Developers' dilemma

A FRESH round of property cooling measures is set to test the resilience and ingenuity of property developers once more. What should investors do?

The timing of Wheelock Properties' latest land purchase couldn't have been worse.

On Jan 10, the luxury-property developer said it would pay $550 million for a 99-year leasehold site on Ang Mo Kio Avenue 2 under a government land sales (GLS) programme. That price tag worked out to $790 psf for the 198,942 sq ft piece of land. With a gross floor area of 709,627 sq ft, analysts­ expect the property to yield about 700 units and fetch an average selling price of about $1,300 psf.

The following day, on Jan 11, the government unveiled what some market watchers say are its toughest measures yet to rein in Singapore's runaway property market. These included hikes in stamp duties for Singaporeans as well as foreigners, further curbs in bank lending for property purchases and the introduction of a seller's stamp duty on industrial properties to discourage a spillover of speculation into the sector.

This is the seventh round of cooling measures introduced since 2009, and it comes after renewed confidence in the property market over the past year. In fact, heavyweight property stocks City Developments, CapitaLand and Keppel Land were among the best performers in the market in 2012, rising 43%, 65% and 84% respectively, versus a 19% gain in the benchmark Straits Times Index. Some small property stocks such as Ho Bee International and Heeton Holdings did even better, soaring 91% and 75% respectively, in 2012.

This was fuelled by a surge in new home sales as well as buoyant selling prices, especially in the mass-market residential sector. According to Knight Frank, developers sold a total of 22,290 new private residential units, excluding executive condominiums (ECs), in 2012. That was 40% more than the 15,904 units sold in 2011 and 37% more than the previous peak of 16,292 units in 2010.

In addition, the market was also turning positive on shares in developers with substantial unsold inventories, because they were trading at substantial discounts to their revalued net asset values (RNAVs). For instance, Wing Tai Holdings has sold only one unit at its super-luxury Le Nouvel Ardmore in the past two years, and 12 units at its mass-market Foresque Residences in Bukit Panjang, based on URA data, but its stock has almost doubled in the past year. SC Global also has substantial unsold units at its developments, The Marq on Paterson Hill and Hilltops, located on Cairhill Circle. Its shares rocketed 70% in December after its controlling shareholder Simon Cheong made a bid for the company at $1.80 a share.

By comparison, Wheelock has been something of an underperformer, with its shares rising only 26% in the past year. The luxury developer that built Ardmore Park, Grange Residences and Scotts Square had a net-cash position of $464 million as at Sept 30. Besides the Ardmore 3 in the upscale Ardmore Park area, which is still largely unsold, it doesn't have much of a pipeline of new developments. In fact, prior to the global financial crisis, it had used a lot of its cash to buy up major stakes in two property companies, Hotel Properties and SC Global.

Now, Wheelock's move into the hot mass-market property sector might have come too late. In the wake of the latest round of cooling measures, shares in property stocks across the board took a hit during the past week. And, analysts have begun downgrading their view on the whole sector. Some of them now see the volume of residential property transactions falling by some 50% in 2013 and prices sliding by as much as 7%. They are also keenly watching the volume of unsold residential units in the system. Notably, more than 38,000 units (including ECs) remain unsold, based on URA statistics, as at last June.

"The measures effectively reduce the affordability of the properties by 13% to 25%," says Joy Wang, an analyst at JP Morgan, in a recent report. "We therefore revise down our physical market forecast to -5% to -20% for mass and luxury markets." The measures are also likely to impact the RNAVs of developers. "We see an average 10% pullback for the sector in the next few months. Residential developers such as City Developments and Wing Tai Holdings could well trade 15% to 20% down from the current level," she adds.

Yet, the latest cooling measures, as with the previous six rounds of measures, do not change the fact that interest rates in Singapore remain low and that inflation is creeping up. And, while efforts are underway to reduce Singapore's reliance on foreign manpower, the country's population is still growing. That makes investing in property a strong proposition and provides developers with an incentive to meet that demand by creating more new supply.

Meanwhile, the banks don't appear to be overstretched, according to analysts. If anything, the curbs imposed on mortgage lending over the last couple of years have kept the banks from becoming overexposed to property and reduced the likelihood of a credit crunch anytime soon. Under the latest round of measures, the minimum cash down payment for individuals applying for a second or subsequent housing loan has been hiked from 10% to 25%. On top of that, loan-to-value (LTV) ratios for individuals with more than one housing loan have been tightened.

Leng Seng Choon, an analyst at OSK-DMG, figures that these restrictions could slow down the pace of loan growth for the local banks, but also improve the profitability of their mortgage-lending business. "We expect housing-loan growth to face headwind, with a lag of two to three years. Housing-loan refinancing will become more difficult, given the reduction in LTV. In this respect, banks with stronger housing-loan expansion over the recent past years would be better able to keep their existing mortgage customers and could see some yield improvement," Leng says.

