We maintain our OVERWEIGHT sector rating. Investors’ interest in thesector should continue to be driven by: i) demand recovery led by front loading of big-ticket items ahead of the GST implementation, ii) M&A angle, and iii) conducive macro environment as a further interest rate hike is unlikely in 4Q. A relief rally post-2015 Budget is possible, as we do not expect any drastic cooling measures to be imposed. 

Two major corporate exercises this year. The share price re-rating of two of our Top Picks for the big-cap property stocks this year – IJM Land and Sunway – has been prompted by the companies’ respective corporate exercise. We expect SP Setia to be the next candidate. Given the exodus of its senior management and staff, we believe its major shareholder, Permodalan Nasional Berhad (PNB), will likely initiate a restructuring plan to re-strategise SP Setia’s market position over the next six months. 
♦  Sector overhang pre-2015 Budget.Investors’ interest in the property sector will likely be tepid ahead of the 2015 Budget announcement. However, we encourage investors to buy on weakness, as we expect neither more drastic measures to be imposed on the property sector nor relaxation of policies. 

“Last-minute” pre-GST front-loading. After a trough in 1Q, new sales improved by about 20% q-o-q in 2Q, but were still 33% lower y-o-y.Demand will likely pick up in 4Q14-1Q15, as potential buyers are increasingly aware of the potential impact of the goods and services tax (GST) on property prices. Although different tax regimes adopted in Singapore and Australia led to indirect/direct impact on the property market, based on empirical evidence, property transaction volume typically spikes prior to the GST rate hike, followed by an increase inproperty prices post-rate hike. 

Conducive macro environment. Other than the M&A angle and preGST front-loading, the macroeconomic environment should be conducive for the property sector post the 2015 Budget. Overall, we expect: i) a stronger GDP growth in 2014, ii) no rate hike for the remainder of the year, and iii) a potential boost from mega infrastructure projects should continue driving investors’ interest in the sector. 

OVERWEIGHT. The sector is currently trading at a 32.5% discount to RNAV, largely unchanged since last month. Should our expectations onthe budget turn out to be in line, the sector will likely see a relief rally. Our Top Picks are IOIPG, Tambun Indah and Matrix Concepts.

Demand Recovery Not Priced In Yet Corporate exercises spark market excitement 
Two of our Top Picks for big-cap property stocks this year – IJM Land and Sunway – have outperformed within our expectations. While IJM Land is being privatised by its parent, IJM Corp (IJM MK, BUY, FV: MYR7.90), Sunway is spinning off its construction and precast unit and listing it as a separate entity, named Sunway Construction Group Berhad. Although both companies have undertaken very different paths, we are positive on both deals, as they should not affect their business operations. Moreover, both deals have also successfully re-rated the share prices, in favour of their shareholders. We believe another major corporate exercise may come by end-2014 or early 2015. SP Setia will likely be the candidate. Given the exodus of its senior management and staff, as well as CEO Dato’ Voon Yin Tow’s early resignation (Dato’ Voon will officially leave the company on 1 Jan 2015), we believe its major shareholder, PNB, will likely initiate a restructuring plan for SP Setia, via privatisation and/or M&A, over the next six months in order to re-strategise the company’s market position. Fundamental valuations of SP Setia should therefore be based on its landbank assets, which are held at low book costs.

Our expectations for the 2015 Budget

Investors’ interest in the property sector is expected to be tepid, especially ahead of the 2015 Budget that will be tabled on 10 Oct. However, we encourage investors to buy on weakness, as we do not foresee any drastic measures to be imposed on the property sector nor relaxation of policies to be announced. After a slew of cooling measures announced in the previous budget, which included: i) an increase in real property gains tax (RPGT), ii) a higher floor price for foreigners’ purchases, and iii) the termination of the developer interest bearing scheme (DIBS), the property market is still reeling from the challenging market conditions. The Iskandar Malaysia market, of which developments are largely driven by Khazanah Nasional, continues to see sluggish demand over concerns of a supply glut in the market. Speculative buying, therefore, has been wiped out to a large extent. As such, the Government is likely to pause from further tightening. Meanwhile, given the Government’s objective to continue promoting a healthy property market and to contain price growth, we think that a relaxation of policies is unlikely either. In addition, household debt/GDP, which stood at 86.8% in 2013, will also take time to wind down.

Key measures imposed in Budget 2014 were: 

i.  The RPGT on properties disposed within the holding period of up to three years rose to 30%. Meanwhile, the RPGT for properties disposed within holding periods of up to four and five years increased to 20% and 15%, respectively. For disposals made in the sixth and subsequent years, no RPGT was imposed on citizens, whereas companies were subjected to a 5% rate. 
ii.  For non-citizens, the RPGT was at 30% on the gains from properties disposed within the holding period of up to five years, while for disposals in the sixth and subsequent years, the RPGT was be at 5%. 
• The new tax regime (1 & 2) took effect effective from 1 Jan 2014 onwards. 
iii.  Raising the floor prices of properties for foreign buyers to MYR1m from MYR500k. 
iv.  The removal of DIBS. Financial institutions are now prohibited from providing final funding for projects involved in the DIBS scheme. 
v.  Introduction of a private affordable ownership housing scheme (MyHome) to encourage the private sector to build more low and medium-cost houses. The scheme provides a subsidy of MYR30k to private developers for each unit built. Among the criteria for the scheme are: 
• Build at least 20% low-cost houses and 20% medium-cost houses in a housing project; 
• The maximum price of low-cost houses is MYR45k and mediumcost houses is MYR170k

• Open to first-time buyers with a monthly household income of MYR3k for low-cost houses and a maximum of MYR6k for medium-cost houses. 

vi.  Increasing transparency in property sales prices, whereby detailed sales prices including all benefits and incentives would have to be displayed.  

