osk research on property

8/8/2019 OSK Research on Property

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PP10551/10/2009(022563)03 September 2010

OSK Research | See important disclosures at the end of this report 1

MALAYSIA EQUITYInvestment Research

Daily News

Sector UpdateMervin Chow Yan Hoong+60 (3) 9207 [email protected] Property

A Brewing Real Estate Mania

OVERWEIGHT

Long-wave real estate trends are clearly driven by demographics, which are

instrumental in prompting a revamp to long-term investment strategies. As we believe

we are currently at the locus of another major turning point in the long-wave real estate

trend, we examine in detail, using demographic analysis, when and which real estate

segment is likely to be hot (and which wont be) for the next decade. Location isalways cited as key to identifying real estate opportunities but what is equally

important but often overlooked is timing. We believe we are seeing the beginning of

what would perhaps be Malaysias biggest residential real estate boom in more than a

decade with key insights being:

A major mass housing boom will likely occur in the first half of this decade;

We are in the early stage of a property super cycle led mainly by mid-to-high end

landed properties which may peak sometime in 2012/13 and followed by a potential

slump;

The current 20-year secular boom in mid-to-high end residential properties since

the early 1990s may peak in 2012/13, after which mass affordable housing could

dominate the real estate theme until circa 2015/16;

Stocks with focus in the mid-to-high end segment (e.g. Sunrise, YNH Prop, IGB

Corp and BRDB) are your best bets for the next 12 months prior to the 2012/13

potential peak. Mass housing developers, especially the fallen angles such as LBS

Bina and MK Land may come to the fore as another major investment theme after

that. For best-of-all-worlds exposure during this period, BUY SP Setia.

Although the expected peak in 2012/13 may be followed by a slump, the phenomenal

boom that immediately precedes it gives investors an excellent opportunity to profit

from the trend, at least for the next 12 months. We therefore seize this opportunity to

upgrade our property sector call to OVERWEIGHT from Neutral.

DemographywilldriveMalaysiasBiggestResidentialRealEstateBoomsincethe

AsianFinancialCrisis


2/41See important disclosures at the end of this report

OSK Research


TABLE OF CONTENT

Abstract Page

FOREWORD ................................................................................................. .......................................................... 3

PROLOGUE: DEMOGRAPHIC WAVE AND THE REAL ESTATE LONG WAVE BOOM-BUST CYCLES .......... 4

CHAPTER 1: THE COMING MASS HOUSING BOOM ...................................................................................... .. 10

CHAPTER 2: HIGH-END PROPERTIES ENTERING FINAL PHASE OF LONG WAVE BOOM ........................ 14

CHAPTER 3: SOWING THE SEEDS OF THE NEXT MANIA .............................................................................. 27

CHAPTER 4: HOW YOU SHOULD INVEST IN THE NEXT MANIA .................................................................... 36



OSK Research


FOREWORD

TERRACE HOUSES SOLD FOR RM1M! BUYERS CAMP FOR 10 NIGHTS TO BUY A NEW HOUSE!

HOMES BECOMING TOO COSTLY FOR THE AVERAGE MALAYSIAN! These are just some of the

headlines that in no small way reflect a recent real estate phenomenon characterised by spiraling

property prices and Malaysians thirst for newly launched houses. The aim of this report is to help

investors understand the real estate environment we are living in, what is likely to happen in the future

and how to profit from this ever-dynamic real estate sector.

The age of great volatility. Investors should recognise that there is a linked sequence of events that has ledus to where we are today. The 1950s Baby Boomers have become more risk averse in their investments since

2003/04. As they approach retirement, they would divert a significant portion of their wealth into savings and

traditionally perceived defensive asset classes such as real estate. As a result, the banks have been sitting on

massive amounts of liquidity and have since been progressively loosening their credit expansion by lending

generously to these baby boomers. Consequently, the collusion between demography and the banks has

created a period of increased volatility in the real estate market in recent years by nurturing a culture of

speculation in the real sector. This helps to explain why the 2003/04 mass housing boom barely lasted for 2

years and how its swift collapse became the prelude to the 2007/08 high-end condos boom when liquidity was

forced to seek a new home. The high-end condos boom, however, also did not last long and in the aftermath of

its implosion in 2009, the system is still flush with liquidity. This money still needs to find a home and it can find

no better abode today than the mid-to-high end landed properties, the last remaining residential asset class

that has yet to experience a bubble since the Asian Financial Crisis.

A brewing real estate mania. Currently, the advent of the 1970s subtle baby boomers into the market in

search of trade-up homes has coincided with the 1950s Baby Boomers who are still eagerly in search of real

estate investment opportunities. With the twin demand coming from two groups of baby boomers, the coming

boom in mid-to-high end residential properties, particularly landed ones, will turn out to be more than an

ordinary upcycle. As has been demonstrated recently, banks will certainly be more than eager to fund and fuel

the boom by encouraging the community and the financial system to leverage further and shift away from

traditional financing to more speculative financing. Hence, euphoria may develop as a result.

2012, the year to watch out. As the euphoria grows, there is a risk that the use of speculative financing would

become so widespread that the only way for the system to stay afloat is for property prices to keep going up

similar to the recent subprime situation in the US. Alas, the constraints of demography imply that the demand

mania may not be sustained post year 2012/13, thus restraining the upward trajectory in property prices. Then

the entire financial system would become vulnerable to a collapse at the smallest trigger, such as the

borrowers inability to honour their monthly mortgage obligations as the first large batch of deferred paymentschemes begins to expire commencing 2011/12. Therefore, these dates strongly suggest that year 2012, or

latest 2013, may mark the peak of what would perhaps be the countrys biggest residential real estate boom

since the Asian Financial Crisis.

Upgrade to OVERWEIGHT (from Neutral). Despite the potential gloom post 2012/13, the phenomenal boom

that immediately precedes it gives investors an excellent opportunity to profit from the trend. The winners in

this phenomenal upcycle between 2009/10 and 2012/13 are clearly the mid-to-high end developers. However,

their current valuations do not appear to be reflecting this as yet. We are upgrading the target prices of all mid-

to-high end residential property developers under our coverage based on a higher P/NTA ratio assumption,

while leaving our earnings forecasts unchanged for now. Since the mid-to-high end landed properties will likely

to be the top performers of the sector, we value their potential P/NTA during this period based on 2.5 above

their respective historical mean, closer to the peak valuation they were trading at during the 2007 upcycle.

Other developers with general exposure to the development of mid-to-high end residential properties have their

P/NTA conservatively valued at about 1.5 above their respective historical mean instead.

Stock PriceRM

TargetRM

Old TPRM

Mkt CapRMm

Volume000

P/NTA (x) FY0ROE %

FY1DY %

Rel. Performance % Rating

FY1 FY2 1-mth 3-mth 12mth

SP Setia 4.40 6.31 3.59 4473.9 1009.3 2.1 2.0 18.0 3.6 -1.3 -0.4 -18.9 Buy

IGB Corp. 1.81 2.41 1.94 2697.4 860.9 0.9 0.9 6.3 1.4 -8.4 -5.2 -18.5 Buy Sunrise 2.00 4.62 2.28 990.8 346.8 0.9 0.8 7.3 2.8 -8.6 -5.3 -21.3 BuyYNH Prop. 1.68 3.03 1.83 681.0 219.6 0.9 0.8 7.7 4.2 -4.3 0.3 -24.3 Buy Bandar Raya 2.24 3.06 1.87 1074.7 511.8 0.6 0.6 5.7 3.3 3.9 28.0 21.8 Buy Plenitude 3.61 4.84 4.00 487.4 69.4 0.6 0.5 8.5 4.7 -9.9 10.2 7.2 Buy Hunza Prop. 1.39 2.88 1.54 270.2 105.1 0.6 0.6 12.8 5.4 -0.4 -2.7 -8.0 Buy Glomac 1.40 1.82 1.82 416.0 187.3 0.7 0.7 8.7 6.4 -9.9 -1.6 14.2 Buy



OSK Research


PROLOGUE: DEMOGRAPHIC WAVE AND THE REAL ESTATE LONG WAVE BOOM-BUST CYCLES

In trying to identify the Trends and Timing of Real Estate Cycles, we discovered that long-term property

trends are clearly driven by the Demographic Wave. The Demographic Wave is a study of the changes

in a populations demography; changes which are, we believe, largely responsible in shifting societys

aggregate demand and preference for properties. This shift thus creates wave-like volatility over time in

the long-term property trend. It helps us understand why and when a particular real estate sub-segment

will rise or fall, despite all known odds pointing to the contrary.

