NN THEME 120918 Malaysian Property Bubble I - The Facts

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    Date: 18 September 2012

    nonameInvestment

    Research

    Robin HU

    [email protected]

    Malaysian Property Bubble I The Facts

    Executive SummaryIn this paper, we address the question of whether the Malaysian

    property sector is in a bubble. As the property sector is very

    diverse, the enquiry is restricted to the residential sector in the

    four key economic states of KL, Selangor, Johor and Penang.

    Collectively, these four states contribute 75% of total residential

    sales and 60% of total residential transaction volume.

    Based on both statistics and income analysis, the Malaysian

    property sector is in a bubble. From a statistical perspective,

    measures of property activities such as property sales, transaction

    volume and sales to GDP ratio have all shown a marked departurefrom historical trends since 2007. From an income perspective,

    property prices are now unaffordable to the average household.

    Due to property prices growing at almost 3x the rate of income in

    recent years, Malaysia median multiple has leapt to 6.1x, well

    above the 3x mark that is considered affordable globally.

    We estimate that, in general, the average Klang Valley household

    can only afford a property in the RM400,000 range implying that

    the farther removed property prices are from this range, the more

    exposed they are to a correction. Specifically, considering that

    most listed property developers are still launching units at the

    RM500,000 to RM700,000 range even for the low end of their sales

    portfolio, we believe they are vulnerable to a correction. Too many

    developers are attempting to sell too many units to too few people

    at too high a price.

    The cause of the bubble can be traced to callous policies by the

    government and financial innovation by the property developers

    that took place in the last five years. In particular, the main culprits

    are the removal of RPGT in 2007, the all-time low interest rates in

    2009 and the DIBS scheme introduced by property developers in

    2009.

    In summary, driven by low interest rates, accommodative

    administrative policies and financial innovation through DIBS, the

    Malaysian residential property sector is currently in a bubble.

    Furthermore, the bubble is now at its end stage as prices are now

    too far removed from fundamentals. Investors should adopt a

    cautious stance as the sector will have limited upside potential and

    a sudden correction is possible.

    Thematic Report

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    Table of Contents

    Property Bubbles in General ...................................................................................... 3

    The mechanics of property bubbles ....................................................................... 3

    Why are property bubbles deadly? ........................................................................ 4

    Scope and Method ..................................................................................................... 5

    Scope restricted to residential in key economic states .......................................... 5

    Two methods: Statistical analysis and income analysis ......................................... 5

    The Statistical Viewpoint ............................................................................................ 7

    Residential sales Marked increase since 2007 .................................................... 7

    Rising sales to GDP ratio ......................................................................................... 8

    Transaction volume Similar to sales, marked rise since 2007 ............................. 9

    Residential price Take it with a pinch of salt ..................................................... 10

    The Income Viewpoint ............................................................................................. 14

    Malaysian household spending pattern ............................................................... 14

    The average Klang Valley household affordability is RM400k ............................. 14

    House price growing faster than household income ........................................... 16

    Rising price to income ratio .................................................................................. 16

    Why Residential Property is in a Bubble .................................................................. 18

    Review of key points from previous sections ....................................................... 18

    Why Msians cant afford what the listed developers are selling ......................... 19

    Where is the bubble then? ................................................................................... 20

    Factors Contributing to the Bubble .......................................................................... 21

    A tale of two halves .............................................................................................. 21

    Bad policy decisions nurtured the bubble ............................................................ 21

    The Removal of RPGT ............................................................................................... 23

    Malaysia RPGT regime .......................................................................................... 23

    RPGT removal spurred property activities ........................................................... 23

    The Nasty DIBS ......................................................................................................... 25

    The background and nature of DIBS ..................................................................... 25

    DIBS as a speculative tool ..................................................................................... 25

    DIBS speculation drove the bubble ...................................................................... 27

    How the Bubble Happened ...................................................................................... 29

    Conclusion ................................................................................................................ 30

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    Property Bubbles in General

    The mechanics of property bubbles

    Below is a brief outline of the mechanisms behind speculative bubbles in the

    property sector.

    Phase 1 (the positive shock). An initial positive shock results in a rise inproperty price. Due to the leveraged nature of property purchase (typically

    a leverage of 10x in Malaysia), the initial price rise results in outsized

    profits. At this point, the initial positive shock can either be interpreted by

    the market as transient or permanent. If the market perceives the price

    rise to be transient then the shock fizzles out. However, if the market

    interprets the shock as the start of a sustainable trend, then the

    perception itself (facilitated by accommodative credit environment)

    becomes a self-fulfilling prophecy and leads to Phase 2

    Phase 2 (the bubble). In Phase 2, a positive feedback loop develops andfuels the bubble. The positive feedback loop typically consists of a mutuallyreinforcing interaction between rising property prices, speculative profits

    and accommodative credit policy. Rising property prices result in outsized

    profits due to leverage. Rising property prices also result in bank expanding

    mortgage lending due to appreciating collateral. Outsized profits attract

    new speculators and easy mortgages allow more people to participate in

    the nascent bubble. Both developments provide fuel for further rise in

    property prices. Eventually property prices become too far removed from

    fundamentals and the whole sector becomes susceptible to a negative

    shock

    Phase 3 (the negative shock.) In Phase 3, property prices are now too farremoved from fundamentals and are being sustained only by newspeculative money flowing into the sector. In this phase, the property

    sector resembles a Ponzi scheme and similar to all Ponzi schemes, the

    inbuilt unsustainability of a self-perpetuating price rise serves as an

    infallible pin that could be relied upon to prick the bubble. Other factors

    could also act as a pin e.g. government action, macro instability etc.

    Whatever the pin may be, the bubble is pricked and property prices began

    to fall

    Phase 4 (the bursting of the bubble) Falling prices now result in outsizedloss due to leverage. At a leverage of 10x in Malaysia, a 10% decline in

    property price is all it takes to wipe out all invested capital. Such amplifiedloss results in panic dumping of properties and creates an intense

    downward spiral. The reinforcing mechanism described in Phase 2 now

    works in reverse. Losses began to spread beginning with the property

    speculators and property developers and if the bubble was serious enough

    then the banks and even the government will be affected as well. In this

    manner, a property problem could potentially lead to a banking problem

    which in turn leads to a fiscal problem

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    Why are property bubbles deadly?

    Credit bubbles amplifies damage. At the heart of every bubble is the relentless

    bidding up of prices. However, the bidding process may or may not be facilitated

    by borrowings.