Tighter measures in Selangor 

The Selangor State Government has also recently imposed tighter measures to curb foreigners from buying properties. Key measures include: 

♦  Foreigners, permanent residents and foreign companies are only permitted to buy residential properties that are priced at above MYR2m for Zones 1 and 2, and units with a minimum threshold of MYR1m in Zone 3. 
♦  Foreigners are only allowed to buy commercial and industrial properties that are priced at above MYR3m in all the three zones. 
♦  Foreigners are not allowed to buy properties set aside for bumiputras, as well as no more than 10% of non-bumiputraunits. 
♦  Foreigners are not permitted to buy agricultural land, Malay reserve land as well as non-strata landed residential and auctioned properties. 
♦  Foreigners under the Malaysia My Second Home (MM2H) programme can only buy directly from developers and not from the secondary market, and are eligible to buy only one residential unit per family.
♦  Zone 1 comprises the districts of Petaling, Gombak, Hulu Langat, Sepang and Klang; Zone 2 consists of the districts of Kuala Selangor and Kuala Langat and Zone 3 constitutes the districts of Hulu Selangor and Sabak Bernam We think the negative impact from these measures is quite muted, as foreign buying has already largely declined following the round of cooling measures announced last year. In addition, areas that foreign buyers are typically interested in are: the Kuala Lumpur city centre, Mont’ Kiara, Bangsar and Damansara Heights – which are located in Wilayah Persekutuan. They are usually less keen on the outer areas. In our view, this set of measures could be a pre-emptive move to prevent foreign developers from buying large tracts of land for property development that could create a glut in the local housing market, as seen in the Iskandar Malaysia market at the moment. Such policies could ensure healthy growth of the property market over the longer term.

Pre-GST front-loading could be a big push 
The effect of front-loading ahead of the implementation of the GST has yet to be evident, as the cooling measures announced in last year’s budget continue to work their way through. Nevertheless and in line with our expectation, after the trough in 1Q, new property sales started to improve by about 26% q-o-q in 2Q – although the amount is still 33% lower y-o-y. We expect the demand for properties to be stronger in 2H, driven by the number of new launches in the pipeline. These new projects should capture “last-minute” buying especially in 1Q15, ie just before the implementation of the GST on 1 Apr 2015, as potential buyers are becoming increasingly aware of the impact of the tax on property prices. Marginal buyers and investors will, therefore, likely frontload the big ticket items ahead. Our checks with developers indicate that the net effect on residential and commercial properties should be a 4-10% increase in selling prices.

Empirical evidence in other countries 

In Malaysia, commercial properties will be subject to a standard rate of the GST (once it is implemented), while the residential properties will be exempted. Although different GST tax regimes are adopted in Singapore and Australia, the increase in GST rates in the past has had a direct and indirect impact on the property market. Based on the empirical evidence, the property transaction volume typically spikes just before the GST rate goes up, followed by an immediate increase in prices and a drop in volume post rate hikes. For instance, the Australian housing market saw a jump in the house price index subsequent to the imposition of its GST from 1 Jul 2000. Similarly, the Singapore housing market also experienced the same trend, ie the volume of property transactions surged prior to the GST rate hike to 7% (from 4%) effective from 1 Jul 2007. Prices continued to increase after the rate hike but the slump in 2008-2009 was the primary result of the subprime crisis.

Expect a more favourable environment in 4Q 

Other than the merger and acquisition (M&A) angle and pick-up in demand ahead of the GST implementation, the macroeconomic environment should also be conducive for the property sector post the 2015 Budget, assuming our expectations are true. Overall, we expect: i) stronger GDP growth for 2014, ii) no rate hike for the remainder of the year, and iii) a potential boost from mega infrastructure projects to continue driving investor interest in the sector. 
Our economists have forecasted a stronger real GDP growth of 5.8% for 2014, higher than 2013’s 4.7%. Growth in 1H was encouraging, with 6.2% and 6.4% recorded in 1Q and 2Q respectively. Although we expect economic growth in 2H to be weaker than 1H – largely due to higher base effect in 2H last year – the better growth throughout 2014 should flow through to the property sector.

Meanwhile, we do not foresee a further interest rate hike for the remainder of the year. This gives potential home buyers more time to digest the impact of the 25bps increase in interest rates in July. Commercial banks have correspondingly also come out with more attractive mortgage rates such as base lending rate (BLR) minus 2.5-2.6%, making effective mortgage rates largely unchanged at around 4.2-4.3%. Therefore, buying interest, in our view, should gradually return towards late 2014.