Jonathan Koh, an analyst at UOB Kay Hian, notes that lending to the property sector has actually been steadily slowing in the face of the previous six rounds of cooling measures. For instance, growth in loans to the building & construction sector has slowed from a recent high of 27.9% y-o-y in January 2012 to 17.7% in November 2012. Similarly, growth in housing loans moderated from a high of 23.4% y-o-y in August 2010 to 16.1% in November 2012.

Even as mortgage lending was slowing, however, property developers managed to keep the party going by shifting their emphasis to more affordable suburban properties and shoebox apartments. The result was that psf prices for shoebox developments such as Robinson Suites hit as much as $3,399. In the outlying areas, psf prices for new mass-market homes such as SeaHill in Clementi reached $1,500 psf.

Some developers also moved into the industrial property space. For instance, Oxley Holdings developed the strata-titled Oxley BizHub that it sold to eager investors. In the past year, prices of industrial properties have jumped 30%.

Will the latest round of stamp-duty hikes and mortgage-lending curbs finally bring the property market under control? Or, will developers find another segment of the market to exploit and keep their sales going? What is their strategy now? And, what could it mean for their share prices?

Beware residential exposure

Vikrant Pandey, an analyst at UOB Kay Hian, figures that developer sales account for 60% of total residential-property sales, while secondary-market sales account for the remainder. Meanwhile, the investment market, which has been targeted with higher stamp duties and tougher bank-lending curbs, accounts for 40% to 50% of total transactions. "Based on household formation and population growth, around 10,000 units are from genuine demand," Pandey says. "Last year, about 20,000 units changed hands, suggesting that the remaining 50% are from investors."

Some analysts say residential-property purchases by foreigners are now no longer a major factor in the demand-supply equation. Deutsche Bank estimates that foreigners and companies currently account for around 7% of new home sales, down from the peak of 30% in 2007. Under the latest round of cooling measures, the additional buyer's stamp duty (ABSD) for foreigners was hiked from 10% to 15%. That puts Singapore on a par with Hong Kong, which imposed a 15% tax on all foreigners last October.

"While the higher 15% tax on foreigners and companies could have a larger impact on the high-end [sector], we note the number and proportion of this group has declined after the fifth round of measures, with Singaporean buyers on the rise," says Deutsche Bank in a report. Indeed, Singaporeans have accounted for the lion's share of recent new home purchases. Deutsche Bank points out, for instance, that Singaporeans made up 80% of the buyers at the recent launch of City Developments' Echelon @ Alexandra Road. Of this, about half were HDB upgraders, according to the report.

Pandey of UOB Kay Hian says the impact of the latest cooling measures is likely to be felt first in the secondary market. "The measures would lead to increased cash outlays, impacting the mass market more negatively than the high end, where buyers are typically cash-rich," he says. If it becomes clear that prices in the secondary market are softening, developers are likely to react by giving away freebies such as furniture vouchers and even outright discounts, he adds. All in, he sees residential-property prices correcting by some 5% this year.

On the face of it, developers with the highest portion of their gross asset value (GAV) in the mass-market sector are likely to be most affected by the latest cooling measures. Among the heavyweight developers, City Developments is viewed as being the most exposed to this sector. According to estimates by JP Morgan, some 41% of its GAV is in Singapore residential property, and unsold inventory accounts for 33% of its GAV.

"City Dev has the highest exposure to residential and may experience a knee-jerk share-price impact," says Yvonne Voon, an analyst at Credit Suisse, in a recent report. However, Voon also notes that the company has a strong track record in managing its business through previous downturns. "We like City Developments for its strong execution, but note that the stock may face a near-term overhang from the policy overhang in Singapore. Therefore, we prefer to adopt a more 'trading' call on this name, and accumulate on weakness."

Echoing this view is Eli Lee, an analyst at OCBC Investment Research, who was among the most bullish voices on City Developments in the past year. "Though CDL management continues to execute well on its residential strategy, we expect headwinds for the group ahead, as these curbs affect demand fundamentals meaningfully," he says in a Jan 14 report that downgrades his call on the stock to "hold".

At the other end of the spectrum is Capita­Land. While it has major residential developments such as D'Leedon that are yet to be fully launched and sold, only 9% of its GAV is actually exposed to Singapore residential property, and unsold units account for 6% of its GAV. That reflects CapitaLand's huge size and substantial exposure to overseas property markets. And, it is why the company is among the few heavyweight developers that analysts still favour.