THE QUEST FOR ANSWERS

More than meets the eye. In late 2002, despite suffering from the contagion effects from the US dotcom bust,

the 9/11 terrorist attacks on the US, the Afghanistan and Iraq wars, and the SARS outbreak, the real estate

market began to show signs of life after years of uncertainties. It first began with the sudden re-emergence of

mass housing boom commencing late 2002. The boom, however, was brief as it came to an abrupt end by late

2004 when demand suddenly collapsed, leading to a massive overhang of affordable houses for the

subsequent years. 6 years have passed since the late 2004 peak and the mass housing market is still in the

doldrums. What brought the mass housing market to its knees, we believe, cannot be largely blamed on

spiraling inflation, prospects of an interest rate hike or a gloomy economic outlook during that period. This is

because such arguments would contradict the fact that the mass housing market still managed, despite all theodds, to spring to life with vigour in 2003. Furthermore, these arguments do not adequately explain how,

despite the strong economic rebound and string of measures and incentives provided by the Government and

the private sector since the peak in late 2004, demand for mass housings remains benign to this day. What

then drove the rally in 2003? Has there been a larger force which ensures that the mass housing market would

remain in a recessionary phase for 6 long years?

Turning the clock further back. If we were to turn the clock back further, we would find many similarly

intriguing examples. For instance, how did townships such as Subang Jaya, USJ, Bandar Sunway and

Puchong explode into bustling towns from almost nothing in a matter of a decade? Even as each launch of

houses was by the hundreds during the 1980s and early 1990s, how was it possible that most were snapped

up almost immediately? Come early and mid-1990, however, why did the trend come to an abrupt end, only to

be immediately replaced by a strong speculative trend in real estate? From where did this huge buying force

come and where did it go? After more than a decade, why have developers not been able to repeat the robus t

performance they achieved during the 1980s and early 1990s today?

Property trends move in cycles. Our discussion so far has demonstrated that property trends cannot remain

at their current trajectory forever and as a result, this can create wave-like volatility in long-term property trends

over time. Inspired by the works of Nikolai Kondratieff, a Russian economist during the 1920s who introduced

the so-called Kondratieff Wave, we began to turn to the possibilities of cycles for answers. We believe that

what may appear to be random movements are in fact seasonally movements and are in tune with the cycles

that govern long-term property trends. Timing is, therefore, a very crucial factor in identifying real estate

investment opportunities.

Rise of the Demographic Wave theory. In our analysis, we discovered that long-term property trends are

clearly driven by the Demographic Wave. The Demographic Wave is a study of the changes in a populations

demography changes which are, we believe, largely responsible in shifting societys aggregate demand

patterns and preference for properties, thus creating wave-like volatility over time in the long-term propertytrend. It also tells us why and when a particular sub-segment of real estate will rise and fall, irrespective of the

known odds pointing to the contrary.



OSK Research


INTRODUCTION TO DEMOGRAPHIC WAVE THEORY

Its about people! The Demographic Wave theory seeks to find answers to how the changes in the

populations demographic landscape can be largely responsible in shifting societys aggregate demand pattern

and preference for properties. The backbone to using the Demographic Wave theory to forecast long-term

property trends is based primarily on the recognition that, firstly, property-buying patterns dochange at different

stages of a persons life as he/she ages. Secondly, there is a period of accelerating momentumin birth rates

(baby booms) and decelerating momentum in birth rates (known as baby busts). Hence, the ageing baby

boomers, by the sheer force of their numbers, can create a force that is significant enough to shift societys

preference for properties. In other words, when a baby boomer moves from a particular life stage to another,this can result in a slowdown, or a bust, in a particular real estate sub-segment, and a boom in another.

Figure 1.1: A depiction of how acceleratingand decelerating momentumin birth rates can create

a wave-like volatility in the demographic landscape over time

Source: OSK Research, U.S. Census Bureau

THE PREDICTABILITY OF PROPERTY BUYING PATTERNS

Predictable property buying patterns at different life stages. As we go through different stages of life, the

kind of property we want and need from the small apartment/house we rent/buy during the early years of our

working life to the starter homes we buy when we decide to start a family, and to the bigger houses we may

want to upgrade to in the later part of our life can be rather predictable. Life priorities change according to

ones life stage. As a simple analogy, say if you gave a fresh graduate a bag of money, he/she would likely use

it to buy a new sports car, get married and/or travel around the world. If the same bag of money was given to a

middle-aged man, he would more likely to save it for retirement. The more investment-savvy ones would

probably buy a property for passive income and/or as an inheritance for his children/grandchildren later. Such a

predictable trend can be divided into 4 distinct stages of a persons life (see Figure 1.2).



OSK Research


Figure 1.2: Predictable property buying patterns at different ages and stages of life in Malaysia

Life StageTypical AgeIndication

Type Of PropertyTypically In Demand

(Based On Life Stage) Remarks

1

Fresh into theworkforce; most donot as yet have thefinancial capacity to

buy a property

Birth to late

20s

Renting properties (no

significant buying

activities yet)

A young adult who has just graduated from college/university and is

entering the workforce will still likely be staying with their parents for

a few more years. Those who work away from home are likely to be

renting an affordable property instead. As they build their own

careers for some years and with enough savings, he/she may then

be able to buy a small affordable property for him/herself, especially

if the property can be rented out later to at least cover part of their

mortgage payments.

2

Aggressivehousehold formation

begins; buying astarter home is

essential to housenew nuclear family

Early 30s tolate 30s

Starter homes (mass-to-mid housings)

As they continue to age and attain financial and career stability,

most will likely be looking to get married, start a family and buy a

house. At this stage, staying with parents or living in a small

affordable apartment/house may no longer be feasible, especially

when the couple begins to have children. As such, especially given

the prospect of a double income in a family and decent savings,

these young couples will be looking to upgrade and buy a starter

home, usually affordable houses, to build their new nuclear family.

3

At the mostproductive age of

life; likely looking toupgrade their homes

to higher-endproperties; risk

appetite is at thehighest

Early 40s to

late 40s

Trade-up homes (mid-to-

high end housings)

In the coming years, as they enter the most productive age of life,

growth in wealth and income begin to accelerate more rapidly. At

this point, with sufficient wealth built over the years, plus confidence

in their income and improving career prospects, most will be looking

for trade-up homes to house their families. Coupled with the

need/desire to further provide for the family, especially to finance

their kids growing expenses (as they enter schools) and future

(higher) education, most will be driven by the desire to invest in

high-return asset classes, including speculating in real estate, with

high tolerance to risk.

4

Looking ahead forretirement; risk

averse; prefer saferasset classes such

as investmentproperties that canyield a long-termstable & decent

return

Early 50s andupwards

Investment properties(mid-to-high end

properties) and vacationhomes

The saying that Asians love properties is particularly true for many

Malaysians who are in their fourth life stage. They would have built

up a substantial wealth portfolio and their children may likely have

completed their university education or have already startedworking. A significant retirement nest egg would have been

established or the children do not need as much financial support. At

the eve of retirement, they are naturally quite risk averse. They

begin to accumulate real assets perceived as safe haven such as

properties (with the objective of getting additional income, security of

a stable cash flow upon retirement or as inheritance for their

children) over other more volatile asset classes such as the stock

market. Naturally, people in this life stage may own multiple

properties.