Long-awaited mega infrastructure projects such as the Klang Valley mass rapid transit (MRT) and high-speed rail networks have yet to be rolled out until now. However, we expect more news flow on these projects to stream in over the next few months. The high-speed rail project is a wild card. It could be a strong re-rating catalyst for the Malaysian property sector, given that connectivity between the Kuala Lumpur city centre and Singapore will be significantly improved.

Outlook on the Klang Valley, Iskandar and Penang markets 

The property market is recovering (see Figure 1) in terms of quarterly sales. Although developers are generally still cautious, in our view, those with landbank in strategic locations, established brand names, decent pricing, impressive designs and concepts would stand out. Penang:Among the three key regions, we remain upbeat on the Penang mainland market, as house prices are still undemanding with the support of more and more infrastructure facilities and business activities. While Batu Kawan has seen new catalytic investments pouring in, such as the cross-border JV with Temasek to build a Penang International Technology Park (PITP) and Business Process Outsourcing Prime (BPO Prime), IKEAand education campuses which may take at least 4-5 years to complete, Tambun Indah is already constructing its own international school (GEMS) in its flagship township, Pearl City, and is aggressively expanding its landbank with the latest 209-acre addition to its portfolio. Recently also, Malaysian Resources Corp has received the green light from the Penang State Government to proceed with its Penang Sentral project in Butterworth. The project, targeted for completion by end-2017, is worth MYR2.3bn and will be the key transport hub in Penang mainland. Meanwhile, we look forward to the state government’s official award for the proposed golf course and theme park projects at Batu Kawan. If Eco World Development (ECW MK, NR) turns out to be the successful bidder (now that it has been widely speculated in various media reports as the winner), we believe the company’s greater presence in the Penang mainland may continue to drive real estate values upward. Klang Valley:The Klang Valley region remains the bread-and-butter market for developers. There are currently a few hotspot clusters for township developments, including Semenyih/Bangi/Nilai/Dengkil areas, Canal City, Rawang, as well as the Kerinchi/Old Klang Road enclave for pockets of developments.

Although there could potentially be too many developers concentrating in the southern Klang Valley area, thus far, Eco World, SP Setia and Mah Sing are able to rake in strong sales from Eco Majestic, Eco Hill and Southville respectively, largely because of the infrastructure developments that will be sunk in for the townships, as well as the design of the landscape that entices potential buyers looking for an upgrade. Similarly, we expect to see encouraging response upon IOI Properties Group’s debut for its Bandar Puteri @ Bangi. IJM Land, on the other hand, has the first-mover advantage in the Canal City area, and is still able to achieve strong take up in its Bandar Rimbayu Phase 3. Given its strong clientele, IJM Land’s Pantai Sentral Park has also seen a full take-up for its Block 1. 

Iskandar: The outlook for the Iskandar Malaysia market is still very challenging. High-rise projects continue to suffer from a lukewarm response from the market. The situation is likely to worsen as the traffic flow over the causeway is expected to be negatively affected over the near term as a result of the 2-way increase in toll charges by the Malaysia and Singapore Governments recently.

However, unlike the oversupply in some parts of Iskandar, we see Pengerang as a silver lining. In April this year, Petronas approved the final investment decision (FID) for the development of the Pengerang Integrated Complex (PIC) comprising a Refinery and Petrochemical Integrated Development (RAPID). RAPID is estimated to cost about USD16bn while the investment on other facilities may cost USD11bn. At the peak of construction, the project would involve a workforce of 70k while at its operational stage, PIC would require 4k employees. Meanwhile, Desaru, which Khazanah Nasional will develop into a tourism hub, has already seen some progress. 
A golf course has already been completed, and a few reputable hotel operators will set up their hotel chains there, including Sheraton, Aman and Datai. Given the prospects and growing demand at Pengerang, we understand that the rental market for residential and commercial properties is already going strong. Therefore, new launches by IJM Land for its Sebana Cove and Malton’s (MALT MK, NR) shop lots should be well received, since the number of projects there will be quite limited over the short term. 

Key risks to our call 
i.  Unexpected market risks due to external factors (such as political risks) that could affect the broad equity market.
ii.  A 50-100bps interest rate hike in 4Q14.
iii.  More punitive measures being imposed

Valuations 
We maintain our OVERWEIGHT stance on the sector. The sector is currently trading at a 32.5% discount to RNAV – which is largely unchanged since last month – mainly due to the concerns on potential new cooling measures. However, if our expectations on the Budget turn out to be in line, the sector will likely see a relief rally. Our Top Picks are IOI Properties Group, Tambun Indah and Matrix Concepts. IOI Properties Group could see the opening of its IOI Putrajaya mall in end-2014 (which rationalises the potential re-rating in our RNAV estimate), as well as its maiden launch of Bandar Puteri @ Bangi in FY15. Meanwhile, Tambun Indah and Matrix Cencepts remain our picks for affordable housing players with a respective thematic angle.

Source: RHB