Developers have had a tough 2020 between supporting their REITs, supporting their tenants, and having to revalue their hospitality portfolios downwards. Among the developers, JP Morgan likes CapitaLand — which is very diversified — and UOL Group for the Singapore reflation play. As part of the usual developers versus REITs battle, the large-cap developers are trading at discounts to their book values while the large-cap REITs are trading near or above their net asset values (NAVs).
Earnings for developers in FY2020 are likely to have been worse than in FY2019. Last year, both developers and REITs had to support their tenants over and above the rebates given by the government. Add to that two months of “circuit breaker” when malls and offices were virtually empty, and then a gradual reopening of the economy in phases.
These curbs, coupled with safe-distancing measures and continued restrictions on the number of people gathering together, are likely to depress mall visits, office occupancy and showflat visits. Hence, developer earnings excluding revaluations are likely to be lower y-o-y. On a positive note, these low levels of earnings provide a low comparable base for 2021 levels.
Already, both City Developments (CDL) and CapitaLand have announced profit warnings. In the case of CapitaLand, revaluation losses would likely cause a profit after tax and minority interest (Patmi) loss in FY2020, and ditto for CDL. The latter says the final quantum of impairment for its 51% stake in Sincere Property Group cannot be determined yet. No surprise then that some Singapore developers are trading at their steepest discounts to book in more than 20 years.
According to a report co-authored by Mervin Song, REITs and property analyst at JP Morgan, developers are trading at a 40% to 50% discount to book, and 0.6 to 1.9 standard deviations below the mean.
Another en-bloc cycle?
According to URA, the take-up rate in 2H2020 was around 6,100 units. Of course, some seasonality exists, with the Hungry Ghosts month and the festive seasons recording lower sales. If developers run low on their landbank, they have two sources of land: government land sales, and collective sales, popularly known as en bloc.
As Song tells it, the mass market could be under-supplied because of healthy take-up rates of new units, the Build-To-Order (BTO) and upgrading cycle, government stimulus, low mortgage rates and relatively low unemployment. This, he argues, could lead to a resurgence of the en-bloc cycle.
First, Song attributes the higher-than-initially expected take-up rate to a few factors tied to last year’s government stimulus.
“I’m most surprised by the resiliency of the property market, and that’s a function of the stimulus that we had last year of $100 billion. Most of that was to support jobs and gave people confidence and security of cash flow,” Song notes. “Affordability was one of the reasons that prices remained so resilient,” he adds, citing low mortgage rates. As part of the stimulus package, mortgage payments could be deferred, and the jobs support scheme helped to keep the unemployment low.
A second major reason could be upgraders. Some five to six years ago, a large bump in BTO completions of HDB units took place. BTO owners are required to hold their units for at least five years, under HDB guidelines. Hence, demand from upgraders could be supporting the number of sales outside of Districts 9, 10 and 11.
“The Core Central Region (CCR) is close to a 10-year oversupply of unsold units based on trailing units. [For] the Outside Central Region (OCR) and Rest of Central Region (RCR), assuming we have a 9,000 to 10,000 sell-through rate, developers would seek to replenish their landbank, and they [could] trigger the Reserve List or look at collective sales,” Song says.
Residential prices firmed as well. According to URA, prices of non-landed properties increased by 3.0% q-o-q in 4Q2020. Prices of non-landed properties in CCR increased by 3.2% q-o-q in 4Q2020, compared with a 3.8% q-o-q decline in 3Q2020.
Prices of non-landed properties in RCR increased by 4.4%, q-o-q in 4Q2020, while prices of non-landed properties in OCR rose by 1.7% q-o-q for the same period.
For the whole of 2020, prices of non-landed properties in CCR decreased by 0.4% y-o-y, while prices in RCR and OCR increased by 4.7% y-o-y and 3.2% y-o-y respectively.