    Property bubble without credit. Assume the situation is such thatproperties can only be purchased with 100% downpayment i.e. noborrowing allowed and hence no mortgages. Therefore, a RM100,000

    property can only be purchased if you have RM100,000. Furthermore, if

    the price subsequently increased to RM105,000 then the gain is

    (RM105,000 - RM100,000)/RM100,000 or 5%. Under such circumstances, a

    bubble could conceivably still form but speculation is more difficult here

    compared to if credit is freely available

    Property bubble facilitated by credit. Assume that the situation is nowsuch that credit is available and properties can be purchased with a 10%

    downpayment. Therefore, a RM100,000 property can now be purchased

    with only an upfront payment of 10% or RM10,000. Furthermore, if the

    price subsequently increased to RM105,000 then the gain is (RM105,000-RM100,000)/RM10,000 or 50%. This is 10x the gain of the aforementioned

    no-credit scenario. Clearly, if circumstances are at all conducive to the

    formation of bubble, then credit will further accelerate that formation

    Bubbles also deflate differently depending on whether credit was involved.

    Property deflation without credit. If the preceding bubble was formedsans credit then the deflation directly impacts only property speculators.

    The property developers may also feel the pain due to an overall slowing

    market but banks and government are generally not affected as under this

    scenario, property purchases involve only the speculator and the

    developer

    Property deflation with credit. In contrast, if the preceding bubble wasfacilitated by credit then a debt deflation could ensue. A property

    speculator facing rapidly falling property price will quickly accumulate

    negative equity. For example, on a 10% downpayment basis, a speculator

    will put in RM10,000 for a RM100,000 house and borrow the remaining

    RM90,000. If the property subsequently declined 15% to RM85,000, the

    speculator now has negative equity of RM5,000

    Debt deflation is malignant as it could lead to mortgage defaults which if

    sufficiently pervasive, will impact not only the property sector but the banks and

    the larger economy as a whole. Faced with defaults, banks will tighten lendingwhich will then lead to further decline in property price, reinforcing the downward

    spiral. If the problem is serious enough, banks could suffer losses or outright

    collapse.

    Property bubbles are frequently credit bubbles. Frequently, property bubbles are

    deadly as they are generally credit bubbles due to the pervasiveness of mortgages

    in the property sector. Downpayment requirement varies from countries to

    countries and from time to time. In Malaysia, downpayment is only 10% for the

    first purchase translating into an inbuilt leverage of 10x. Subsequent purchase may

    attract downpayment of up to 30% resulting in a still high leverage of 3.3x. In

    short, because property bubbles are frequently credit bubbles, the fallout from the

    bursting of property bubbles generally extend beyond the property sector.

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    Scope and Method

    Scope restricted to residential in key economic states

    The property sector can be subdivided into different segments such as residential,

    commercial, retail and industrial. These segments have different dynamics and as

    such, it is important to delineate right at the outset the segment underinvestigation. In this report, the analysis and any conclusions drawn are restricted

    to only the residential segment in four key economic states KL, Selangor, Penang

    and Johor. These four states alone contribute 75% of total residential sales and

    60% of total residential transaction volume.

    This particular segment is chosen for a number of reasons. Firstly, the residential

    segment is relatively more susceptible to bubble conditions compared to say the

    retail, commercial or industrial segments. This is because the residential segment

    has the widest reach (everyone will eventually buy a house but not everyone will

    buy a shopping mall) and the least sophisticated decision-makers (participants in

    non-residential segments are typically professionals). The residential segment

    ubiquity and easy participation by large numbers of unsophisticated participantsprovide fertile ground for speculation and thus bubble formation.

    Secondly, all the major listed property developers in Malaysia derive the majority

    of their revenue from the residential segment in the four key economic states. At

    the end of the day, the analysis here is meant to serve investors. Therefore, the

    analysis must focus on the segments that the listed property developers are most

    exposed to.

    Two methods: Statistical analysis and income analysis

    Two methods are used to establish that the Malaysian residential property

    segment in the four key economic states of KL, Selangor, Johor and Penang is in a

    bubble. The two methods are:

    Statistical analysis Income analysis

    In statistical analysis, statistics from NAPIC is used to show that:

    both property sales value and property transaction volume have behavedabnormally in the years since 2007

    these changes are caused by specific events that took place circa 2007-2009

    For statistical analysis to succeed, both points need to be established as sales value

    and transaction volume exhibiting a break from historical trend may not be a

    sufficient cause for concern by itself. It is only a concern if it can be shown that the

    break from historical trend was caused by specific events. This establishes

    causation and help explains the bubble.

    In income analysis, we attempt to show that the average property price has

    increased materially beyond the reach of the average households. The income

    approach relies on inconsistency between the income data and the property price

    data to demonstrate that both cannot be correct. Either the property price is

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    correctly captured and the average income is understated or the average income is

    correctly captured and the property price is too high.

    The two methods above can be referred to in isolation. One point to note is that

    statistics is a very crude tool as statistics aggregates away substantial amount of

    important details. For example, using the median price for houses essentially takes

    only the middle of the price distribution and ignores prices on both the left and

    right tails of the distribution. As such, even if prices changed substantially at thetails (say high-end condominium prices doubled), the median remains unaffected.

    All in all, the income approach is preferred due to its inbuilt consistency check.

    Given a property price, the range of income and mortgage rates that would make

    the property affordable can be easily derived. Here we do the reverse by first

    establishing a range income and then use that to show that the current property

    prices are unaffordable.

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    The Statistical Viewpoint

    Residential salesMarked increase since 2007

    Half of total property sales is residential. Total property sales was RM138bn in

    2011. The majority of property sales, 45% or RM62bn, was contributed by

    residential. Commercial property was the second largest, constituting 20% orRM28bn of sales. Other segments constituted the remaining 35%.

    Figure 1:Total property sales breakdown 2011

    Source: NAPIC

    75% of sales came from just four states. Geographically, Selangor was the single

    largest state for residential property sales contributing RM23bn or 37% of RM62bn

    residential sales. This was followed by KL (18%, RM11bn), Penang (12%, RM8bn)

    and Johor (8%, RM5bn). In total, 75% of all residential sales came from these four

    states. In fact, Selangor and KL by themselves already occupied 55% of sales.

    Figure 2:Residential sales by geography 2011

    Source: NAPIC

    Marked increase in sales since 2007. Residential sales has shown a marked growth

    since 2007.

    Annual residential sales have doubled to RM62bn in 2011 from justRM29bn in 2006. This is an annualized growth rate of 16% CAGR over the

    five year period 2006-2011

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    In comparison, residential sales grew by only 6% CAGR over the precedingfive year period 2001-2006

    Comparison on residential sales growth over two five year periodsTable 1:

    Five year

    2001-2006

    Five year

    2006-2011

    Growth in residential sales

    value (CAGR)6% p.a. 16% p.a.

    Growing even during global recession? Looking closer at Figure 3, it can be seen

    that the years 2007, 2010 and 2011 were years with very strong +20% growth. In

    fact, at 13%, 2008 was a year of very strong growth as well considering that sales in

    the fourth quarter of 2008 were effectively decimated by the Lehman crisis of Sep

    2008. Seen in this light, it appears that the Malaysian residential property sector

    has been on an upswing for at least half a decade punctuated only by the globalrecession in 2009. Even then, the 1% growth in 2009 was still good considering it

    took place against a backdrop of global recession1.