Source: OSK Research

Predictability of property buying patterns via income analysis. In addition to the changing wants andneeds, our financial capacity to attain these also changes as we enter a different life stage. This is hardly

surprising since we accumulate experience as we age, and gain trust in the workplace and proficiency in our

professions, which enable us to climb the corporate ladder and command higher incomes until we retire. Higher

income translates into higher purchasing power and therefore the ability to buy bigger houses in the later life

stages. To see whether that is the case for Malaysia, we conducted a test on the data we harvested from more

than 200 respondents during our consumer surveys in 2008 and 2009. Our findings are interesting as they

indicate that Malaysians income levels dochange in a predictable manner as they enter different life stages

(see Figure 1.3) and are therefore highly capable in influencing property-buying patterns. A Malaysian typically

moves from renting an affordable property to buying an affordable house, in order to construct their new

nuclear family, before moving on to trade-up homes as confidence in their income and career prospects grow.

Pre-retirement, with sufficient wealth built over the years, he/she may become an active real estate investor.



OSK Research


Figure 1.3: Individual monthly income by age groups in Malaysia, based on OSK Researchs

Consumer Survey conducted in year 2008 and 2009 in Klang Valley and Penang

0% 10% 20% 30% 40% 50% 60% 70% 80%

Age 18-25:

Life Stage1

Age 26-35:

Life Stage2

Age 36-50:

Life Stage3

Age > 50:

Life Stage4

High Income (>RM10,000) Mid-high Income (RM5,000-10,000)

Mid Income (RM2,001-5,000) Low Income (



OSK Research


Figure 1.4: Year-over-year percentage change in birth rates in Malaysia. Figure highlights the

existence of the 1950s Baby Boomers (Wave I), 1980s Echo Boomers (Wave II) and more subtle

boomers (Wave a and b) in Malaysia post World War II.

Notes: Grey areas highlight periods of baby booms


Other more subtle baby boomers. In addition to the two major baby booms identified

above, Malaysia also experienced some more subtle baby booms since the 1950s, identified

as Waves (a) and (b) in Figure 1.4. Obviously, given their much weaker acceleration in birthscompared to the 1950s Baby Boomers and the 1980s Echo Boomers, their impact on the

dynamics of the real estate market is generally less pronounced vis--vis the latter two.

INTERPRETING A PEAK IN DEMOGRAPHIC WAVE

What does a peak mean? The Birth Wave (see Figure 1.4) highlights that the growth in birth rates has been in

positive territory most of the time, implying that birth rates have increased almost every year. Hence, one may

conclude that follow through demand for properties should increase every year and may therefore invest in a

property at any time (the anytime-is-a-good-buy mantra). This is a very dangerous conclusion to make

because although birth rates have been increasing every year much of the time, they occur at different

momentum. For example, if the CAGR for demand in affordable houses fell from 10% to 5% over the long term

(i.e. because some baby boomers moved on to upgrade to high-end properties) but the CAGR for the incoming

supply of properties was at 10%, there would be indigestion, leading to fall in rental and prices of affordable

homes. As supply usually lags demand by at least 2-3 years, changes in the macro environment during the

time lag, such as the populations aggregate preference (as baby boomers move on to next life stage) as well

as inflation, interest rates and economic fortunes may render what was initially deemed the right quantum of

supply, too much. Further complication arises when developers, who usually reap remarkable returns early in

the upcycle, tend to get carried away and over-build. When this new supply floods the market, especially at a

time when demand is weak, the sector may tip into a downcycle. Therefore, in reality, each peak of the

Demographic Wave will almost certainly result in a recession phase given the inefficient nature of the market.



OSK Research


THE AGENDA FOR THE REST OF THE REPORT

Key summary insights. As we believe we are at the locus of another major turning point in the long-wave real

estate trend, the rest of this report will examine in detail why, how and when we think certain sub-segments of

the property market will rise and fall, based primarily on the Demographic Wave principles. The following are

the key summary insights to the rest of the report:

A major mass housing boom may occur during the first half of this decade;

We are in the early stage of a property super cycle, to be led mainly by mid-to-high end

landed properties, and will peak sometime in 2012/13, but may be followed by a slump;

The current 20-year secular boom in mid-to-high end residential properties since the early

1990s may peak in 2012/13, after which mass affordable housing could dominate the real

estate theme until circa 2015/16;

Stocks with focus in the mid-to-high end segment (e.g. Sunrise, YNH Prop., IGB Corp. and

BRDB) are your best bets prior to the year 2012/13 peak. Mass housing developers,

especially the fallen angles such as LBS Bina and MK Land, may spring up as a major

investment theme early in the next decade. For the best-of-all-worlds exposure, BUY SP

Setia.



OSK Research


CHAPTER 1: THE COMING MASS HOUSING BOOM

Based on the Demographic Wave theory, this chapter examines why we think the country is set to see

its next major boom in the mass housing market commencing soon, before peaking around year 2015.

Mass housing will likely overtake mid-to-high end residential properties as the main real estate theme

(after the latters peak in 2012/13, as will be explored further in the next chapter) until year 2015. We

also look at how the earlier cohort of baby boomers influenced the mass housing boom-bust cycle in

the past. Our conclusion, using the Demographic Wave theory, explains how certain mega townships

such as USJ, Bandar Sunway and Puchong, commencing all at about the same time in late 1980s,

turned into bustling towns from almost nothing in a matter of a decade. It also explains why the masshousing market boomed very early in the 21

stcentury, peaked in circa year 2004 and is still in the

doldrums today even after 6 years.

NEW HOUSEHOLD FORMATION & THE COMING MAJOR MASS HOUSING BOOM

The 1980s Echo Boomers march into new household formation. The prime factor that influences the long-

term boom-bust cycle of mass housings is the populations rapidness in forming new families, which in turn is a

function of demography. The 1980s Echo Boomers are due to enter their early 30s, or Life Stage 2, soon (see

Figure 2.1), thus providing a catalyst for a major mass housing boom commencing approximately year 2011.

The boom will peak around 2015, however, when the last batch of the 1980s Echo Boomers is expected to

enter their prime age of buying starter homes. The last time a major mass housing boom occurred was duringthe 1980s, which lasted until early 1990s. During the interceding years since the peak in early 1990s and now,

there was also a mild mass housing boom, which began immediately after the Asian Financial Crisis and

peaked in mid-2000s.

Figure 2.1: Year-over-year percentage change in population entering into age 30-34, the prime

age for new household formation in Malaysia

Notes: Grey areas highlight periods and potential periods of booms in new household formation




OSK Research


THE 1980s MEGA TOWNSHIPS

A walk down memory lane. To appreciate what is in store for the mass housing market early next decade

when the rapid new household formation is due to take place, we reckon it would be interesting to shed some

light on how the earlier cohort of baby boomers influenced the mass housing boom-bust cycle in the past.

The 1950s Baby Boomers and the advent of 1980s mega townships. The mid-1980s to very early 1990s

was a remarkable period for the mass housing market, which was a period marked by flourishing mega

townships. Of the thousands of houses from each of the township launched annually, almost all were snapped

up immediately, a phenomenon that, unfortunately, is not repeated today. What was more remarkable was thatmost of these mega townships, when they were first launched, were located in the middle of nowhere (e.g.

Puchong). For these developers to make such bold moves meant that they were highly confident that they

were able to capitalise on the thirst for homes and the rapid rise in demand for mass housings at that time.

What fuelled the demand was the fact that the 1950s Baby Boomers were then entering their prime age for

new household formation (see Figure 2.2), and were seeking affordable houses for their new nuclear family.

Given the sheer population of these baby boomers, the demand wave for affordable houses during the period

was indeed phenomenal. It is therefore not surprising that these townships mushroomed into bustling towns

from almost nothing in the span of just a decade.

Figure 2.2: Launches of mega townships in Klang Valley were highly concentrated during/around

periods of supposed robust new household formation in Malaysia as baby boomers entered the

age of 30-34

Source: OSK Research, U.S. Census Bureau, Companies data



OSK Research


THE EARLY 21ST CENTURY MILD MASS HOUSING BOOM

Early 1970s subtle baby boomers and the early 21st century mild mass housing boom. The property

market came out from the 1997/98 Asian financial crisis just in time for the next mass housing boom in

1999/2000, when the 1970s subtle baby boomers reached their prime age for new household formation. It was

not an easy ride, however. Barely two years into the upcycle, the mass housing market was hit by the

contagion effects from the US dotcom bubble burst, the 9/11 terrorist attacks in the US, the Afghanistan and

Iraq wars, and the SARS outbreak. Although these events did not drive all potential buyers away, they spooked

a lot of people and many deferred their purchase of homes as a result. However, after years of waiting, they

grew impatient. Sometime in 2003, with a little help from a slew of incentives from the Government and a cut ininterest rate, these potential buyers returned with a vengeance. When most of the potential buyers who

delayed their purchase of houses during those last two uncertain years returned in 2003 and 2004, they did so

at a time when other 1970s subtle baby boomers, who by then had reached their prime years for new

household formation, were also looking to buy a home. Therefore, what we saw was four years (2001-2004) of

potentially high demand for mass housing compressed into two short years in 2003 and 2004, causing sales of

newly launched affordable houses to surge to unprecedented levels since the Asian Financial Crisis.

