Is fear of residential supply glut overblown?

By Feily Sofian,

Lin Zhiqin

/ The Edge Property |

October 24, 2015 8:00 AM SGT

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Landlords may opt to leave their properties vacant if rents fall beyond a certain level as they would not justify replacement costs for the wear and tear inflicted by tenants. As a result, the dreaded supply glut and sky-high vacancy rates alone may not translate into a steep rental decline. Landlords may also prefer to wait for a market recovery rather than commit to a low rent over the next one to two years.

Therefore, it may sound counter-intuitive but a study by The Edge Property shows the correlation between vacancy and rental performance weakens as vacancy rates trend up.

When vacancy rates of private non-landed homes were within a healthy range, rents behaved according to market expectations. For example, when vacancy rates were between 6% and 6.9%, rents increased by 0.6% per quarter on average. And when vacancy rates climbed to between 7% and 7.9%, the rental increase slowed to 0.5% per quarter. As vacancy rates trended up to between 8% and 8.9%, rents declined by an average of 0.8% per quarter. No surprise here.

However, when vacancy rates were at 9% to 9.9%, rents declined by just 0.1% per quarter on average. Similarly, when vacancy rates were at their historical high of 10% to 10.9%, rents slipped by just 0.2% on average per quarter (see Table1). In other words, high vacancy rates of 9% or more did not cause rents to nosedive.

Table 1: High vacancy rates above 9% did not cause rents and prices to plunge

VACANCY RATE (%)	AVERAGE Q-O-Q CHANGE
RENT (%)	PRICE (%)
5 to 5.9	4.6
6 to 6.9	0.6
7 to 7.9	0.5
8 to 8.9	-0.8
9 to 9.9	-0.1
10 to 10.9	-0.2

Source: URA, The Edge Property

There were a total of 23 quarters between 1Q1999 and 2Q2015 when vacancy rates were at least 9%. Out of that, 13 quarters witnessed rental increase and only 10 saw rental decline.

A simple linear regression between vacancy rates and rental index showed an R-square value of 0.48. Another regression between vacancy rates and percentage change in rents showed an even weaker R-square value of 0.16.

The same can be said about prices. Between 2Q1988 and 2Q2015, there were a total of 31 quarters when vacancy rates were at least 9%. However, out of that, about half or 17quarters witnessed prices declining, while the remaining 14 saw prices increase. Hence, the average price decline when vacancy rates hit at least 9% was just 0.8% quarter-on-quarter (q-o-q) on average.

Historically, rents and prices only fell by a significant magnitude during a recession, when homeowners’ primary incomes were under threat. In 4Q2000, for example, rents fell 3.2% q-o-q as the global economy was hit by the Nasdaq crash. Similarly, prices fell 2.7% in 3Q2000, followed by 3.6%in 4Q2000 and another 4.5% in 1Q2001. Separately, rents fell 5.7% q-o-q in 4Q2008, followed by 8.8% in 1Q2009 and 5.6% in 2Q2009, amid the global financial crisis. Concurrently, prices dipped 6.4%, 15.1% and 4.7% respectively.

Singapore’s residential property market is bracing for a potential supply onslaught of 11,105 non-landed units in 2H2015 and another 20,381 units in 2016. In the worst case scenario, we expect the vacancy rate to hit 12% over the next six months, given the average take-up of just 7,700 units annually over the past decade. As illustrated earlier, sky-high vacancy alone may not single-handedly topple rents and prices. It is worth noting, however, that vacancy rates could hit an unprecedented high in 2016. In the meantime, recessionary risks continue to mount with economists polled by The Edge Property projecting anaemic economic growth into 2016.

Against this backdrop, The Edge Property is expecting the current rate of rental and price decline of 1% q-o-q in recent quarters to accelerate to 2%, leading to a total decline of around 5% over the next six months for private non-landed homes. Notwithstanding, the prospect will be uneven across different segments and prospective buyers who do not need to rely on rental income should scout for value deals and defensive assets such as those in growth corridors, near MRT stations and amenities or with unique location attributes.

We also polled four market experts for the outlook of private non-landed homes for the next six months. Here’s more from them:

Alan Cheong, Head of research, Savills Singapore

We believe there will be greater interest from local and overseas buyers in the high end segment in 2016 when they realise that it represents an attractive relative value proposition when compared with London and Hong Kong. Rents, however, may remain subdued because headcount and budget cuts amongst multinational companies will translate into lower demand from expatriates. Expect high-end prices to rebound 2% over the next six months while rents are likely to continue southbound, between 5% and 10%.