    Figure 3:Malaysia residential sales and growth 1989-2011

    Source: NAPIC

    Rising sales to GDP ratio

    Sales to GDP ratio now above historical trend. In the last decade, there has been

    only four times that the residential property sales to GDP ratio has risen above 6%.

    The years were 2004, 2009, 2010 and 2011. As can be seen, three out of the four

    years took place in the last three years. Last year residential sales to GDP ratio was

    the highest at 7.3%.

    This means that the marked rise in residential sales since 2007 was not a by-

    product of, and in tandem with, an overall rise in Malaysia GDP. Instead, it seems

    1

    We will show how the Malaysian property sector has been sustained by artificial tools beginning 2007 in laterparts of this report but for now note that the property sector began to take off in earnest in 2007 and continued

    growing despite the global recession

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    to have been driven by endogenous factors unique to the Malaysian property

    sector, resulting in property sales growing faster than GDP.

    Figure 4:Malaysia residential sales to GDP 2000-2011

    Source: NAPIC

    Transaction volumeSimilar to sales, marked rise since 2007

    Selangor accounts for a quarter of transaction volume. Total residential property

    transaction volume in Malaysia was 269,789 units in 2011. Again, the single largest

    contributor was Selangor (28%, 75k units) followed by the other three key states

    KL (9%, 24k units), Johor (12%, 31k units) and Penang (12%, 31k units)2.

    Collectively, these four states contributed 60% of total transaction volume.

    Figure 5:Residential units sold by state 2011

    No of residential units sold 2001 2006 2011

    KL 9,963 14,374 24,314

    Selangor 41,773 48,228 75,344

    Johor 24,594 22,958 31,084

    Penang 14,133 15,439 30,674

    Other states 85,745 81,556 108,373

    Total Malaysia 176,208 182,555 269,789

    Source: NAPIC

    Marked rise in transaction volume since 2007. Similar to sales, there has been a

    marked rise in transaction volume since 2007. From Figure 6 below, it can be seen

    that transaction volume spiked to 9% in 2007 in stark contrast to the 0% in 2006

    and -7% in 2005. Then transaction volume rose another 9% in 2008, declined 2% in

    2009 due to global recession before resuming at 7% in 2010 and a huge 19% in

    2011.

    2Incidentally, in terms of transaction volume, KL and Selangor are mirror image of each other. About half of KL

    transactions were condominiums/apartments while about half of Selangor transactions were terraced houses. Onthe flipside, 20% of KL sales were terraced houses while 20% Selangor transactions were

    condominiums/apartments.

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    Figure 6:Number of residential sales in Malaysia

    Source: NAPIC

    Spike in volume a departure from historical trend. To put into perspective how

    abnormal the spike in transaction volume, the table below compares two five-year

    periods.

    In the five years period 2001-2006, transaction volume was as good as flatat 0.7% CAGR

    In the five years period 2006-2011, transaction volume grew dramaticallyto 8% CAGR, a stark contrast to the preceding five year period 2001-2006

    Figure 7:Growth in residential transaction volumeFive year

    2001-2006

    Five year

    2006-2011

    Growth in residential transaction volume

    (CAGR) 0.7% p.a. 8% p.a.

    Residential priceTake it with a pinch of salt

    The problem with house price statistics. In earlier sections, we highlighted that

    statistics can be a very crude tool for decision making. This is best exemplified by

    property price statistics. For example, the two statistics used above, sales value

    and transaction volume, are actually fairly reliable due to the nature of how these

    statistics are recorded. Property transactions are very transparent and recorded in

    details by the government in order to establish rights to properties. That is why

    every transaction incurs a stamp duty. As a result, property transactions (sales

    value and transaction volume) are comprehensively and compulsorily captured.

    They are exhaustive.

    In contrast, property prices are not captured in this manner. Instead, a sampling

    method is used. Sampling entails pre-selecting a particular set of properties and

    updating its market price periodically. Immediately, the sampling approach

    presents some problems.

    Firstly, the pre-selected sample must be representative and this is clearlydebatable

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    Secondly, what exactly is the market price and what does it mean tohave a market price? In fact, we think the notion of a market price is

    itself incorrect and misleading. The term last transacted price is probably

    more apt and as any stock investor can elucidate, last price is not the same

    as market price at all

    Official statistics a bit removed from reality. Theory aside, the table below

    highlights how unrealistic the official property price statistics can be. For example

    The average price for a 2-3 storey terraced house in Selangor was capturedat RM300,000 in 2009. Any Malaysians will agree that this is unrealistic. A

    terraced house in Petaling Jaya would already cost at least RM700,000.

    Farther out in Shah Alam, the price would probably be at closer to

    RM500,000 in 2009 (RM650,000 in 2011). In fact, one would be lucky to

    get a mid-end condominium for RM300,000 in PJ what more RM300,000

    for a 2 storey terraced house

    Similarly, the price of a terraced house in KL was recorded as RM519,000.This is again unrealistic. One would be lucky to afford a 1-bedroom

    apartment in KL for RM500,000

    These price points are similarly divorced from reality in Johor and Penang as well.

    Note also that the price increase of 2.8% for Selangor is also highly suspicious. The

    actual rate is probably closer to 10%-15% on a crude estimate basis.

    Price for 2-3 storey terraced houseTable 2:

    RM 2000 2009 CAGR 00-09

    KL 288k 519k 6.7%

    Selangor 233k 300k 2.8%

    Johor 176k 202k 1.5%

    Penang 196k 387k 7.8%

    Negeri Sembilan 162k 312k 7.5%

    Perak 102k 164k 5.4%

    Melaka 136k 209k 4.9%

    Pahang N/A N/A N/A

    Terengganu* 66k 119k 6.8%

    Kelantan* 73k 93k 2.7%

    Perlis* 68k 108k 5.2%

    Sabah 132k 295k 9.3%

    Sarawak N/A N/A N/A

    Source: NAPIC, *1-1/2 storey terraced house

    In line with the above, we will rely as little as possible on NAPIC price statistics and

    property price indices. Instead, we will rely on other sources such as actual real

    estate agent quotations, advertised prices and developers launch prices.

    Official property price growth 4.4% looks too low. Nonetheless, below is a quick

    view of some price statistics from NAPIC for completeness purposes as these data

    points are frequently quoted. According to the official statistics from NAPIC, in the

    decade between 2001-2011, Malaysia overall property price increased by 4.4% per

    annum. More recently, in the five year period between 2006-2011, the growth was

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    5.1% CAGR with higher than average growth seen in the last two years 2010 (8.2%

    per annum) and 2011 (6.6% per annum).

