Property Sector - 2017 Outlook ~ Attractive Valuation Trade
- Trading near multi-year lows, implying attractive risk/reward ratios.
- Policy relaxation and potential Merger & Acquisition (M&A) activities could lift sentiment.
- Pick diversified plays like City Developments and UOL.
Property prices to remain on a downtrend, luxury end of the market is bottoming.
- We maintain our view that prices for Singapore's luxury end property market will continue to remain stable given expected continued higher transaction activity in a finite supply space.
- Prices for homes in the suburban regions are expected to still moderate by 3-5% on the weight of high supply completion coupled with rising vacancy risk going forward.
- We expect developers with exposure in the high-end residential market to continue clearing existing unsold inventories given improved sentiment.
Land banking in Singapore to pick up, opportunities through collective sales and potential Merger & Acquisition (M&A) activities could pick up.
- With a close to c.20% increase in total property transactions YTD, we have seen SG developers clearing a substantial portion of their unsold inventories on their balance sheets and we believe that most will be looking to acquire once again to replenish their land banks.
- While we expect opportunities in the upcoming 1H17 government land sales (GLS) to be competitive, a possible avenue to add to their land banks could be collective sales sites and potential M&A activities among the listed developers.
- These will be driven by pressure to sell off inventories given additional buyer stamp duties (ABSD) and Qualifying Certificate (QC) deadlines.
Diversification strategy to take a breather given currency volatility.
- Developers are expected to seek opportunities to diversify their earnings base geographically and will likely continue seeking higher returns overseas.
- We expect capital cities of Sydney, Melbourne and the UK to remain high on developers’ horizon as these cities are offering the highest currency adjusted returns despite recent heightened currency volatility.
Uncertainty of pace of interest rate increases probability of a policy relaxation.
- We believe that negatives from a weakening residential outlook in SG are priced in and expect further declines in market residential prices to push towards the government’s eventual easing of selective speculative measures currently in place. This is expected to lift investors’ sentiment towards SG Developers.
Macro uncertainties could impact on buyer sentiment and sustainability of transaction volumes.
- The expected slowdown in domestic economy might lead to potential job losses, and could result in an abrupt stop to the current positive property transaction momentum, which might weigh on buyer sentiment going forward. A scenario where unemployment rate rises closer to 4.0% (vs 3.0% currently) might result in a >10% further fall in home prices.
- A key uncertainty is the prospect of higher interest rates from 2017 onwards, which will have a negative impact on home affordability.
- Commercial portfolio to provide earnings stability but might see downside if domestic economy weakens.
- The commercial segment, especially the office sector and retail sectors, have also been weak and will likely see weakening rents which could mean downside to estimates for SG developers going forward.
Valuation & Stock Picks
Sentiment boost if government tinkers; developers’ valuations offer attractive risk/reward ratio.
- We see attractive risk/reward ratios at this level for SG developers at a P/NAV of 0.7x, which is close to the - 1SD level. We believe that sentiment could improve upon a potential policy relaxation, as uncertainties of the pace of interest rate increase in 2017 impact future price direction. This, in our view, will likely come post a peak-to-trough fall in prices of close to 13-15% (current drop is close to 9% from the peak), estimated by the end of 2017.
- The SG developers are trading at an average 45% discount to RNAV currently, close to -1SD of the mean and downside could be limited at this level.
Prefer diversified plays.
- Under the above scenario, we prefer diversified companies with a multi-sourced income profile, with strong recurrent cashflows that will remain more resilient than others.
- Our top picks are City Developments and UOL.