According to JP Morgan’s report, historical demand for residential units averages 8,000 to 9,000 units a year. For the whole of 2020, developers sold 9,982 private residential units, compared with the 9,912 units in the previous year, URA says.
As at 4Q2020, 26,498 units were vacant, and 42,976 units were under construction. At that rate, JP Morgan estimates that it would take around three years to clear the vacant units. The vacant and pipeline units hide the disparities in the underlying segments, JP Morgan says. According to its calculations, they represent just 1.7 years of supply for the mass market, or the OCR segment, and 2.6 years supply for the mid-segment, or RCR. JP Morgan points out that the 7,700 units in CCR could take 10 years to clear.
Beware rising prices
If developers start to stock up on land as they sell down their units, land prices could start rising should developers start bidding more aggressively. Last month, for instance, around a third of 1,862 units at Normanton Park were sold on a weekend.
“Price rises increase the policy risk. We are expecting price increases of between 1% and 3% this year. That is supportive for developers’ share prices,” Song indicates. However, he is concerned that the “flour could be more expensive than the bread”, referring to the potential for land prices to rise.
Because of the recession in 2020 — Singapore GDP growth fell sharply by 5.8% — ultra-low interest rates and stimulus in global economies have pushed up asset prices. Singapore was no exception. Yet, ministers have articulated that property prices should rise in tandem with economic growth. With URA price indices up, and economic growth down, a disconnect obviously exists.
“If property prices were to go above 5%, investors would be nervous given that the government wants the property market to be stable and for prices to track income growth. Policy risks exist as prices go up by more than 5%,” Song warns.
Best property proxies
If land prices firm, what would be the best proxy? “Historically the two names would be CDL and UOL, given their historical exposure, and to a lesser extent CapitaLand,” Song says. “UOL is the clearer residential play at the moment,” he adds.
The CDL story has been extensively reported. Three directors, including Kwek Leng Peck, a cousin of executive chairman Kwek Leng Beng, have resigned since October last year, citing differences over the developer’s investment in Sincere Property Group, a troubled Chinese developer.
In an announcement, CDL stated that its total investment in Sincere amounts to around $1.9 billion, including an equity investment, subscription of bonds, loan guarantees, and so on. The announcement also warned that Sincere may have challenges meeting China’s three red lines.
In August 2020, China imposed the three red-lines guidance on selected developers in the wake of growing debt levels, rising land prices and strong residential sales.
The regulators will assess developers’ finance situation against three criteria or red lines. These are: i) liability to asset ratio of less than 70%, ii) net gearing ratio of less than 100%, and iii) cash to short-term debt ratio of more than one time. If the developers fail to meet one, two, or all, of the “three red lines”, regulators would place limits on the extent to which they can grow debt.
Sincere’s gearing is two times, according to Song. Based on the three red lines, gearing needs to fall to one time. To get to one time, CDL may need to inject more capital.
Of course, local developers like CapitaLand and CDL which operate in China have no problems meeting these three red lines. In its businesss update in November last year, CDL said net gearing ratio factoring in revaluation surplus from investment properties stood at 52% with interest cover at 4.1 times. Total borrowings have a weighted average debt expiry of 2.4 years. CDL’s management is likely to give more clarity on its exposure and its plans for Sincere during its FY2020 results briefing.
“CDL now has a higher risk profile but on a risk reward framework we are overweight on the stock,” Song says.
In reality, developers usually trade at discounts to NAV (see charts on weekly price to NAV). For instance, UOL has not traded at NAV in the past 10 years. CDL is now trading at two standard deviations below the mean, which is a 10-year low. CDL used to trade at or above its book value. CapitaLand is at one standard deviation below the mean and it has just rebounded off a 10-year low.
“While we expect property prices to rise 1% to 3% per year over 2021-2022, ROEs are likely to be still sub-optimal over FY2021. We maintain our view that price-to-book multiples should gravitate towards the one time average during 2013-2017,” JP Morgan says.