    Figure 8:Malaysia residential price growth

    Source: NAPIC

    Geographically, the average increase in property price in the five year period

    between 2006-2011 was 6.3% for KL, 5.7% for Selangor, 2.6% for Johor and 5.8%

    for Penang.

    Figure 9:Residential price growth in KL, Selangor, Penang and Johor

    Source: NAPIC

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    Actual property price growth closer to 10%-15%. In our view, the official statistics

    tend to understate actual increase in property price (perhaps due to either their

    sampling or averaging methods). This can be substantiated by referring to the

    actual launch price disclosed by the listed property developers. Take SPSB

    developments for example:

    A SPSB two storey terraced house in Setia Alam was sold for RM218,000 in2004 while in comparison a similar house in the township was launched atRM668,000 in 2011. This represents an annualised increase of 17% per

    annum

    In Setia Eco Park, semi-detached that were first launched in 2005 ataround RM600,000 now command prices above RM2 million, an

    annualised increase of 22% per annum.

    Such price increase is not unique to SPSB but can be observed in developments

    launched by almost all other developers such MSGB, E&O, BRDB, GAM, IJMLD, etc.

    As such, it is estimated that the actual increase in property price is not 4.4% per

    annum as calculated by NAPIC but closer to 10%-15% per annum based on the

    developers launch prices and secondary sales price.

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    The Income Viewpoint

    Malaysian household spending pattern

    Breakdown of spending according to official statistics. According to official

    statistics3, there are 6.4m households in Malaysia. The largest concentration of

    households can be found in Selangor (1.3m households, 21% of total), Johor (0.8m,12%) and Sabah (0.6m, 10%).

    The average Malaysian household consists of four persons and earns an income of

    RM4,7004

    per month5

    and spends RM2,465 per month. As expected, the three

    largest components of expenditure are housing (RM583 per month, 24% of total),

    food (RM447, 18%) and transport (RM361, 15%). Also note that almost 80% of

    housing expenditure is related to the cost of housing itself. Ancillary costs such as

    utilities takes up the remaining 20%.

    Monthly RM expenditure per household (urban) 2009Table 3:

    RM 2009Food & Non Alcoholic Beverages 447 18%

    Clothing & Footwear 79 3%

    Housing, Water, Electricity, Gas 583 24%

    Furnishing, Household Equip 100 4%

    Health 33 1%

    Transport 361 15%

    Communication 147 6%

    Recreation & Culture 121 5%

    Education 39 2%

    Restaurants & Hotels 285 12%Miscellaneous 270 11%

    Monthly expenditure per household 2,465 100%

    Source: Department of Statistics, Malaysia

    The average Klang Valley household affordability is RM400k

    Average Msian household can only afford a RM110k unit. Based on the official

    statistics above, the average Malaysian household spend RM583 per month onhousing and utilities (the actual housing component itself is only RM466).

    Nevertheless, let us assume that the average Malaysian household spend higher

    than this, say RM600, on housing alone. For RM600 per month, on a 5%6

    30 year

    mortgage, the average Malaysian household can only afford at most a RM110,000

    unit.

    3Department of Statistics, Malaysia 2009

    4Urban household

    575% of Malaysian household earns less than RM5,000 per month

    6The current (floating) mortgage rate is closer to 3.75%-4.00% but we do not think this is sustainable. We have

    used 5% which is not too different from the current fixed mortgage rate 4.8%

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    Average Klang Valley individual can only afford a RM200k unit. The official

    average household income of RM4,700 per month is an average taken across the

    whole of Malaysia and as such may be lower than the average income in key urban

    areas. In particular, key economic areas such as the Klang Valley should have

    higher household income. This is indeed the case with the official average

    household income for Klang Valley closer to RM7,000 per month.

    Let us assume that the average income in Klang Valley is higher than the officialstatistics of RM7,000. In fact, let us assume it is RM8,000 or alternatively, the

    average income for an individual in Klang Valley is half of this or RM4,000. From

    this gross income, we will then deduct statutory contributions and typical monthly

    expenses in order to derive as the residual, the maximum income available for

    housing. The calculation is shown in Table 4 below.

    As can be seen, based on an average individual gross income of RM4,000, after

    deductions for statutory contributions and monthly expenses, only RM1,110 is

    available for mortgage payment (note we have not imputed savings). For RM1,100

    per month, the average individual in Klang Valley can only afford a property

    around RM200,000. This is 33% lower than the average terraced house price of

    RM300,000 in Selangor and 60% lower than the average terraced house price of

    RM516,000 in KL. In other words, if you are an average individual residing in Klang

    Valley, then even with no savings, you cannot afford a terraced house.

    Estimated maximum amount available for housing (individual)Table 4:

    RM 2009

    Gross income 4,000

    Tax (300)

    EPF (440)

    Net income 3,260

    Food (500)Transport, parking, car installment (1,200)

    Others (450)

    Max amount available for housing 1,110

    Average Klang Valley household can only afford a RM400k unit. Now if we

    approximate a household maximum available fund for housing by simply

    multiplying the above RM1,100 limit for an individual by two, then the average

    household in Klang Valley can only afford a property around RM400,000 which is

    actually close to average terraced house price of RM300,000 in Selangor andRM516,000 in KL.

    In summary, based on statistics, it can be concluded that

    The average household cannot afford an average terraced house inSelangor or KL

    The average Klang Valley individual also cannot afford an average terracedhouse in Selangor or KL

    Only with the combined income of two Klang Valley individuals, devotingall their income to mortgage repayment (no savings, after deductions for

    statutory contributions and monthly expenses), can a terraced house inSelangor or KL be considered affordable

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    House price growing faster than household income

    Officially property price growth in line with income growth. Anecdotally, typical

    starting pay for a fresh audit graduate ten years ago was RM2,000 compared to the

    current RM3,000. This translates into a growth of 4% per annum in line with the

    growth in average household income of 3.7% as tabulated by the department of

    statistics.

    In comparison, the property house price in Malaysia increased by 4.4% over

    roughly the same period (see Table 5 below) with 6% in KL, 3.9% in Selangor, 2% in

    Johor and 5% in Penang. This seems to show that the average property price

    increase was only slightly above the average household income increase.

    House and income growth rateTable 5:

    Source

    House Price

    Index

    2001-2011

    Terraced house

    2000-2009

    KL NAPIC 6.0% 6.7%

    Selangor NAPIC 3.9% 2.8%

    Johor NAPIC 2.0% 1.5%

    Penang NAPIC 5.0% 7.8%

    Malaysia NAPIC 4.4% N/A

    Average household

    income(urban)*Dept of statistics 3.7%

    *2002-2009

    But in reality, property price growth 3x that of income. As we highlighted

    previously, price statistics from NAPIC should be taken with a pinch of salt as the4.4% estimated rate of growth in house price appears too low. Instead, based on

    the developers launch price, the average increase in property price should be

    closer to 10%-15% p.a. in the last five years. On this basis, the average property

    price increase (10%-15%) is actually almost 3x that of the average salary increase

    (3.7%). In other words, property price has increased disproportionately faster than

    income increase in the last five years.

