Thursday, January 8, 2009

Developers may want to take that haircut right away

PROPERTY consultancy groups have issued reports over the past couple of weeks reporting declines in Singapore residential property values, especially for the high-end segment, in 2008 - with pretty grim prognoses for 2009 too. This will mount pressure on listed property groups to make provisions for Singapore residential sites.

When listed property groups did not announce such provisions in their Q3 results last year, the thinking among analysts was that these companies would take haircuts in their books on their pricier residential sites only in second-half 2009, or even later.

DTZ recently published a report estimating a 21.6 per cent decline in average prime non-landed freehold private home prices in 2008 and predicted a further 15 to 20 per cent drop this year.

CB Richard Ellis last week also said that in 2008, average prices of new luxury homes under construction had slipped 30-35 per cent in prime districts 9 and 10 and by 10-13 per cent in Marina Bay and Sentosa Cove.

Developers could argue that while property consulting groups may talk about declines in property values, there has been a scarcity of transactions to confirm the declines.

Nonetheless, for companies that acquired sites at high prices which are above current values, there’s a case for booking the provisions in Q4 2008 - and moving on.

For one, most developers reported strong earnings in first-half 2008 that can help cushion against provisions on their Singapore residential landbank - if they choose to book them in their Q4 and full-year 2008 financial statements.

However, if they postpone the decision till 2009, the haircut could add further strain to bottomlines going ahead, which are already expected to weaken on the back of poor home sales, an all-round weaker economic showing and lower valuations for investment properties (these refer to assets like office buildings and shopping centres held for rental income). Right now the mood is so weak, that if developers were to announce provisions for their Q4 results, it would not dent sentiment much further. It may be better to flush out all the bad newsflow now.

Making provisions sooner also clears the decks for developers to price projects more attractively to tap any windows of opportunity to launch projects - and begin a new cycle of profit booking. As a big property group said over seven years ago when announcing massive residential provisions, the exercise provided it ‘pricing flexibility to generate cashflow’.

Beyond writing down sites to current values, at least one big developer in the past went a step further and provided more than it perhaps needed to.

This is what many analysts say CapitaLand did in August 2001, when it marked down the value of its residential assets, mostly landbank, by $508 million, in its half-year result statement.

Analysts said the group wrote down the value to below then market prices. In short, it overprovided. The group’s management refuted this point, but the strategy may be revisited by some property groups today spring cleaning their books.

Ask most property agents today and they’ll tell you potential buyers are asking at least 20-25 per cent off current property values before they will make a commitment. This is to cushion against future price falls. Indeed, expectations are running high among analysts for a further drop in home prices this year.

Given this scenario, some developers may find it sensible to mark down values of high-cost residential sites in one fell swoop (not just to current valuations but also to factor in likely future price movements), instead of making a series of piecemeal adjustments over a period of time.

Of course, such a strategy may be frowned upon as an exercise in earnings management in some quarters.

This time round, CapitaLand may not be the market leader in making provisions for its residential landbank.

Still, some analysts point out that breakeven costs for two sites it bought in 2007 - Farrer Court and Char Yong Gardens - are higher than what new projects on these sites would command today. Other listed property groups too acquired sites at steep prices during the property fever.

Examples include two 99-year leasehold condo plots on Sentosa Cove - the Beachfront Collection site that SC Global bought at $1,800 psf per plot ratio in 2007, and The Pinnacle Collection plot purchased by a Ho Bee and IOI Properties joint venture in early-2008 for $1,822 psf ppr.

The latter was the highest price paid for a condo site in the waterfront housing precinct. Then there was the 99-year leasehold Grangeford site, bought at $1,810 psf ppr by Overseas Union Enterprise in 2007.

In fact, a seasoned property agent says that pretty much most sites bought in 2007 would be below water today. There is indeed impetus for developers to make provisions.

However, there will be ramifications. Beyond issues of managing earnings, for some developers, there could be a real limit to how much they can write down their sites as provisions may trigger breaches in loan covenants. They may be asked by their banks to top up more equity.

That would stretch smaller developers, many of whom are already highly leveraged and cash strapped.

Source : Business Times - 8 Jan 2009

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