ST : Property stocks still stuck in the basement

Aug 30, 2010

CAI JIN

Property stocks still stuck in the basement

Why developers' shares are not keeping up with soaring home prices

By Goh Eng Yeow

PRICES of private homes have gone through the roof and have even eclipsed the 1996 peak, yet share prices for property developers seem stuck in the basement, unloved and neglected.

Even though local banks have swung close to 2007's highs, several developers are still languishing at half of their peaks back then.

This is surprising given that sales of new homes this year are on track to overtake 2007's record 14,811 units, after 9,957 units were snapped up between January and July.

Conventional market wisdom dictates that the booming residential market and the soaring prices home-seekers are willing to pay should translate into hefty profits for developers - and therefore higher share prices.

But not so, with analysts estimating that the property sector is trading at a hefty 20 per cent discount to valuation.

This is despite the jump in profitability experienced by some developers in their second-quarter results.

CapitaLand, for one, swung to a hefty gain of $476 million for the second quarter from a loss of $157 million a year earlier, as the lustre from the property boom rubbed off on its profit and loss account.

But its share price is still down 44 per cent from its 2007 all-time high of $7.12.

It is a stark contrast to the boom year of 2007, when real estate counters were traded at a premium to valuations.

Are investors missing something here? Surely, the market's dour view on property counters is out of sync with the realities of the market.

Of course, it is easy to blame global uncertainties for the malaise afflicting property counters.

It was the foreign fund managers who recognised that property counters were undervalued in 2007 and propelled them to record highs in the liquidity-induced rally that year.

But the sub-prime mortgage crisis in the United States has knocked many of these former masters of the universe out of action.

Still, there seems to be more to this conundrum than foreign fund managers becoming risk-averse.

Few will deny that our housing boom is largely shaped by events beyond our shores, particularly the loose monetary policies implemented by US Federal Reserve chairman Ben Bernanke as he pared interest rates to almost zero last year to revive the troubled US economy.

Because the US dollar is the world's reserve currency, this move sharply depressed interest rates around the world.

Some banks in Singapore have slashed mortgage rates to as low as below 1 per cent to grab a bigger slice of the mortgage market.

Home-buyers have gleefully taken the opportunity of negligible borrowing costs to buy bigger, and in some cases multiple, properties, driving prices sharply higher in the process.

But interest rates cannot stay in the doldrums forever and the stock market may simply be pricing a risk premium into the price of property counters, in case the tide turns on the booming housing market.

Let us take a home-buyer who secures a 25-year, $1 million loan to buy his dream condo.

At a mortgage rate of 1.25 per cent, a back-of-the envelope calculation shows a monthly repayment of $4,375.

If the mortgage rate climbs back to 4 per cent - the prevailing rate three years ago - his instalment will escalate by almost 50 per cent to $6,666.

It is a simple illustration of how rising interest rates can make a big dent on the affordability of owning a home, especially alongside commitments like a car loan.

What worries some investors is that the Fed may be forced to start raising US interest rates as soon as 2012 to fight off inflationary pressure.

Higher interest rates may cause some home-buyers to walk away from their purchases, especially those who had bought properties under an interest-only payment scheme previously offered by developers to jack up sales at launches.

The scheme was scrapped by the Government in September last year but many projects that had already been financed by this option are scheduled for completion in 2012, just as the Fed may raise rates.

It is this market segment that has investors spooked as it is the one most likely at risk of defaults, as buyers can walk away from their purchases by simply forfeiting their downpayments.

Of course, defaults in 2012 will not materialise if property prices keep rising, allowing buyers to unload their purchases for a profit before they are completed.

But the likelihood is that price rises will moderate.

A recent Kim Eng Research report estimates that developers have about 15,600 unsold condos on hand.

This is more than sufficient to satisfy demand, even if it reaches 2007 highs. And that figure does not include new launches likely to hit the market and the growing supply of existing condos put up for sale.

It explains why equity investors are not taking any chances on property stocks, even though it seems unlikely that any home-buyer may default in today's buoyant market. The months ahead will determine which party has read the market correctly.

engyeow@sph.com.sg

Cai Jin runs every Monday and covers financial matters and corporate governance issues that can affect investors. The two Chinese characters marry wealth with good fortune - the two crucial factors that any investor needs to prosper.


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Home-buyers have gleefully taken the opportunity of negligible borrowing costs to buy bigger, and in some cases, multiple properties, driving prices sharply higher in the process.