    Rising price to income ratio

    Globally, median multiple of 3x is considered affordable. Based on medianmultiple (median house price divided by gross before tax annual median household

    income), the Demographia International Housing Affordability classify housing

    markets into four categories as per the table below.

    Historically, the median multiple clustered around 3x globally and as such, markets

    with multiples 3x and below are considered affordable. Affordability declines as

    the multiple increases.

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    DIHA affordability classificationTable 6:

    Median multiple

    Affordable 3x and under

    Moderately unaffordable 3.1x to 4.0x

    Seriously unaffordable 4.1x to 5.0x

    Severely unaffordable 5.1x and over

    Source: DIHA

    Applying the above definition, DIHA derived the following median multiples for the

    selected countries below. Some of the countries considered unaffordable based on

    this definition includes Australia, Canada, Hong Kong, New Zealand and United

    Kingdom. In contrast, the two countries that has just experienced a property

    bubble, Ireland and United States, now have median multiple closer to the

    historical 3x.

    Median multiple for selected countries 2012Table 7:

    National median

    Australia 6.7

    Canada 4.5

    Hong Kong 12.6

    Ireland 3.4

    New Zealand 6.4

    United Kingdom 5.0

    United States 3.1

    Source: DIHA

    With a multiple 6.1x, Malaysia is unaffordable. Based on official statistics7,

    the mean household annual household income in Klang Valley is RM84,000(RM7,000 x 12)

    the mean price of a terraced house is RM516,000 in KL and RM300,000 inSelangor

    This implies a median multiple of 3.6x in Selangor and 6.1x in KL. Considering

    current launches are still being priced at minimum in the RM500,000 to

    RM700,000 range in Selangor and KL, the actual median multiple is closer to 5.9x

    to 8.3x, significantly above the 3x that DHIA considers affordable.

    Malaysia median multiple 2011Table 8:

    RM Median multiple

    Annual household income Klang Valley 84,000

    Mean price terraced house KL 516,000 6.1x

    Mean price terraced house Selangor 300,000 3.6x

    7Here we used mean instead of median as per DIHA due to data limitation

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    Why Residential Property is in a Bubble

    Review of key points from previous sections

    All indicators point towards a bubble. Based on statistics, we arrived at the

    following:

    1. There has been a marked increase in sales value since 2007. Average fiveyear CAGR increased from 6% to 16% (pg 7)

    2. There are only four years in the last decade where the sales to GDP ratiohas risen above 6%. The years were 2004, 2009, 2010 and 2011 (pg 8)

    3. There is a marked increase in transaction volume since 2007. Average fiveyear CAGR increased from 0.7% to 8% (pg 9)

    Comparison of residential sales value and transaction volumeTable 9:

    CAGRFive year

    2001-2006

    Five year

    2006-2011Growth in residential sales value 6% p.a. 16% p.a.

    Growth in residential transaction volume 0.7% p.a. 8% p.a.

    And based on income, we arrived at the following:

    4. The average Klang Valley household can afford only properties in theRM400,000 price range (pg 15)

    5. House prices have grown faster than income. Our estimated actual rate ofgrowth of house price of 10%-15% is almost 3x the 3.7% growth in income(pg 16)

    6. Malaysia median multiple of 6.1x is significantly above the 3x that DHIAconsiders affordable (pg 17)

    Therefore based on both statistics and income, all six separate indicators point to

    the same conclusion that the Malaysian property sector is now in a bubble8. And

    by bubble, we mean that the sentiments in the property market is now overly

    positive and removed from fundamental resulting in the average property prices

    being pushed beyond the affordability of the average household.

    All these six indicators are independent of each other yet they are consistent intheir conclusion. Not only that, the statistics also singled out 2007 as the year

    where the bubble took off in earnest. The next section will provide an explanation

    for this.

    8As a reminder, our scope is restricted only to residential property segment in KL, Selangor, Johor and Penang

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    Why Msians cant afford what the listed developers are selling

    Only 12% can afford what the listed developers are selling. Out of a total

    transaction volume of 270k units for Malaysia, the four states, KL, Selangor, Johor

    and Penang contributed 60% or 161k units. And out of this 161k units sold, only a

    slim 12% or 20k units were priced at RM500,000 and above.

    5,600 units from KL

    10,300 units from Selangor 900 units from Johor 3,200 units from Penang

    Expectedly, 23% of residential units in KL were transacted at RM500,000 and

    above. However, once we moved out of KL, the ratio drops quickly to 14% in

    Selangor, 3% in Johor and 11% in Penang.

    This has important implication for the listed property developers. As the listed

    developers sales portfolio typically consists of property priced at RM500,000 and

    above, this implies that the listed property developers are effectively serving onlythe top 12% of the market and with 50% of that market concentrated in Selangor.

    It is a narrow market and they are hardly catering to the mass market at all.

    Residential units sold by price range 2011Table 10:

    KL Selangor Johor Penang

    RM1m 2,231 3,022 147 831

    Total 24,314 75,344 31,084 30,674

    % more than RM500k 23% 14% 3% 11%

    Source: NAPIC

    Current selling price implies too high a median multiple. On pg 15, it was

    highlighted that the average household in Klang Valley can only afford a property

    around RM400,000 which is close to average terraced house price of RM300,000 in

    Selangor and RM516,000 in KL.

    However, most of the listed property developers are already launching units at a

    minimum RM500,000 to RM700,000 range, higher than the official averageterraced price of RM300,000 in Selangor and RM516,000 in KL. At this RM500,000

    to RM700,000 price range, the median multiple jumps to 6.0x to 8.3x, materially

    above the 3x that DHIA considers affordable.

    If we consider the average selling price of properties launched by listed developers

    (which is closer to RM700,000) instead of the average terraced house price of

    RM300,000 in Selangor and RM516,000 in KL (both already understated in our

    view), then the problem of affordability becomes clear. Most people simply cannot

    afford what the developers are selling. In fact, 88% of Malaysians cannot afford to

    buy what the listed developers are selling.

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    Where is the bubble then?

    Price instead of location definition. Property, by nature, is not homogeneous. Two

    units in the same vicinity may be priced differently for multitude of reasons such as

    design, build quality, furnishing, amenities, developers reputation, etc.

    As such, it would not be helpful to say, for example, that condominiums in

    location X is in a bubble. Instead, we think it is more helpful to highlight thebubble from a perspective of price and say for example that condominiums priced

    above RMXXX,XXX is in a bubble. Even then, this can also be inadequate for a

    RM500,000 condominium may be expensive in the suburb but surely it is cheap if it

    is located a stones throw away from KLCC.

    All in all, it makes more sense to highlight the bubble from a price perspective

    rather than categorically by location. After all, our definition of bubble is made

    with reference to affordability.