Figure 2.3: Launches and take-ups of new residential schemes in Malaysia

10%

15%

20%

25%

30%

35%

40%

45%

50%

55%

-

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

100,000

2009200820072006200520042003

Units

Units Sold (RHS) New Units Launched (RHS) Malaysia Take-up Rate (LHS)

Notes: In the years of 2003 and 2004, >23-26% of the transactions in the overall residential sub-segment in Malaysiawere represented by the take-ups in newly launched units which were unusually high vis--vis the subsequent years.The high volume of launches in 2003/04 represents the mass housings boom and the steep contraction in subsequentyears signifies the bust of the mass housing boom as the market becomes increasingly dominated by niche-lower-density-high-end residential developments.

Source: NAPIC

The downfall. The boom in 2003 and 2004 must have convinced many emboldened developers to leverage

up, aggressively buy large tracts of land and embark on aggressive launches of mass housing projects.

Unfortunately, the mass housing boom inevitably peaked in the same year in 2004. Although there was still

new household formation, its momentum began to decelerate rapidly post-2004. Therefore, when demand

momentum failed to keep up with the rate of new and planned supply entering into the market, the mass

housing market rapidly fell into a deep recession for 6 long years (see Figures 2.4 and 2.5), exacerbated

further when desperate developers began to undercut one another to liquidate their inventory. Some

developers with very weak balance sheets failed and their projects were abandoned. It was also during this

time that some prudent and financially sound developers began to move in to grab market share, which

partially explains why SP Setias Setia Alam, even though launched at the peak, is still doing very well today as

buyers flock to trustworthy developers.



OSK Research


Figure 2.4: Real average affordable housing price index inSubang Jaya, Selangor

Figure 2.5: Real average affordable housing price index inTaman Mayang, PJ, Selangor

0.70

0.75

0.80

0.85

0.90

0.95

1.00

1.05

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Price Index, Base Year = 1996

Real Housing Price Index In SS 12, 14, 18 (Single Storey Terrace)

Source : NAPIC, Bank Negara Malaysia, OSK Research

0.80

0.85

0.90

0.95

1.00

1.05

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Price Index, Base Year = 2000

Real Housing Price Index In Taman Mayang (Double Storey Terrace)

Source : NAPIC, Bank Negara Malaysia, OSK Research

CHAPTER CONCLUSION

Mass housing the next big thing. The mass housing market has been in the doldrums for 6 long years. Its

momentous peak in 2004, preceded by a short but impressive upcycle, almost instantly came close to wiping

out the unprepared mass housing developers when the momentum in new household formation began to slow

dramatically. When these developers failed, the larger and more financially sound developers began to move in

to grab the former developers market share as buyers flocked to the more trustworthy developers. In the

aftermath of the downfall, some of these distressed developers have been rigorously repairing their balance

sheets, streamlining their operations and doing what is necessary to return to their glory days. If they can do

that in time for the next major boom in mass affordable housing early next decade, these developers are likel y

to be able to gain increasing visibility among the investment community in the coming years.

13-Year Mean = 0.85

9-year Mean = 0.96



OSK Research


CHAPTER 2: HIGH-END PROPERTIES ENTERING FINAL PHASE OF LONG WAVEBOOM

The countrys current boom in the higher-end residential properties is probably in its longest bull run

ever, spanning almost two decades since the early 1990s. Despite the occasional setbacks since the

onset of the boom, Malaysias higher-end residential properties have always rebounded much stronger

than before. This, unfortunately, has also given rise to the illusion of the infallibility of properties. This

chapter argues for the fact that we are now entering into the final phase of this secular boom, which

will be characterised by a period of fast rising property prices in the mid-to-high end residential

segment, particularly landed ones, dizzying euphoria and the populations exceptionally highconfidence in investing in these properties. It will begin roughly around year 2009/10 and peak in

2012/13. Following that, as detailed in the next chapter, the outlook gets a lot more uncertain and

worrisome.

INTRODUCTION: THE GREAT HIGH-END PROPERTY BOOM

A 20-year secular (long wave) boom. The prevailing property theme during the 1980s, particularly in the

second half, was mass housing. By the turn of the next decade, the market made a transition from one that

was dominated by affordable housing to higher-value residential properties, as the 1950s Baby Boomers

turned from forming new households to buying trade-up homes (see Figure 3.1). Another major transition

occurred in the early 21st

century; although mid-to-high end properties were still the prime focus, the purposeand means of acquiring them began to change dramatically in the 2000s as the 1950s Baby Boomers moved

from upgrading their properties to accumulating investment properties perceived as safe long-term

investments. Thus, the mid-to-high end property boom, which began in the early 1990s, came in two almost

successive waves, resulting in a boom that has survived almost two decades. As a result, despite the

occasional setbacks such as the 1997/98 Asian financial crisis, the Age of Turbulence in early 21st

century as

well as the most recent global Great Recession, Malaysian higher-end residential properties have always

rebounded much stronger than before (see Figure 3.2).

Figure 3.1: Percentage share of number of properties transacted annually based on prices

60%

65%

70%

75%

80%

85%

90%

95%

100%

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Klang Valley: Mass Houses Klang Valley: Mid-to-high End Houses

Klang Valley: High End Houses Source : NAPIC

Increasing number ofhigh-end propertiestransacted since

1993/94. Acceleratedsince 2003/04

Fast increasingnumber of mid-to-high end propertiestransacted since1993/94. Acceleratedin the mid-1990s andagain since 2003/04



OSK Research


Figure 3.2: Real mid-to-high end residential property housing prices (using Taman Tun, KL, as

proxy) and real Average Residential Housing Price (ARPP)

Notes: Areas in grey indicate periods of economic turbulence

Source : NAPIC, Bank Negara Malaysia

The final lap. The 20-year secular boom in mid-to-high end residential properties cannot go on indefinitely.

This is because if the 1950s Baby Boomers have been the main engine driving the current secular boom, then

their eventual absence, as they reach retirement, will spell an end to the boom if there is no credible demand

force to promptly fill the void. Emerging from the recession of 2009, the Malaysian higher-end residential

property segment is set to enter the final phase of this secular boom before it peaks in early next decade. The

rebound will be unlike any normal recovery we have seen since the 1997/98 Asian Financial Crisis. Instead, it

will likely be a period characterised by fast rising property prices in the mid-to-high end residential segment,

particularly landed ones, widespread euphoria and the populations exceptionally high confidence in investing

in these properties. This unusual phenomenon during the final phase of the secular boom, we believe, will be a

prelude to its ultimate peak after running its course for some 20 years. As we speak, this trend may have just

begun to run its course, as indicated by the remarkable rebound in real average residential property price since

late 2009 (see Figure 3.2).

THE UP-GRADERS & THE COMING BOOM IN TRADE-UP HOMES

The property up-graders. Upon entering Life Stage 3 in our late 30s, many of us will be driven by the desire

to invest in high-return asset classes with great tolerance to risk given greater financial demands. In addition,

with sufficient wealth built up over the years, and confidence in our own income and career prospects, most ofus would also be looking to buy bigger houses in more prominent addresses to house our families. When the

baby boomers become up-graders, they become an important demand catalyst driving the mid-to-high end

property boom-bust cycles.