Overall, prices in the city fringe will be determined by the tug of war between developers’ pricing and resale transactions. The former will continue to command steady pricing at levels similar to pre-TDSR (total debt servicing ratio) levels, while the latter will be under downside pressure from individual holders who need to transact.

Rents will also be under pressure, but less so than for the high-end and mass- market segments as the city-fringe area has the convenience of being located close to major work and play districts. Foreign nationals who previously could afford to rent in the high-end segment will gravitate towards homes in the city fringe. We expect prices of homes there to stay flat over the next six months and rents to trend down by another 5%.

Like for those in the city fringe, new projects in the mass-market will command higher prices than those in the resale market. Consequently, the overall prices may remain flat in 2016. For rents, the flood of completions in 2016 will suppress rents even more than those in the city fringe as tenants have a large array of newly completed units to choose from. Expect mass-market rents to decline by 10%.

Donald Han, Managing director, Chesterton Singapore

High-end prices will continue to come under pressure as developers affected by the qualifying certificate try to sell completed stock, at a discount. Bulk sales may put further pressure on the high-end price index in a market with low levels of activity. Expect rents and prices to trend down by up to 5%.

The city-fringe segment has remained fairly resilient, accommodating downgraders from the high-end segment and upgraders from mass-market private homes and HDB. Rents and prices could ease between 3% and 5%.

Mass-market homes will continue to be under pressure from record completion this year and in2016, and increasing vacancy levels. Nearly 70%of new supply comes from the mass-market segment. Projects located close to MRT stations and retail centres will do well; those further away will take a longer time to lease out. Expect rents to decline between 5% and 8%.

Lee Nai Jia, Regional head of research, DTZ

Prices and rents in the high-end resale market are likely to continue to hold firm, while demand is expected to pick up in October and early November, before the holidays start. While the anticipated increase in the US Federal Reserve’s funds rate may be a concern, any increase may be a result of US government’s confidence in the recovery of the world economy. Additionally, most of the target buyers of high-end property are well-heeled and they purchase for wealth preservation or investment purposes.

Rents and prices in the city fringe are likely to trend downwards slightly. Demand for smaller units in the city fringe is expected to remain strong as they require a lower quantum. Mass-market rents and prices are likely to soften further with more properties obtaining their TOP. However, projects in choice locations are expected to be popular among buyers with HDB addresses.

Ong Teck Hui, National director, research, JLL

Over the next six months, we do not expect property cooling measures to be eased by the government, so residential property prices will continue their downward trend. There will be additional headwinds from an economic slowdown and anticipation of interest rates being increased. Generally, we expect rents and capital values to soften by 4% to 6 % in the next six months (4Q2015 and 1Q2016).

We are also seeing a slowdown in the other property sectors such as office, retail and industrial, with rents and prices also declining. In general, investors are likely to be deterred by the economic slowdown and expectations of falling prices.

In the residential leasing market, around 21,000 units are expected to be completed in 2015 and 2016 each, at a time when leasing demand has weakened owing to tightening of foreign labour intake, as well as the economic slowdown. There will be tighter expatriate rental budgets but as rents have declined in tandem and new supply has increased, there are now wider options for tenants. It is now a tenants’ market.

Market trends

Rising mortgagee sales

According to JLL, mortgagee sales have been rising as more home owners face difficulties repaying loans. Comparing the first three quarters of 2015with the same period last year, residential mortgagee sale listings have risen 57% while successfully concluded sales climbed 67%.

Chesterton’s Han says turmoil in the global stock market wiped out some $7 billion worth of Singapore STI (Straits Times Index) market capitalisation from May to September this year. Properties owned by individuals and corporates that are unable to service loans may be repossessed by banks and in turn, placed onto the market for auction. Some properties with default loans are assets bought by foreigners at the peak of the market, and banks have taken possession of these.

Savills’ Cheong attributes the rise in mortgagee sales to overleveraging before the TDSR was introduced. “The spate of cooling measures has put some traders in dire straits because their ability topay, pre-TDSR, was always in question and their income levels were tied to the state of health of the property market,” he explains.

Shift of interest towards other asset classes

We are seeing interest among local investors and smart money coming back into the landed market, particularly the Good Class Bungalow market, according to Han. “In the last five years, landed property prices have been more resilient compared with that of the non-landed segment. Since only locals can buy these, the volume of transaction is naturally lower. Transaction volume in1H2015 doubled compared with the same period in 2014,” he notes.

