We believe that near term property demand will be supported by the healthy economic recovery and improving job market but this is partially offset by the interest rate hike and rising cost of living. Beyond 2022, the demand outlook is less clear due to the looming global recession risk. On the supply end, labour shortage issue will likely persist in the near to medium term, resulting in (i) lower cash flow to developers; (ii) lower earnings recognition; and (iii) slowdown in new launches. Given that near term earnings recognition from new and ongoing projects will come under pressure, we believe developers that will fare better during this period are developers that have (i) higher completed inventories to support sales; and (ii) property investment segment to provide recurring income. As such, we recommend Sunway and IOI Prop as our top picks for the sector.

Economic recovery supportive of sales. Property developers under our coverage recorded an encouraging sales growth in 2QCY22 as sales picked up by +29.8% QoQ with 7 out of 8 of developers recording positive growth (see Figure #1). Moving in to 2HCY22, sales would be supported by (i) healthy economic recovery (1H22 GDP growth +6.9% YoY, HLIB CY22f: +6.5% YoY); (ii) improving labour market with unemployment rate declining to 3.7% in Jul 2022 (vs. pre-pandemic 3.3% in Feb 2020); (iii) resumption of sales gallery and physical marketing campaigns; and (iv) the recent introduction of i-Miliki campaign. To recap, i-Miliki offers a 50% stamp duty discount for houses priced at RM500k-RM1m for period 1 June 2022 to 31 Dec 2023, while for houses priced <RM500k remain exempted for stamp duty until Dec 2025.

Minimum wage hike. In addition, we believe the minimum wage hike to RM1.5k (+25% from RM1.2k) effective May 2022 will support wage growth for the lower and middle income segments. Employers are likely to make salary adjustments for the middle income segment as well to reflect the revised pay scale. As such, an improving labour market coupled with wage growth should augur well for buyers’ spending power in the longer term.

Measured increase of interest rate vs US. In Malaysia, BNM started hiking OPR since May 2022 with a total of +75bps YTD (+25bps hike each in May, July and Sep), bringing OPR from 1.75% to 2.50%. Comparing this with the US, the Fed started hiking interest rate in Mar 2022 with a total of +300bps YTD (+25 bps in Mar, +50 bps in May, +75 bps each in June, July and Sep), bringing FFR from 0-0.25% to 3-3.25% (see Figure #2 and #3). Due to the steep hike in the US, this has created a negative shock to the housing market, with its 30-year mortgage rate doubled YTD to 6.59% as at 23 Sep 2022, while existing home sales declined -26.5% YTD as at Aug 2022 (see Figure #4 and #5). Contrasting this with Malaysia, we see that our rate hikes are more spread out and of a smaller quantum. Furthermore, pre-pandemic, the OPR rate in the past decade has always been in a stable range of 3-3.25%, and as such, the rate hikes did not come as a surprise as it is within expectations that interest rates would eventually revert to the normalized range of 3-3.25% once the economy started recovering from the pandemic. As such, the measured pace of rate hikes coupled with the expectation of mean reversion of rates are less likely to create a shock to the property market in Malaysia. BNM data on residential loan applied and approved support our view as both remained healthy while the approval rate has also inched up to 42.9% in July (from 40.6% in June) (see Figure #6).

Rising inflation. Another downside risk to demand stems from the rising cost of living. Malaysia inflation rate came in at +4.7% YoY in Aug 2022. In comparison with other regions and countries (EU +9.1% YoY, US +8.3% YoY, Thailand +7.9% YoY, the Philippines +6.3% YoY and South Korea +5.7% YoY), our inflation rate is on the lower end due to (i) price controls and subsidies; and (ii) BNM started earlier in its rate hike cycle during early stage of economic recovery. Nonetheless, the inflationary pressure will still dampen buyers’ spending power and as such, buyers may choose to hold off property purchase or opt for the rental market until inflationary pressures start easing. 

Looming global recession risk. While the economic recovery remains supportive of sales in 2HCY22, however, the picture is less clear in 2023 due to the increasing risk of a recession in the US, UK and Europe, which may have a contagion effect on Malaysia through trade links. The wild card comes from China on whether its economy will be able to rebound depending on the easing of Covid-19 restrictions and its property market stabilizing. Given that economic health is the biggest driver for the property market, a slowdown in the local economy will inevitably negatively impact the property market.

Labour issue taking centre stage. On the supply side, developers are increasingly facing labour shortage pressures which impedes construction progress for their projects. While developers in general are guiding that this issue could be resolved by 3-4Q22, we are of the view that the issue will take longer to resolve given the wide imbalance between labour supply and demand. For perspective, a report from Reuters on June 2022 estimated that Malaysia lacks c.1.3m workers, with construction sector alone taking the lion share of 550k workers. While 390k foreign workers intake were approved, only 47k have arrived as at end-Aug (i.e. <5% of the workers needed). Given the wide gap to fill and that the construction sector has to compete with other sectors for labour, we anticipate that the shortage issue will persist in the near to medium term. The slowdown in construction will impact the cash flow for developers as payment to developers depends on site progress. Slower site progress will also impact revenue recognition for developers. Other than that, contractors will also compete and pinch workers from competitors, which will drive up labour cost.