OSK Research


Figure 3.3: Year-over-year percentage change in number of population entering into 40-44, the

typical age for Malaysian families to upgrade their properties to trade-up homes

Notes: Grey areas highlight periods and potential periods of booms in trade-up homes


Tracing their footsteps. Dato Alan Tong shocked the market in the early 1990s when he said that he would

be developing large tracts of rubber plantations in the northern fringe of Kuala Lumpur into a high-end affluent

residential address. That place would soon be known as Mont Kiara. There were critics who believed that the

neighbourhood at that time was too isolated and had little to no infrastructure. By the mid-1990s, however,

merely a few short years into its launch, the place gained considerable popularity as a desired neighbourhood

of the affluent. Mont Kiara was not an isolated story, however, for similar shocking stories also sprang up

around the Klang Valley at almost the same time in the early 1990s. Sri Hartamas, Mont Kiaras adjacent

neighbour, also took off together with the latter in the early 1990s and quickly became popular by the mid-

1990s. Bandar Utama consisted of nothing but palm oil estates with a sparse population until 1991 when See

Hoy Chan Holdings began to develop the township, and it quickly became popular by the mid-1990s. These

developers must have sensed a wind of change that was about to sweep across the entire nation. This change

was the major turning of the Demographic Wave as the 1950s Baby Boomers were gaining affluence and were

moving from buying affordable houses during the 1980s to buying trade-up homes in droves in the 1990s. That

was the story of how the first wave of the current 20-year secular boom in mid-to-high end residential

properties began.

A boom in trade-up homes from 2009/10 to 2012/13. Moving from forming new households in the early

2000s, the first batch of the 1970s subtle baby boomers is expected to begin to enter the age of buying trade-up homes in more desirable addresses by 2009/10 (see Figure 3.3). This will thus spark a sudden increase in

demand for mid-to-high residential properties, mimicking the trend of the early 1990s. As we speak, this trend

may already have started unfolding since late 2009 as developers launches are increasingly focused on this

particular residential segment to meet the sudden onslaught of demand (see Figure 3.4). However, given the

difference in how the 1970s subtle baby boomers came into being compared to the 1950s Baby Boomers, this

will be a milder version of the up-grading activities that occurred during the early 1990s. The mini boom will

peak by 2012/13 as the last batch of the 1970s subtle baby boomers is expected to enter their third life stage

by then.



OSK Research


Figure 3.4: Comparison of the percentage representation by price range of houses launched from

1Q07-1Q10 in the Klang Valley

10%

22%

13%

2%6%

10% 12% 10%17%

5% 7%

30%

29%

18%

19%

37%22%

16%

34%

33%

26%16%

5% 12% 0%

26%11%

23%

19%

10%

22%

36%

20%

19%

24% 32%

27%29%

26%

34%38%

46%

60%

47% 46% 48% 46%

36%40%

35%

63%59%

67%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10

RM400k

Source: JLW

OLD MONEY & THE INCREASED VOLATILITY IN THE 2000s

The old money. The quip that Asians love properties is particularly true for many Malaysians who entering

into Life Stage 4, typically from the age of late 40s/early 50s and onwards. This group would have built up a

substantial wealth portfolio and a reasonably comprehensive insurance coverage with little financial demands

from the family. Now at the eve of retirement (retirement age is 55 for the private sector and 58 for the public

sector), they are naturally quite risk averse, but at the same time not too conservative as to keep everything in

cash or low-risk products. Known as the old money dilemma, the biggest question facing this group is how to

preserve their wealth to finance their retirement for the years to come. Investment in the financial markets suchas the stock market is undesirable as it is usually associated with high volatility. This thus leaves the group with

two other investment options which are traditionally thought of as being capable of offering a certain degree of

defensiveness, i.e. to hold cash (or low-risk-low-return investments) and/or invest in real assets (e.g. real

estate). With cash not being a good hedge against inflation, the real estate option becomes more attractive.



OSK Research


Figure 3.5: Year-over-year percentage change in number of population reaching ages 50-54, the

typical age for affluent Malaysians to invest aggressively in real estate


Old money and the rise of volatility. As baby boomers turn more risk averse, they will substantially reduce

their exposure to volatile asset classes and divert a significant portion of their wealth into savings and

traditionally perceived defensive asset classes such as real estate. To investigate the likely effect of this, when

the 1950s baby Boomers began to enter into their fourth life stage in early-mid-2000s (see Figure 3.5), retail

participation in the domestic stock market also fell in 2004/05 and has since continued to remain lacklustre (see

Figure 3.6), hinting at a close correlation. Even the robust stock market performance in 2006/07 failed to makemuch of a difference. The declining money multiplier, M1/M2 ratio, may also indicate a similar relationship with

the 1950s Baby Boomers having turned more risk averse in their investments since 2003/04 (see Figure 3.7).

As a result, the banks today are sitting on very high levels of liquidity. Pressured to find ways to put their

excess reserves to work, especially during periods of economic boom, the banks have been progressively

loosening their credit expansion in recent years. The repercussion of this is profound because while we have a

group of 1950s Baby Boomers who are looking to accumulate traditionally perceived safe real assets, we also

have the banks which are lending generously to these baby boomers to fulfill the latters investment goals.

Therefore, paradoxically, instead of stability, the collusion between demography and the banks has generated

a period of increased volatility in the real estate market in recent years by nurturing a culture of excessive

speculation in the sector.



OSK Research


Figure 3.6: Breakdown of trading (by value) on Bursa Malaysia

42% 45% 44%54%

44% 49%59% 54%

43% 40%50%

43%

29% 34%37%

23%

51% 48% 45%36%

42%43%

35% 40%51% 54%

45% 53%71% 66%

63%

77%

7% 7% 11% 10% 14%8% 6% 6% 6% 6% 5% 3%

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Retail (LHS) Institution (LHS) Others (LHS) Trading Value Index, Base Year = 1993 (RHS)

Source: Bursa Malaysia

Figure 3.7: The Money Multiplier M1/M2 Ratio

17.0%

19.0%

21.0%

23.0%

25.0%

27.0%

29.0%

31.0%

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

1H2010

Money Multiplier, M1/M2 Ratio

Notes: M2 is seen as precautionary money (i.e. Fixed Deposits) and M1 the more liquid form (i.e. Current Accounts). Whenthe populations are risk lovers, M1/M2 will rise. Vice versa, when the populations turn more risk averse, they will divert asignificant amount of their excess capital to more defensive asset classes and the money multiplier ratio will fall.

Source: Bank Negara Malaysia, NAPIC

Follow the old money. As the first batch of the 1950s Baby Boomers reached their fourth life stage

sometime in 2003/04, this sparked the second (and final) wave of the 20-year secular boom in mid-to-high endresidential properties. Their fervor for real estate caused increased volatility across different residential asset

classes, although one at a time rather than broad-based, within a short time-span in the 2000s. For example,

their possible participation in the 2003/04 mass housing boom intensified the boom and contributed to its

severe collapse in 2005/06. Subsequently, they may have channeled their funds to drive the 2007/08 high-end

condos boom to astronomical levels before it collapsed under its own weight in 2009/10, although not entirely.

During the two bust periods, proactive 1950s Baby Boomers hedged their wealth in mid-to-high end landed

properties in well-established locations. Therefore, we learned that one of the main investment themes in the

2000s is to follow the old money, i.e. as the 1950s Baby Boomers continue to enter their fourth life stage in

droves, where would they be investing their money next? The rest of this chapter seeks to answer that

question.



OSK Research


Figure 3.8: 1950s Baby Boomers proactively move their funds from one residential asset class to

another as they enter the life stage of real estate investments in the early 21st century

Source: OSK Research, Malaysian Property Market Reports

OLD MONEY FUELED THE 2003/04 MASS HOUSING BOOM

The 2003/04 mass housing boom. As stated in the previous chapter, the 2003/04 mass housing boom came

about as the 1970s subtle baby boomers bought houses to form their new households. As many of them

deferred their decision to purchase during the turbulent years at the turn of the 21st

century, their sudden return

into the market all at about the same time in 2003/04 caused sales of newly launched affordable houses to rise

to levels never seen in any given year since the Asian Financial Crisis. This was inevitable because buying a

house for new household formation was viewed as a necessity and not many couples were willing to delay that

decision for too long. The 1970s subtle baby boomers rush for affordable houses in 2003/04 coincided with a

time when the first batch of the 1950s Baby Boomers began to divert their wealth from volatile asset classes to

defensive ones such as the real estate. As such, although not under the category of high-end property, we

nonetheless suspect that some of the 1950s Baby Boomers, at least to a certain extent, jumped on the

bandwagon and participated in the mass housing boom in 2003/04, contributing to the unprecedented surge in

sales of new affordable houses. Mass housing was one of the major residential asset classes that the 1950s

Baby Boomers may have invested in as they entered their fourth life stage.