There is also sporadic interest in shophouses, adds Savills’ Cheong. However, the units may have to be exposed to the market for quite a long time before they get transacted.

Han notes an increase in buying activity of shophouses on the outskirts of the Central Region, particularly those near future growth catalysts such as Joo Chiat, which is close to the Paya Lebar sub-regional centre. There is also renewed interest in Little India and Kampong Glam shophouses, where values have not risen as much as those in the CBD and there is more upside potential. Investors also prefer shophouses with retrofitting/redevelopment opportunity, he says.

Buying overseas properties

“Singaporeans are discerning investors and would usually avoid markets where prices are peaking. Middle Eastern, Hong Kong and Chinese investors, on the other hand, are more peak-market in vestors, with a higher appetite for risk,” says Han.

Singaporean investors are scouting for properties priced between $500,000 and $1 million and these may take them to fringe markets such as London’s Zone 2 and the suburbs of Melbourne and Sydney, where prices are deemed more affordable and where locals can always afford to buy. Tokyo remains a favourite, with the 2020 Olympics providing anticipation of steady capital growth.

GDP, Sibor and exchange rate

On a final note, two economists polled by The Edge Property share their outlook on macro-economic indicators that may impact the property market.

Francis Tan, Economist, UOB

Singapore’s manufacturing sector (at 19% of GDP in2014) remains weak and has contracted for four consecutive quarters, on a y-o-y basis. Indeed, in the latest release, the manufacturing sector saw a 7% decline y-o-y in August. It was the seventh consecutive month that Singapore’s manufacturing sector had contracted.

If the September numbers come out worse than expected, we could possibly revisit the issue of the city state facing its first technical recession in six years again, after the Trade Ministry’s advanced GDP data shows that Singapore had narrowly averted such a label owing to a 0.1%q-o-q seasonally adjusted annual growth rate estimate for 3Q2015.

Slower growth prospects in the manufacturing sector will weigh on our GDP growth outlook. Economic uncertainties plaguing our top export destinations, the eurozone, US and China, remain and will continue to drag on manufacturers’ and exporters’ confidence. Singapore’s still-tight domestic labour market remains a supply-side constraint for production.

The slower appreciation in the Singapore dollar nominal effective exchange rate (SGD NEER) announced by the Monetary Authority of Singapore on Oct 14 may have limited positive impact on final export demand owing to the city state’s relatively high import content within its exports. The more important aspect for a significant increase in exports will be income growth in our key export destinations.

Saktiandi Supaat, Head of FX research, Maybank

The Singapore economy is currently facing headwinds from higher domestic interest rates, ongoing structural reforms to improve productivity (including tightening of the labour market) and government measures to curb car and property prices.

However, these are likely to be mitigated to a certain extent by tailwinds of expansionary fiscal policy, favourable inflationary environment and purchasing power effects from lower crude oil prices. Overall, growth is expected to slow in 2015, as reflected in the official growth forecast of 2% to2.5%. Our economic team’s expectation for 2015is a 2.2% y-o-y growth expansion.

The sluggish growth so far should continue into 2016 as weak external demand is likely to remain a drag. Global growth and hence, global demand, is likely to be uneven in 1H2016 and might not be able to provide domestic exports and tourist arrivals with a significant lift. Ongoing rebalancing in China is likely to be supportive of external demand ahead as the focus on consumption could boost imports from the region, including Singapore. We do not foresee growth pickup until 2H2016, when global growth becomes more entrenched as recoveries in the US, European Union and Japan take hold. It is in this light that our economic team is expecting real GDP to pick up moderately, expanding by just 2.8% in 2016.

Table 2: Most regional currencies expected to change marginally against the Singapore dollar

	OCT 21, 2015	END-2015 (F)	END-1Q2016 (F)
UOB	MAYBANK	UOB	MAYBANK
SGD/AUD	0.99	0.98	1.04
SGD/RMB	4.55	4.48	4.59
SGD/IDR	9,858	10,277	10,563
SGD/INR	46.75	46.15	47.18
SGD/MYR	3.08	3.08	3.06
3-month Sibor	1.01	1.15	1.29

Source: Bloomberg, UOB, Maybank

This article appeared in The Edge Property Pullout, Issue 700 (October 26, 2015) of The Edge Singapore.

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