Slowdown in launches. 1H22 launches were slow, with new launches significantly trailing developers’ full year target (see Figure #7) due to (i) labour shortage; (ii) developers adopting a wait-and-see approach due to volatility in building material costs; and (iii) delay in project approvals as government agencies process backlog cases accumulated during the lockdown. As a result of labour shortage, we continue to anticipate that launches will be slow in 2H22 due to (i) developers simply do not have enough workers to develop new projects and as such, may not be able to deliver the projects on time; and (ii) the slowdown in operating cash flow from ongoing projects to fund new project development.

HOC aggravated housing supply glut. The HOC was introduced in 2019 to (i) encourage home ownership; and (ii) bring down residential property supply in the market. During 2020-2021, the campaign was extended as a support measure during the pandemic. Nonetheless, not only did housing supply not ease, but it had actually built up during the HOC period and peaked at Dec 2021 (see Figure #8). We believe that this is partly because the HOC was not limited to only completed inventories, but developers were also allowed to launch new projects under the campaign. This incentivized developers to launch more new projects under the HOC. As the HOC has a requirement of 10% discount to property prices, developers would be able to set their new launches price to account for the 10% discount, while there is less flexibility in price adjustment for completed inventories. Due to this, developers are focusing their efforts in selling new launches rather than from completed inventories, thereby contributing to the build-up in completed inventories. We believe the housing supply build up has in part contributed to the slowing growth in housing price as reflected in the HPI index, with the latest 2Q22 HPI contracting by -1.17% (see Figure #9).

Short term pain, long term gain. Due to labour shortage and consequently lower construction progress, sales from new launches would result in slower cash flow and lower revenue recognition to developers. To facilitate better cash flow and to ensure stable earnings recognition, developers are likely to shift their focus back to selling completed inventories. The effort to clear completed inventories coupled with a slowdown in new launches should help to lower the housing supply. Property overhang data has shown sequential easing in 1Q22 and 2Q22 from its peak in 4Q21 (see Figure #8). The continued easing in property overhang should bolster for a more healthy increase in house prices in tandem with inflation growth.

Budget 2023 preview. As Budget 2023 is a pre-election budget, any measures introduced are likely to be targeted towards the B40 and M40 buyer group. As such, measures that are targeted to help developers (such as lower foreign ownership threshold to clear completed inventories, lifting taxes on imported construction materials to ease building material cost, etc.) are less likely to be introduced as the government is likely to save its bullets towards measures that can create more tangible benefits towards the B40 and M40 group. Conversely, measures that target buyers directly may be on the cards. These include, for example, personal tax relief for first time homebuyers, lowering home financing cost for government servants, etc. The reintroduction of HOC is on the top of most developers’ budget wish list, while the Ministry of Housing and Local Government had also similarly indicated that it hoped MOF will approve a 100% stamp duty exemption for properties priced between RM500k-RM1m on condition that it is for the first time homebuyers and for developers to give a minimum of 10% discount. While we are cognizant that there is already i Miliki campaign in place, nonetheless, we do not discount the possibility of HOC being reintroduced given that this measure is more attractive than i-Miliki and that it will give direct tangible benefits to the often neglected M40 buyers group.

Keeping up with the property sector. As property developers tend to have lumpy revenue recognition, especially from oversea projects, while the commencement of new property investment operations can provide the start of new recurring income stream, it is easy to lose track on the timeline of these events. For the ease of investors, we introduce an event tracker to keep track of these key events and milestones that will impact earnings. Please see Figure #9 for more details.

Maintain our Neutral rating on the sector. Piecing together the information we presented, we believe that near term property demand will be supported by the healthy economic recovery and improving job market but this is partially offset by the interest rate hike and rising cost of living. The positive wage growth arising from minimum wage hike is also another positive for buyers’ purchasing power, especially in the longer term. Beyond 2022, the demand outlook is less clear due to the looming global recession risk. On the supply end, labour shortage issue will likely persist in the near to medium term, resulting in (i) lower cash flow to developers; (ii) lower earnings recognition; and (iii) slowdown in new launches. In order to generate cash flow and ensure stable earnings recognition, developers are likely to focus on clearing their completed inventories. We believe that this short term pain could foster for a healthier sector as this will ease the property oversupply and support a healthy growth in housing prices. Given that near term earnings recognition from new and ongoing projects will come under pressure, we believe developers that will fare better during this period are developers that have (i) higher completed inventories to support sales; and (ii) property investment segment to provide recurring income. As such, we recommend Sunway and IOI Properties as our top picks for the sector.

Source: Hong Leong Investment Bank Research - 29 Sept 2022