OLD MONEY DROVE THE 2007/08 HIGH-END CONDOS BOOM

The 2007/08 high-end condos boom. When the mass housing market collapsed in 2005/06, some 1950s

Baby Boomers sought shelter in high-rise condominiums as well as in mid-to-high end landed properties, the

two residential asset classes that had yet to experience a bubble since the Asian Financial Crisis. As a result,

activities in high-rise condos began to warm up, spurring more launches of high-end condos and forcing prices

to move up slowly in certain centralised locations, although prices in general were still relatively stable. Not

many realised the repercussion from this, however, for the 1950s Baby Boomers were still sitting on a lot of

cash and eager to invest again. Upon signs of a recovering economy by late 2006, this group quickly redirected

its wealth to more risky real estate asset classes and high-end condos were an obvious choice, thus sparking

the 2007/08 high-end condos boom. Launches of high-end condos intensified further during this period and

new record-high prices were frequently reported. At its zenith in late 2008, prices of new high-end condos in

Kuala Lumpur City Centre (KLCC) averaged >RM1,400psf and RM700-900psf in Mont Kiara. At the eve of the

boom back in year 2006, they merely averaged about RM700psf and RM400psf respectively.



OSK Research


Figure 3.9: Klang Valley luxury condos (priced >RM400psf) supply cycle

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

2007 2008 2009 2010 2011 2012

Additional Supply Over '06 Total Supply

4-star Condos And Above

Source: JLW, OSK Research

A huge bubble. There was little doubt that the boom since early 2007 had been one big speculative bubble.

Based on the average price of RM1,400psf in KLCC for a 1,500 sq ft high-end condo, the investor would have

to demand >RM10,000/month for rental just to break even in terms of cash flow (based on an 80% margin of

financing at a fixed borrowing cost of 5.99% for a period of 30 years). To earn a decent 7.0% yield, the investor

would have to demand a monthly rental exceeding RM12,000. This sort of rate was definitely out of the reach

by most of the local population, hence the targeted market segment was likely to be wealthy expatriates or

those subsidised by their companies. Even so, not many of were prepared to pay for such rates. As a result,

vacancy rates of newly completed high-end condos today are as high as an estimated 80% in the KLCC.

The downfall and the partial implosion. Distress emerged in late 2008 when new supplies of high-end

condos began to inundate the market. Amid that, the onset of the global financial crisis in late 2008 shocked

the entire market, setting the stage for an inevitable implosion in late 2008 that lasted until sometime in 2009.

Initially, some speculators/investors who did not have strong holding power contributed significantly to the

downward pressure. Others, however, hung on to their properties, thus cushioning the effects of the downward

spiral on prices. Thus, for example, high-end condos in the KLCC area only fell to about RM900-1,000psf on

average and rebounded to about RM1,000-1,200psf in the rest of the year 2009, instead of correcting back tothe pre-boom levels. The reason the implosion did not reach full circle, we believe, was mainly due to the still

very favourable demographic landscape. This, in turn, contributed to the optimistic psychology and convinced

many to hold on to their investments. This was aided further by favourable financing costs:

Favourable demographic landscape. During the partial implosion of the high-end condo

market in 2009/10, the Demographic Wave had yet to reach its major turning point (refer back

to Figure 3.5) as many 1950s Baby Boomers were still entering their fourth life stage. This

implied that demand potential was still, in fact, growing very rapidly during the period, which

would support the high-end condos market once prices had fallen substantially enough and/or

their high risk premium during the period had been substantially met, which, in turn,

contributed to the

Optimistic psychology. In other asset classes such as the stock market, investors who have

high leverage recognise that their wealth is declining more rapidly than stock prices and sothey sell off. Speculators in real estate, on the other hand, are different, at least initially. Their

borrowings are not day-to-day brokers loans but come from banks on extended terms. They

have real assets, not just paper claims. Most choose to wait for the recovery that they reckon

is just over the horizon. As most recent buyers have been the 1950s Baby Boomers who are

in their fourth life stage and given the fact that the demand market continued to grow rapidly,

they were inclined to hold on to them. In addition, the fact that many were also likely to be

affluent and had much less exposure to the stock market (as discussed earlier, which shielded

many from the stock market meltdown in late 2008) provided the necessary holding power for

many to do so; and

Sudden huge supplywave hit the market in

late 2008

Mountingupward supplypressure again

in 2010

The final butfatal supplywave to hitthe market inlate 2011



OSK Research


Figure 3.10: Graphical explanation of the partial implosion in high-end condos in 2009/10

Source: OSK Research

Favourable financing costs. Bank Negara Malaysias series of measures to substantially

lower interest rate, which were promptly followed by the commercial banks, boosted their

holding power further, which enabled them to cling on to these properties and weather the

storm. Since the onset of the global financial crisis in late 2008, banks average base lending

rates had been lowered by as much as about 121 bps to about 5.51%, before inching up

again since early year 2010 as signs of the recession in 2009 waned.

An imminent rebound. Demand for high-end condos was dry in early 2009 as many prospective buyers

anticipated a further collapse in prices and were therefore sitting on the sidelines. However, when certain

developers began to offer attractive discounts/rebates (which brought effective prices much closer to the pre-

boom levels) and innovative financing schemes (which would effectively transfer substantial amounts of risk

from the buyers to the developers in the early years), many flocked to buy those properties. This indicated thatthere were still many eager buyers (and still growing rapidly as well, as indicated by our Demographic Wave

model) but would only buy if their demand for high risk premium had been sufficiently met. As the sustainability

of the economic recovery appears increasingly more convincing, the risk premium demanded by prospective

buyers will narrow significantly by late-2010, an indication that the Klang Valley high-end condos are likely to

rebound soon.

Sell into strength. An imminent rebound does not mean a long-term sustainable recovery. For starters, the

road to recovery will be a bumpy one as Klang Valleys newly completed high-end condos continue to be

plagued by very high vacancy rates. Secondly, they will be hit by another major supply wave by late-2011, a

repercussion from the aggressive launches since year 2007. These factors alone, however, may not

necessarily cause many speculators/investors to fret, as the partial implosion in year 2009 has proven. They

are unmoved by the prospect of low, if not zero, cash flow from their investments as long as there are

prospects for further capital appreciation. What may more likely to cause them to panic is when it becomes

apparent that the buying momentum can no longer be sustained for the long term as this would imply limited

prospects for capital appreciation. If the favourable demographic landscape, a catalyst to support long-term

buying momentum, is removed from the equation in Figure 3.10, it is obvious that the pillars of the entire

bubble structure will weaken and a mere push will cause the structure to crumble. That is precisely what may

happen sometime in 2012/13 when the Demographic Wave is set for a major turning as the last batch of the

1950s Baby Boomers enters into their fourth life stage (refer back to Figure 3.5). The bubble cannot last

indefinitely and investors who are highly exposed to this segment should take note of the rebound and take

profit prior to the peak in 2012/13.



OSK Research


OLD MONEY HEDGES IN HIGHER-END LANDED PROPERTIES IN UNCERTAIN TIMES

In landed properties they trust. When the 2003/04 mass housing boom peaked in late 2004 and collapsed in

years 2005/06, some proactive 1950s Baby Boomers hedged their wealth in mid-to-high end landed properties

located in well-established locations. When the 2007/08 high-end condos boom began to implode and coupled

with the looming recession in late 2008, funds again sought shelter in mid-to-high end landed properties. Such

hedging, paradoxically, caused prices of these properties to outperform most other residential asset classes

amid times of uncertainties while others faltered (see Figure 3.11). On the other hand, during the 2003/04 mass

housing boom and 2007/08 high-end condos boom, the same mid-to-high end landed properties slowed

significantly as more funds were channeled to speculate and fuel the two booms. The unusually highconfidence in mid-to-high end landed properties as safe haven investments, boosted further by a decade of

unbroken track record, will have great ramification for some years ahead in the next upcycle as it is the only

remaining residential asset class that has yet to experience a bubble since the Asian Financial Crisis.