    That being said, considering that the average Malaysian household can only afford

    properties circa RM400,000 based on income, then naturally the farther property

    prices are removed from this mark, the more unsustainable they are.

    Be cautious at RM500,000 and above. In our view, based on the number of units

    being offered for sale, supply outstrips demand in the following segments

    Condominiums between RM400,000 to RM600,000 are rather bubbly.RM600,000 and above is overly bubbly

    Terraced houses between RM600,000 to RM800,000 are rather bubbly.Anything close to RM1m is overly bubbly

    Price guides are less helpful for semi-detached and bungalowsTable 10 is a handy guide. As can be seen, once outside KL, property priced at

    RM500,000 and above are effectively catering to top 12% of buyers. Morespecifically, top 14% in Selangor, top 3% in Johor and top 11% in Penang.

    Cumulatively, this amounts to 5,600 units in KL and 14,500 units in the remaining

    states of Selangor, Johor and Penang (and this was during 2011, a boom year for

    property). There is simply not enough households that can afford that many units

    priced at such range.

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    Factors Contributing to the Bubble

    A tale of two halves

    Why two distinct halves? From Table 9 in the previous section, it is obvious that

    residential sales value and transaction volume exhibited two very distinct periods.

    The second five year period 2006-2011 clearly has much higher growth comparedto the first five year period 2001-2006.

    Sales annual growth jumped to 16% p.a. in the second period compared to6% in the first period

    Transaction volume annual growth jumped to 8% p.a. in the second periodcompared to a negligible 0.7% p.a

    Why do the two periods differ so much in growth rate? And why was there a spurt

    in activity from 2007 onwards? The answer lies with bad policy decisions.

    Bad policy decisions nurtured the bubble

    Property sector stoked by bad policy decisions since 2007. The property sector is

    very susceptible to policy decisions as the government controls the single key

    determinant of housing affordability; the interest rate. A 100bps change interest

    rate will change housing affordability by around 10%-15%. Moreover, the

    government also decides on other administrative policies that directly affect the

    property sector such as the loan-to-value ratio (LTV), interest deductibility for

    housing, withdrawal of pension fund for housing purposes and the most important

    component of all, the real property gains tax (RPGT).

    Unfortunately for Malaysians (but fortunately for the property developers), thegovernment loosened its stance on all fronts.

    The RPGT was abolished on 1 April 2007. Capital gains tax declined from30% to zero overnight

    The central bank of Malaysia BNM cut the overnight policy rate (OPR)three times for a total 150 bps between Nov 2008 and Feb 2009, bringing

    the OPR from 3.5% to an all-time low of 2% where it stayed for a year.

    Consequently, the BLR (which the mortgage rate is based on) was brought

    to its all-time low of 5.55% as well (see Figure 10 below). Malaysia had

    never seen such low rates before. (The effective mortgage rate was even

    lower. Whereas previously banks used to price mortgage rate at BLR plus,

    in the last few years banks have been pricing mortgage at BLR minus. For

    example, despite the current BLR of 6.6%, banks are still currently offering

    30 year mortgages at BLR minus 2.4% resulting in a still very low effective

    interest rate of 4.2%. In fact, it is not uncommon to find mortgage rates at

    sub 4% at all)

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    Figure 10:Malaysia OPR and BLR 2006 to 2012

    Source: CEIC

    The government provided tax relief on interest paid on housing loan up toRM10,000 a year for three years for properties purchased between Mar

    2009 and Dec 2010

    From 1 January 2008, the government allowed monthly EPF withdrawal forhousing purposes

    9

    Liberalisation of Foreign Investment Committee ruling on foreignpurchases, removing the cap on the number of houses foreigners can buy

    and to allowing them to borrow from local banks

    Ripe for a bubble. An all-time low interest rates, removal of capital gains tax,

    interest deductibility and other administrative policies really ensure that property

    prices have nowhere else to go but up. In fact, it is almost as if the government

    wanted a property bubble as they seemed to have used every tricks in the bag to

    make sure the bubble inflates.

    Nevertheless, in our view, the single most important driver of the bubble was

    actually introduced not by the government but by the private sector. This is the

    DIBS scheme introduced by private developers in January 2009 (specifically it was

    first introduced by SPSB). Above and beyond the aforementioned callous policy

    decisions by the government, it was really DIBS that provided the afterburner to

    propel the market to new speculative height.

    The fact that low interest rates stoke property prices has already been abundantly

    discussed by others so we will not dwell further on this. Instead, we will look at

    RPGT and DIBS in the next section as they relate specifically to Malaysia.

    9The impact of this is best explained in SPSB own words and we quote verbatim The governments landmark

    decision to allow monthly EPF withdrawals to fund mortgages, which is estimated to unleash some RM9.6bn

    annually, will profoundly impact the property market. We expect this to spur demand for a wide spectrum ofproperties across the board as the 5 million EPF contributors take advantage of this flexibility to boost their

    purchasing power

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    The Removal of RPGT

    Malaysia RPGT regime

    The removal of RPGT. Tax on property in Malaysia was introduced in 1974 under

    the Land Speculation Tax Act which, as its name implies, was put into effect to curb

    property speculation. The year after, in November 1975, the Land Speculation TaxAct was replaced with the present Real Property Gains Tax.

    Malaysian RPGT regime can be divided into six periods:

    Period A ran the longest from 1975 to May 2003. During this period, RPGTwas as high as 30% for disposal within two years before graduating to 20%

    in 3rd

    year and eventually zero after fifth year

    RPGT was suspended twice. Once from Jun 2003 to May 2004 (Period B)and another time from April 2007 to Dec 2009 (Period D). During these

    periods, no tax was payable

    There was an intermission where RPGT was reintroduced from Jun 2004and Mar 2007 (Period C) at the old rates that existed pre May 2003

    After the second suspension of RPGT in Period D, RPGT was reintroducedon Jan 2010 but at a much lower rate of 5% (Period E)

    We are currently in Period F which is similar to Period E except that the taxrate has been increased slightly to 10% for property disposed within two

    years

    The current RPGT regime of 10% is very mild both with reference to historical rates

    of 30% and also in comparison to other countries.

    Malaysia RPGT regimeTable 11:

    Period A

    Nov75

    31 May 03

    Period B

    1 Jun 03

    31 May 04

    Period C

    1 Jun 04

    31 Mar 07

    Period D

    1 Apr 07

    31 Dec 09

    Period E

    1 Jan 10

    31 Dec 11

    Period F

    1 Jan 12 -

    current

    Disposal within 2 years 30% No RPGT 30% No RPGT 5% 10%

    Disposal in 3rd

    year 20% 20% 5% 5%

    Disposal in 4th

    year 15% 15% 5% 5%

    Disposal in 5th

    year 5% 5% 5% 5%

    Disposal after 5th

    year Nil Nil Nil Nil

    RPGT removal spurred property activities

    Removal of RPGT stimulated property activities The removal of RPGT has a

    stimulative effect on the property market. Figure 11 below highlights in light gray

    the years where RPGT was removed and the corresponding upward swing in price

    and transaction.

