The fall in mortgage rates and oil prices would have the effect of a tax stimulus equal to 2-3 per cent of GDP. Indeed, the fall in mortgage rates has caused mortgage applications for home purchases to soar.
Most encouragingly too, we see significant acceleration in US money supply growth. In the wake of Lehman, this had crashed to just 1.5 per cent. M2 is now growing at more than 8 per cent. M2 leads economic growth by about 12 months and equities by six months. Hence, Singapore property market demand is likely to recover by Q4 2009.
What about supply? Would all property sectors benefit equally from the expected recovery in demand? There appears to be a divergence here.
The private residential market has been correcting for a year. In some prime developments, there have been isolated transactions 30-40 per cent off peak levels already. However, this is not representative of the market. This is representative of the credit and liquidity crisis which forces sellers who may need to sell quickly (there are always such sellers) to accept any bid that comes along. Meanwhile, rentals, which are a function of the relatively low vacancy rate of 6 per cent, have stayed relatively firm - that is, forced sellers are parting with prime freehold properties at yields close to 5 per cent. With borrowing costs at less than 2 per cent, investors are factoring a 50 per cent drop in rentals. This is not likely, given Urban Redevelopment Authority (URA) supply data stretching out to 2012.
From the table, we see that there will be about 24,500 completions between 2009 and 2011 or about 8,000 units a year. This is about the average historical absorption rate for private residential properties. Yes, there will be softness in 2009 because of the weak macro picture but things should tighten up by 2010. The expected rebound in the global economy in 2010 should restore vigour to rental and capital values.
The same conclusions cannot be drawn for the office market. Effective rentals along Shenton Way have already fallen by 30 per cent as weak macro demand has been exacerbated by fresh supply from non-traditional sources such as transitional offices and business parks. Based on URA data of office buildings under construction, available office space will balloon from 6.6 million square metres to 7.8 million sq m in 2012. Based on the average historical annual absorption rate of about 110,000 sq m, the projected occupied space would be 6.5 million sq m - that is, about 16 per cent of all office space would be vacant. This is comparable to the 16 per cent vacancy rate in Q4 2004, when the office market troughed and rents in Shenton Way fell to $3 psf per month.
The office market is, therefore, unlikely to be robust even if the global economy recovers in 2010. Indeed, I expect capital values to fall by more than 60 per cent from peak values. However, URA data shows little office supply after 2012. Therein perhaps lies the seed of the next boom in office properties.
The writer is CEO of financial adviser New Independent. He welcomes feedback at josephchong@ni.com.sg.
This article is for information only.
Readers should seek independent advice.
Source : Business Times - 10 Dec 2008
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