Figure 3.11: In early 21st century, higher-end landed homes (using Taman Tun in KL as a proxy)

outperformed the sector in times of adversity and vice versa

Source: OSK Research, NAPIC

THE COMING PHENOMENAL BOOM IN HIGHER-END LANDED PROPERTIES

The coming boom in trade-up homes. As discussed earlier in the chapter, the arrival of the 1970s subtle

baby boomers into the market to look for trade-up homes commencing 2009/10 will cause a stir in the sector

and fuel an increase in demand for mid-to-high residential properties, mimicking the trend which occurred

during the early 1990s. We may also likely see mushrooming greenfield projects to develop the-next-iconic-

affluent-addresses to capture this fast-growing pool of property up-graders, similar to how Mont Kiara, Sri

Hartamas and Bandar Utama emerged unexpectedly in the early 1990s to become the highly-sought-after

addresses of the affluent.



OSK Research


An ordinary boom turns extraordinary. The boom in trade-up homes in 2009/10 may soon attract a torrent of

capital from the 1950s Baby Boomers who are still thirsting for real estate investment opportunities. This may

create a positive feedback loop that will accelerate the flow of funds by the 1950s Baby Boomers into this

particular residential asset class and soon entice the 1970s subtle baby boomers to become real buyers-cum-

speculators and join the buying frenzy. As a result, in the later phase of the cycle, the supposed ordinary

upcycle may be amplified and morph into a phenomenal boom.

A momentous union. The phenomenal boom is created precisely because a group of baby boomers who are

aggressively buying up trade-up homes bumps into another group of affluent baby boomers who are on the

lookout for real estate investments both with the inclination for higher-end properties. Such occurrences, ormore famously known as property super cycles, have occasionally surfaced in the past, such as in the early

1980s and early-mid-1990s (see Figure 3.12). Generally, the process giving rise to such super cycles has

always been similar it begins with a boom in real demand from a particular group of baby boomers in their

third life stage, which in turn entices the baby boomers in their fourth life stage to channel their wealth into that

particular residential asset class. Mortgage boom and widespread euphoria quickly develops as more buyers

jump into the bandwagon, thus fuelling the boom further.

Figure 3.12: Demographic indicator of real estate bubble formation in Malaysia

Notes: Employing the wave theory from physics, when the two demand waves converge, they can either superimpose or cancelout each other. Thus, when the two waves superimpose on each other to create demand, this can create a phenomenalproperty upcycle, as indicated by the areas in grey.




OSK Research


A property super cycle in the making. What makes a property super cycle extraordinary is not only due to

its magnitude but also its duration and irregularity. Post-Asian Financial Crisis, it took 12 years for real average

residential property prices to surpass the previous peak in 1997 (see Figure 3.13). In the interceding years, not

a single boom came close to a fraction of the magnitude and duration of the early-mid-1990s property super

cycle. Similar observations are made in the high-end landed properties (see Figure 3.14), i.e. real prices had

been stagnant or occasionally rose marginally to give investors meager excess returns over general inflation.

By late 2009, the entire landscape began to change; not only did real prices begin to surpass the previous

historical peak in 1997 but the encouraging magnitude of the jump in real prices was nothing like what we have

seen since the Asian Financial Crisis. What remains to be tested is whether this momentum can at least be

sustained over a longer duration but clearly, this is a sign of an encouraging emerging new trend. If this was inresponse to the coming phenomenal boom in higher-end landed properties as described above, then, without

doubt, we are likely to be in the early stages of another property super cycle that will primarily be led by this

particular residential asset class.

Figure 3.13: Real Average Residential Property Price Index

Source: NAPIC, Bank Negara Malaysia, OSK Research

Figure 3.14: Real average mid-to-high end landed properties price index in Taman Tun (KL)

Source: NAPIC, Bank Negara Malaysia, OSK Research



OSK Research


The 2012/13 peak and its repercussions. The last batch of the 1950s Baby Boomers will begin to enter their

fourth life stage by 2012/13, before eventually moving on to their retirement (refer back to Figure 3.5).

Coincidentally, the last batch of the 1970s subtle baby boomers are also due to enter their third life stage in

2012/13, marking the end of the boom in trade-up home which begins in 2009/10. Just as surely as the

2009/10 boom in trade-up homes will justify the coming property super cycle, its peak in 2012/13 will probably

imply that the euphoria and widespread speculation during the period will no longer have fundamental

substance. This twin turning in the Demographic Wave may significantly weaken the pillars that support the

bubble structure, which may crumble at a gentle push.

CHAPTER CONCLUSION

The age of volatility. The residential real estate cycle since the early 2000s has been marked by frequent and

violent volatilities. The 1950s Baby Boomers have become more risk averse in their investments since

2003/04, as exhibited by lower participation in traditionally more volatile asset classes such as the stock

market. As they approach retirement, they would divert a significant portion of their wealth into savings and

traditionally perceived defensive asset classes such as real estate. As a result, the banks today are sitting on

very high levels of liquidity. Pressured to find ways to put their excess reserves to work, especially during

periods of economic boom, the banks have been progressively loosening their credit expansion in recent years.

The repercussion of this is profound because while we have a group of 1950s Baby Boomers who are looking

to accumulate traditionally perceived safe real assets, we also have the banks which are lending generously to

these baby boomers to fulfill the latters investment goals. Therefore, paradoxically, instead of stability, the

collusion between demography and the banks has generated a period of increased volatility in the real estate

market in recent years by nurturing a culture of excessive speculation in the sector.

Follow the old money. Despite of the implosion in high-end condos and the recession of 2009, the system is

still flush with liquidity. This money, at the end of the day, still needs to find a home and can never find no

better sanctuary today than in mid-to-high end landed properties, the last remaining residential asset class that

has yet to experience a bubble since the Asian Financial Crisis. Coincidentally, because this will also be a

period when the 1970s subtle baby boomers are expected to aggressively upgrade their residences by

snapping up trade-up homes in more desirable locations, the coming boom in mid-to-high end landed

properties may turn out to be a phenomenal one. However, if these two groups of baby boomers are the

primary engine driving the upcycle, then their eventual absence by 2012/13 may bring an end to the boom if

there is no credible demand force to fill the void. This report has so far emphasised on the general investment

behaviour of the baby boomers, i.e. the people who drive the booms in real properties. Yet, at the heart of most

upcycles still lies the financial system, without which there would be no meaningful boom. We will discuss thecentral role of banks in funding and fueling real estate booms in the following chapter.



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CHAPTER 3: SOWING THE SEEDS OF THE NEXT MANIA

I love real estate. Its tangible, its solid, its beautiful. Its artistic, from my

standpoint, and I just love real estate.

-Donald Trump-

The conclusion from our Demographic Wave analysis in the previous chapter is that as we emerge

from the recession of 2009, Malaysian higher-end residential properties will enter the final phase of the

20-year secular boom before it peaks sometime in 2012/13. The rebound is expected to be rather

phenomenal and will be characterised by fast rising property prices in the mid-to-high end residentialsegment, particularly landed ones, widespread euphoria and the populations exceptionally high

confidence in investing in such properties. By 2012/13 however, there is the real risk that the super

cycle may slump just as spectacularly. Using the Minsky Model as an illustration, this chapter explores

how this coming real estate mania will develop, the central role of the banking sector in funding and

fueling it, and the repercussions that will follow. The chapter also argues that what may unfold over the

next few years is far from being merely a theoretical possibility, especially given the recent

developments in the real sector.

INTRODUCTION: MANIAS & PANICS

The timeless Minsky Model. The late Hyman Minskys theories link financial market fragility in the normal lifecycle of an economy with speculative investment bubbles endogenous to financial markets. Minsky claimed

that in prosperous times, when corporate cash flow rises beyond what is needed to pay off debt, a speculative

euphoria develops, and soon thereafter debts exceed what borrowers can pay off from their incoming revenue,

which in turn snowballs into a financial crisis. As a result of such speculative borrowing bubbles, lenders tighten

credit availability, even to companies that can afford loans. The topography to a mania that ends in a crisis

goes through the following five stages displacement, monetary expansion, euphoria, profit taking and panic.