    Once the RPGT was removed in 2003-2004, sales grew 9% and 27% in 2003and 2004, a marked departure from the 1% and -5% recorded in the

    preceding years 2001 and 2002

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    This can be observed again the second time RPGT was removed in 2007-2008 where sales leapt 24% and 13% in 2007 and 2008. Again this is in

    contrast to the -3% and 4% recorded in the preceding years 2005 and 2006

    The year 2009 was an exception as despite RPGT being removed, salesgrowth was only 1% due to the global recession

    The most recent years 2010 and 2011 were also years of high growth asRPGT was reintroduced not at the historical 30% but at the almost

    negligible rate of 5%

    Figure 11:Malaysia residential sales growth 2001-2011

    Source: NAPIC

    Similarly, from a property transaction perspective, the same behavior can be

    observed. The years where RPGT was removed were years where transaction

    volume leapt strongly and departed markedly from years where RPGT were in

    force (see Figure 12).

    Figure 12:Malaysia residential transaction growth 2001-2011

    Source: NAPIC

    Therefore, historically at least, the removal of RPGT has consistently stimulated

    property price and transaction volume.

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    The Nasty DIBS

    The background and nature of DIBS

    What is DIBS? Subsequent to the global recession following the Lehman crisis in

    September 2008, the Malaysian property went into remission. As SPSB described

    it10

    The global financial crisis brought consumer sentiment to an all-time low,

    even below the Asian Financial Crisis levels. In the months of November and

    December, sales dropped more than 70% to RM30m a month compared to the

    preceding year. We had to think of new ways to re-ignite consumer interest.

    In order to spur sales, SPSB introduced the Setia 5/95 scheme.

    Hence, the introduction of the Setia 5/95 Home Loan Package. The financing

    package worked on the premise of a 5% down payment with no interest

    payable during construction with the purchaser servicing his 95% loan only

    upon completion of the property. Added incentives included in the package

    were the absorption of legal fees and stamp duty on the Sale & PurchaseAgreement, Loan Agreement and the Memorandum of Transfer by the

    developer.

    SPSB Setia 5/95 scheme and similar schemes by other developers have since came

    to be known as a Developer Interest Bearing Scheme (DIBS). Under DIBS, a

    property buyer just needs to pay a 5% down payment. No further payment is

    required until the property is completed.

    DIBS success, copycat schemes and subsequent expansion. The DIBS was very

    well received and soon other developers replicated the scheme. For example,

    IJMLD introduced their version of DIBS named My Space Plan interest bearing

    scheme on 1 April 2009. In SPSB words,

    The financing package was launched in January 2009 and not only garnered

    great buying interest from the public but saw other industry players follow suit

    introducing various incentives for property purchasers. Overwhelming response

    to the campaign saw the Group extending the initial three-month period for

    another three months to end in July.

    DIBS as a speculative tool

    Why DIBS is nothing but a speculative tool. Property purchase can be naturally

    attractive to speculators due to its inbuilt leverage.

    1. At the typical down payment of 10%, the inbuilt leverage in a propertypurchase is 10x

    2. As long as the property price appreciation is higher than the cost offinancing, then property speculation becomes highly profitable

    Generally, in the past, property speculation has not been attractive in Malaysia as

    mortgage cost and the long run rise in property prices tend to be almost similar

    and thus cancel each other out, resulting in no speculative gain. However, the DIBS

    10Verbatim, SPSB annual report

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    remedied this problem by introducing two attributes that makes it attractive to

    speculate on properties.

    Firstly, the DIBS temporarily removed the mortgage cost component byabsorbing interest cost during construction. Without the mortgage cost to

    act as restraint, any growth in property price results in speculative profit

    immediately

    Secondly, reducing the down payment from 10% to 5% doubled thealready high leverage from 10x to 20x and significantly magnifies any

    speculative profit

    How DIBS create speculative profit. The aforementioned (1) interest cost

    absorption and (2) reduction of down payment from 10% to 5% work in tandem to

    create large speculative profits as long the property price does not decline11

    . Even

    if the property price just rose 3% in a year, the speculative profit can be very large.

    For example12

    ,

    Assume that a speculator purchased a property for RM500,000 and sold ita year later after it has appreciated by 3% to RM515,000

    The down payment is 5% or RM25,000 The gross proceed is RM515,000 less RM500,000 or RM15,000. The return is RM15,000/RM25,000 = 60%. (Alternatively, this can be

    derived by multiplying the asset appreciation 3% by the leverage 20x)

    The reason why property speculation is now profitable is because the cost of

    servicing the debt during the construction period, which served as the single

    largest hurdle rate in the short term, has been nullified by the interest absorption

    clause under DIBS. Note also that the RPGT was only reintroduced in January 2010.

    This means that when the DIBS was first introduced in January 2009. All thespeculative gain was tax free13

    .

    From bad to worse. DIBS, instead of being a temporary marketing tool, has now

    become a permanent fixture in property sales. Three years after it was initially

    conceived in January 2009 by SPSB, it is still very much alive and very much more

    virulent. The current variant of DIBS has become even more of a speculative tool

    compared to its original variant.

    Take for example the DIBS offered by MSGB for its M-City properties recently in

    2012. In addition to the standard interest and incidental costs absorption as per

    the original DIBS scheme, MSGB has gone one up and introduced the following

    incentives

    1. Reduced down payment from 5% to 2% and thereby increasing theleverage factor from an already high 20x to 50x!

    2. an 8% rebate3. partially furnished4. 1 year maintenance

    11The property sector now resembles a Ponzi scheme. There will continue to be speculative profits so long as the

    property price does not decline

    12

    We have excluded a few incidental costs involved in the selling of the property13

    Imputing RPGT will reduce the gain slightly as there are deductible allowances under RPGT

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    Figure 13:Incentives offered by MSGB for M-City

    Source: MSGB advertisement 2012

    DIBS speculation drove the bubble

    Why are incentives needed if property is affordable? The above MSGB property

    advertisement begs the question, if property is affordable, why is there then the

    need to offer incentives? The fact that a barrage of incentives is needed to sell a

    property, does this not imply that the current property price is too high?

    Furthermore, note how all the incentives really served to artificially support

    property prices. Incentives such as an 8% rebate, partial furnishing, legal fees and

    incidental cost absorption, interest cost absorption and 1 year maintenance (other

    gimmicks include guaranteed rental) all serve to prevent property prices from

    declining as they would in a property market left to function on its own under the

    rule of demand and supply.