"We prefer developers with more exposure to non-Singapore residential [property], as we expect prices for Singapore residential to remain flattish, while developers may face margin compression, given rising cost pressures [especially land costs]," says Voon of Credit Suisse. She reckons that CapitaLand and its 64%-owned CapitaMalls Asia (CMA) — the region's largest mall owner-developer — could be more compelling investment cases in 2013, as they also provide a proxy to China consumption-led demand.

Both CMA and CapitaLand also have recurring income from their existing real estate investment trusts and investment-property portfolios. Additionally, ASX-listed Australand provides a steady income stream for CapitaLand, while many of CMA's shopping malls around the region are now becoming operational.

Peripheral players pose risks

Whatever their exposure to the residential-property market, the big property developers that are constantly acquiring land and completing projects might not be the most risky stocks in the sector at the moment. The real risk might lie with the peripheral and niche developers that have taken unusual risks in recent years.

Fragrance Group, for instance, has grown fast in recent years by taking a risk on developments in the less savoury parts of Singapore such as Geylang. It has also undertaken several projects with Aspial Corp, an affiliated company that is best known for its jewellery stores and pawnbroking business. Fragrance and Aspial recently bought a plot in Tanah Merah for $285 million. Aspial has also acquired a leasehold site on Jalan Jurong Kechil.

In the process, Aspial has stretched its balance sheet. The company currently has a net gearing ratio of around 2.3 times and it has been suffering from significant net-cash outflows. Last year, it implemented a scrip-dividend scheme and raised equity via a placement and a rights issue. It remains to be seen how Aspial and Fragrance will cope with a possible slide in demand for new homes in the face of the latest cooling measures.

Among other peripheral developers are construction company Hock Lian Seng Holdings and King Wan Corp. The two companies have acquired a Dairy Farm site for $244 million under a 50:50 joint venture. Although Hock Lian Seng is still in a net-cash position, its equity base of $116 million isn't all that big. For its part, King Wan has about $20 million in cash and an equity base of just $82 million. That could put them in a position of having to price their development cheaply to ensure it gets sold quickly.

Elsewhere, Maybank Kim Eng recently slashed its earnings forecasts for Lian Beng Group, a contractor-turned-developer, citing slower profit recognition from and higher capital layout for its property development business. For its 1HFY2013, Lian Beng reported a 35% fall in earnings to $19.8 million. According to Maybank Kim Eng, the property-cooling measures, among other things, are likely to impact Lian Beng's earnings negatively and its ability to pay dividends. It has downgraded its recommendation on the stock to "hold", with a price target of 45 cents, or about six times forecast earnings for FY2013.

Meanwhile, niche luxury developers such as SC Global and Wing Tai could find it harder to launch new projects in the face of the latest cooling measures. And, they could face increased pressure to accelerate sales of their unsold inventory if the property market begins heading south.

Wing Tai was recently downgraded from a "buy" to a "hold" by Deutsche Bank. "While valuations are undemanding at 0.69 times price-to-book and the counter is trading at a 34% discount to RNAV, the company is susceptible to the expected demand contraction, given its high-end residential focus," the bank says in a report. "Re-rating catalysts are elusive, with planned launches of its luxury Ardmore projects likely to be deferred. Its balance sheet is, however, solid, with gearing of 0.14 times, a historical low which should enable it to wait out the challenging operating conditions and restock its landbank at potentially more attractive margin," the report adds.

SC Global faces the added risk of being hit with substantial fines. Under government rules designed to prevent hoarding of property, the company could be made to pay some $5.5 million to the government for unsold units at its flagship development, The Marq on Paterson Hill. However, SC Global matters little to most investors now. Its controlling shareholder Cheong has already secured more than 90% of the company through his offer at $1.80 a share, and might move to compulsorily acquire the rest of it and take it private.

Will SC Global change its strategy as a private company? Interestingly, as with Wheelock's recent purchase of land in Ang Mo Kio, the timing of Cheong's offer wasn't great. The offer was unveiled last month and initially closed on Jan 16, just five days after the government announced its latest cooling measures. (The offer has since been extended to Jan 30.)

Wheelock, which owned some 19% of SC Global, initially resisted Cheong's offer. Shortly after the offer was announced, Wheelock began accumulating SC Global shares on the market at just above the offer price of $1.80. Tan Bee Kim, senior executive director at Wheelock, said at the time that SC Global shares were trading at some 40% to 50% below their RNAV. "We would be unable to buy property assets directly at anything like these prices," she added.

On Jan 16, however, Wheelock did an about turn, announcing that it had accepted Cheong's offer and disposed of its entire stake in SC Global for a consideration of $133.5 million. Wheelock attributed its change of heart to "recent market developments and new investment opportunities".

The timing of Wheelock Properties' latest land purchase couldn't have been worse.

This story first appeared in The Edge Singapore weekly edition of Jan 21-27, 2013.