Displacement is an exogenous shock to the macro system that changes the outlook and increasing opportunity

for profit. The boom and optimism spreads to the banking system, which begins to lend aggressively. The

credit expansion is not just through the banking system but through financial innovation that encourages

leverage, increasing profits as well as risks. It is here that the financial system evolves significantly from

traditional/hedge financing (where a borrower is able to service the loan and pay off the principal over time) to

speculative financing (cash flow is able to service the loan but not the principal) before advancing further to

Ponzi financing (cash flow can never meet neither payment requirements). Monetary expansion leads to the

third stage of overtrading, when borrowers begin to speculate and euphoria begins. In the fourth stage, the

market begins to top and there is a period of financial distress. There is growing uneasiness that some

overtrading firms/individuals and financial institutions will fail, and when they do, everyone rushes for the exit.

In the final stage, there may be panic that feeds on itself.

Sowing the seeds of the mania. The onset of the recession of 2009 sent shockwaves to all market players

but thanks to our relatively healthier banking system as well as the households healthy balance sheets, it did

not send our economy and financial system into a tailspin. However, it did set off a chain of events that would

have great ramifications years later, a result of the confluence of reactions from different market players in their

attempts to counter the blow from the recession. These events and their consequences, at least at the surface,

appear to be a mania that is developing on its own. In reality, they are the necessary conditions that facilitate a

potential proliferation of a great real estate mania for the years to come, which is very likely to be already in its

early development stage.

A BREWING MANIA: CREATING THE NECESSARY CONDITIONS

Smart old money on the move. During the implosion of high-end condos and the recession in 2009, some

1950s Baby Boomers sought shelter in mid-to-high end landed properties, which was the only residential asset

class that had yet to experience a bubble since the Asian Financial Crisis. However, this phenomenon was

generally limited to some savvy old money hedging their wealth in completed properties in well-established

locations but not so much in new property launches. The others, however, remained on the sidelines hoping in

vain for home prices to fall. For the developers to entice the old money to invest in their new property

launches again at a time when risk aversion was high would require a plan that was out-of-the-box.



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The advent of innovative financing schemes. The recession caught many developers off-guard as new

property sales fell sharply, hindering their efforts to launch new projects as well as leaving certain developers

saddled with inventory. Faced with rapidly exhausting unbilled sales, rising competition and the managements

good reputation to keep, certain developers became creative and offered innovative home financing packages

to attract prospective home buyers. The pioneer of such schemes was developer SP Setia, which in January

2009 came up with the 5/95 Home Loan Package which required a buyer to place a mere 5% downpayment

of the value of the property and be entitled to obtain a margin of financing of up to 95%. He/she would not be

required to pay anything else, including the loan principal and financing cost, until vacant possession. This

proved to be extremely popular as such a scheme would allow investors to transfer a substantial amount of risk

to the developers in the early years. As a result, new property sales during this period were even moreremarkable compared to during any other booms in the past 10 years (see Figure 4.1). The overall effect was

very clear the biggest beneficiaries of such schemes were the mid-to-high end residential properties. Soon,

other developers jumped on the bandwagon and within weeks, innovative schemes that involved deferring

payment by another 1 or 2 years after vacant possession hit the market.

Figure 4.1: Approved home mortgages spiked up sharply since early 2009, reflecting the sudden

increase in buying of mid-to-high end residential properties

0.7

0.9

1.1

1.3

1.5

1.7

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4.2

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No. of units transactions

Index, Base = 4Q99

Approved Housing

Mortgage LoanIndex, Base = 4Q99

Approved Mortgage Home Loans Index (LHS)

Residential Units Transacted Index, RM250,000/unit (RHS)

Source: Bank Negara Malaysia, NAPIC, OSK Research

The banks fervor to lend. The banks fervor to lend to the residential real estate sector even during the global

recession (see Figure 4.1) was driven by a confluence of factors. For starters, domestic banks were still awash

with liquidity (see Figure 4.2). As the countrys financial system and household balance sheets were still

healthy, the high level of liquidity pressured the banks to put their excess reserves to work. By early- to mid-2009, the banks not only found a way to lend aggressively again but at the same time able to minimise their

lending risk as well by teaming up with developers to offer innovative house financing schemes. These

schemes were a win-win for the banks and developers. On one hand, it would lower the banks lending risks, at

least in the initial years, as interest payments would be backed by the blue-chip developers. The banks were

also not too concerned whether property prices would fall in the near term because they were essentially

betting that prices would, at least, remain firm in the longer term. On the other hand, this enabled the

developers to liquidate their inventory and recommence the launch of development projects to replenish their

unbilled sales. As lending risks were significantly reduced, the banks pressure to put their money to work

drove down the systems average lending rates to historical lows by mid- to late-2009. On the other side of the

coin, these schemes opened up a lucrative investment opportunity to speculators and avid real estate investors

as they are now able to transfer a substantial amount of their risk to the developers in the early years.



OSK Research


Figure 4.2: Commercial banks loans-to-deposit ratio and average lending rate

4.5%

5.5%

6.5%

7.5%

8.5%

9.5%

10.5%

11.5%

12.5%

13.5%

14.5%

72.0%

77.0%

82.0%

87.0%

92.0%

97.0%

102.0%

4Q96

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Loans-to-deposit ratio of Commercial Banks (LHS) Average Lending Rate (RHS)

Source: Bank Negara Malaysia

Excessive appetite for risk. Beneath the remarkable mortgage boom is the growing appetite for risk, both

from domestic households and financial institutions. We note that such schemes have significantly shifted most

of the homebuyers and banks short-to-medium term risks to the developers. Consequently, these schemes

may have potentially pushed the homebuyers and banks short-to-medium term risks to way below their

respective desirable risk levels. Amid the easing of the recession and in the wake of the next property upcycle,

these market participants, especially the old money, may then realise that they may have been overly

underweight on real estate and may therefore grow impatient in increasing their exposure in the sector.

However, in the course of doing so, the entire system is actually taking on more risks than it normally should,

such as the case since mid-2009 when both the domestic households (see Figure 4.3) and banks (see Figure

4.4) exposure to mortgage loans increased substantially all of a sudden.

Figure 4.3: Household debt-to-GDP ratio and household residential mortgage-to-GDP ratio

61.0%

63.0%

65.0%

67.0%

69.0%

71.0%

73.0%

75.0%

77.0%

22.0%

23.0%

24.0%

25.0%

26.0%

27.0%

28.0%

29.0%

30.0%

31.0%

32.0%

2002 2003 2004 2005 2006 2007 2008 2009

Household Residential Mortgage-to-GDP Ratio (LHS)

Household Borrowings-to-GDP Ratio (RHS)




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Figure 4.4: Commercial banks mortgage-to-total deposits ratio and mortgage-to-total loans ratio

23.0%

24.0%

25.0%

26.0%

27.0%

28.0%

29.0%

30.0%

25.0%

27.0%

29.0%

31.0%

33.0%

35.0%

37.0%

39.0%

1Q02

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3Q06

1Q07

3Q07

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3Q08

1Q09

3Q09

1Q10

Residential Mortgage-to-Total Deposits Ratio (RHS) Residential Mortgage-to-Total Loans Ratio (LHS)


Developers incentives to extend the lifespan of innovative financing schemes. Thanks to the innovative

financing schemes, as discussed earlier, new property sales achieved by the developers, even during the

recession of 2009, have been stunning. Therefore, in addition to the unprecedented success, the developers

has all the incentives to continue to extend those innovative financing schemes, in the present form or another,

beyond their required lifespan, even during a period of economic boom if necessary, to at least match the

remarkable sales performance in the yesteryear and appease their shareholders expectations. A classic

example would be that the case of SP Setia, which introduced the 5/95 Home Loan Package in January 2009.

When the scheme expired in July 2009, it introduced the Best For The Best home loan scheme in Oc

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