    The truth is that, at current launch prices, properties are simply not affordable to

    many (we have justified this view on the basis of statistical and income analysis in

    earlier sections). All the aforementioned incentives, are really just insidious means

    to postpone14

    a property price decline by reducing the net effective purchase price

    of property while keeping the gross price high.Why property developers are afraid of falling property prices. This brings up

    another question, why are property developers so afraid of falling property prices?

    Isnt selling a RM550,000 unit with RM50,000 incentives thrown in the same as

    selling a RM500,000 units? From a bottom line perspective, the property

    developers should be unperturbed. Why then do property developers not just

    simply sell properties at the price sans incentive but expend efforts instead in

    devising various incentives? This is a very peculiar situation. It is hard to think of

    another industry where the sellers choose to advertise a higher rather than a lower

    14We have used the word postpone rather than prevent because it is not possible to stop the property price from

    reverting to its fundamental price. Postpone, yes. Prevent, no.

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    price for their products if the sellers net profit is the same under either scenarios.

    Lower prices, and not higher prices, move goods.

    In fact, there is only another industry in which the sellers may have an interest to

    keep the prices high even at the expense of their net profit in the short term. It is

    an industry which we are familiar with i.e. the stock market. Here, speculators

    accumulate position in a stock and then subsequently try to create enthusiasm for

    a stock through upward price movement in order to (hopefully) exit the wholeposition at a higher price.

    Therefore, it is now clear why property developers artificially keep property prices

    high even at the expense of profitability. This is because the property prices are

    now so high that the sector is now being supported by speculators rather than real

    buyers. The real buyers have already been priced out of the market and the

    property developers know it. That is why they actively chose to keep property

    prices high (in order to appeal to the speculative buyers) instead of doing what is

    logical and cut prices to sell more units (in order to appeal to the buy-to-stay

    buyers). The property developers are fully aware that they are now catering to the

    speculators.

    Property developers or derivative sellers? It is worth mentioning that there are a

    number of differences between speculation in the stock market and speculation in

    the property market.

    Firstly, market activities are monitored in the stock market but not in the property

    market. NAPIC collect statistics but NAPIC does not have monitoring and

    enforcement powers similar to that of the Securities Commission.

    Secondly, you cannot buy stocks in the stock market with only a 5% down payment

    but you can do so with properties. In the financial market, there is a term for

    instruments that provides you exposure to an underlying asset class at a fraction of

    the price of the asset. It is called a derivative and this is precisely the role of DIBS in

    the property market. In fact, it resembles a forward contract with a very low

    margin requirement (2%-5%). If DIBS is a derivative, then that makes the property

    developers the derivative sellers. As mentioned in the opening chapter, every

    bubble is expedited by credit. Here, the role of credit providers is being filled by

    the property developers (abetted by banks).

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    How the Bubble Happened

    In summary, here is our simplified version of how the bubble developed

    The removal of RPGT on 1 April 2007 kickstarted the property market butthe bubble was still nascent at this stage. Nevertheless, the signs were

    there as residential sales growth shot up 24% in 2007 compared to only 4%

    in 2006. This was the second time RPGT was removed. The previous timeRPGT was removed back in 2004 also resulted in a jump in activities as

    residential sales growth also shot to 27% then

    The sales momentum continued into 2008 but was decimated by theLehman collapse in Sep 2008. Still the overall sales growth for 2008 was

    still good at 13% due to strong sales in earlier quarters

    First quarter 2009 marked the period where two developments worked intandem to give the property market its ultimate boost. Firstly, BNM

    reduced the interest rate by 150bps to an all-time low of 2% and

    maintained it there for the whole of 2009 in response to the global

    recession. Correspondingly, mortgage rates dropped to an all-time low aswell. Secondly, the property developers introduced DIBS which turned out

    to be a highly efficient speculative tool

    The two developments above solidified the bubble in 2009. For 2010 and2011, the bubble essentially fed on itself and kept growing

    This brings us to 2012 where sustained increase in property prices since 2007 has

    now resulted in properties being out of reach for the majority of households.

    Figure 14:Malaysia residential sales growth 2001-2011

    Source: NAPIC, years where RPGT was suspended are highlighted in gray

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    Conclusion

    In this paper, we address the question of whether the Malaysian property sector is

    in a bubble. As the property sector is very diverse, the enquiry is restricted to the

    residential sector in the four key economic states of KL, Selangor, Johor and

    Penang. Collectively, these four states contribute 75% of total residential sales and

    60% of total residential transaction volume.Based on both statistics and income analysis, the Malaysian property sector is in a

    bubble. From a statistical perspective, measures of property activities such as

    property sales, transaction volume and sales to GDP ratio have all shown a marked

    departure from historical trends since 2007. From an income perspective, property

    prices are now unaffordable to the average household. Due to property prices

    growing at almost 3x the rate of income in recent years, Malaysia median multiple

    has leapt to 6.1x, well above the 3x mark that is considered affordable globally.

    We estimate that, in general, the average Klang Valley household can only afford a

    property in the RM400,000 range implying that the farther removed property

    prices are from this range, the more exposed they are to a correction. Specifically,

    considering that most listed property developers are still launching units at the

    RM500,000 to RM700,000 range even for the low end of their sales portfolio, we

    believe they are vulnerable to a correction. Too many developers are attempting

    to sell too many units to too few people at too high a price.

    The cause of the bubble can be traced to callous policies by the government and

    financial innovation by the property developers that took place in the last five

    years. In particular, the main culprits are the removal of RPGT in 2007, the all-time

    low interest rates in 2009 and the DIBS scheme introduced by property developers

    in 2009.

    In summary, driven by low interest rates, accommodative administrative policies

    and financial innovation through DIBS, the Malaysian residential property sector is

    currently in a bubble. Furthermore, the bubble is now at its end stage as prices are

    now too far removed from fundamentals. Investors should adopt a cautious stance

    as the sector will have limited upside potential and a sudden correction is possible.

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    Rating structure

    The rating structure consists of two main elements; fair value and conviction rating. The fair value reflects the security

    intrinsic value and is derived based on fundamental analysis. The conviction rating reflects uncertainty associated with the

    security fair value and is derived based on broad factors such as underlying business risks, contingent events and other

    variables. Both the fair value and conviction rating are then used to form a view of the security potential total return. A

    Buy call implies a potential total return of 10% or more, a Sell call implies a potential total loss of 10% or more while all

    other circumstances result in a Neutral call.

    Disclaimer

    This report is for information purposes only and is prepared from data and sources believed to be correct and reliable at

    the time of issue. The data and sources have not been independently verified and as such, no representation, express or

    implied, is made with respect to the accuracy, completeness or reliability of the information or opinions in this report. The

    information and opinions in this report are not and should not be construed as an offer, recommendation or solicitation to

    buy or sell any securities referred to herein. Investors are advised to make their own independent evaluation of the

    information contained in this research report, consider their own individual investment objectives, financial situation and

    particular needs and consult their own professional and financial advisers as to the legal, business, financial, tax and othe r

    aspects before participating in any transaction.