Is KL heading for Dubai-style property crash?

By Khairie Hisyam

CIMB Research’s warning that the Malaysian commercial property market is at risk of a Dubai-style crash has drawn mixed reactions from industry players. While some agree that a crash is looming others feel there is more room for building in Kuala Lumpur.

Most of those who responded pointed in particular to the large number of planned office projects in Kuala Lumpur and cautioned that it may not be possible to attract customers to fill the burgeoning space. However most felt the crash if it comes will not be as bad as Dubai’s.

In a recently released strategy report, CIMB Research called for a reconsideration of mega commercial development projects as these would only worsen the current office space oversupply situation in Klang Valley, warning that Malaysia should learn from Dubai’s commercial property crash during the global financial crisis (GFC).

Expressing concern over the oversupply situation, the research house suggests pacing new supply from mega commercial projects — such as the Tun Razak Exchange (TRX), the 118-storey Warisan Merdeka Tower and the Rubber Research Institute land in Sungai Buloh — and wait for demand to catch up with supply.

This will allow better equilibrium and for pressure on rental rates to remain more manageable, said the research house. “However, this is a difficult balancing act as private property developers continue to build more commercial space and there appears to be little let-up.”

Speaking to KiniBiz in July on the subject, real estate researcher Professor Ting Kien Hwa commented that this is because the industry environment is still conducive for developers to keep building. “In fact, after the GFC interest rates even went down, so developers found that they can still build.”

Are we at risk of a commercial market crash?

Commenting to KiniBiz, ENK Ventures managing director Enoch Khoo feels CIMB’s caution should be taken seriously by the powers that be.

“I think it is the right call,” said Khoo who founded his property firm. “I think we can argue (about it) and be positive etc but nothing can fight against the supply and demand theory.”

But is a Dubai-style crash likely if we do not slow down on our mega commercial projects?

“For the office segment, yes (it is likely),” said Khoo flatly, stressing however that the possible crash is only applicable to the office space segment of the market. “For residential (sector) I don’t see it crashing.”

On the other hand, Eddy Wong, managing director of property consultancy DTZ Nawawi Tie Leung, feels it is not likely.

“I don’t think we’re anywhere near Dubai — Dubai grossly overbuilt and we are nowhere near (that point),” said Wong to KiniBiz.

Wong acknowledged however that there is concern about the large number of supply coming onstream. “But I think developers will adjust as they go along,” said Wong, adding that market players would be aware of the risk.

An economist in the financial sector, who declined to be named, also thought that while the oversupply concern is real, a crash is perhaps stretching it. “I don’t think it will get to the point of a crash.”

‘Heed the Dubai lesson’

CIMB Research pointed to Dubai’s commercial property market crash during the 2008–2009 recession as a lesson for Malaysia to take heed of, given that “the early story of Dubai is similar to Malaysia’s current ambitions”.

“The rationale for building the iconic tallest office tower and other commercial projects are partly to lift industry standards in KL, as was the case in Dubai, which was said to be short of available class-A office space needed for the emirate to remain attractive in the global marketplace.”

Seeing a property development boom after the Dubai Investment and Development authority, styling Dubai as a property haven, shifted its economic focus from being oil-based to being technology-based, the GFC in 2008 left Dubai struggling to service its debts as the exodus of expatriates caused mass unemployment.

“Another striking similarity is the involvement of the government and Middle East investors in the masterplan and parcelling of the large-scale developments as well as the downstream involvement of more international investors,” added the research house, pointing out that Dubai even had an advantage over Malaysia then given that 80% of Fortune 500 companies were already located in Dubai against a backdrop of persistent undersupply in its pre-boom years.

Compared to Klang Valley’s overall occupancy rate at 79.8% at the moment after falling for the fifth straight year — new supply growth at 7.8 million sq ft outstripped demand growth at 4.8 million sq ft — Dubai’s occupancy rates were stable at 97–99% at the time.

But is the Dubai comparison apt?

But that does not tell the whole story, according to Veena Loh, general manager of Malaysia Property Inc, echoing Wong of DTZ’s comment that Dubai grossly overextended itself.

Malaysia Property Inc is an Economic Planning Unit (EPU) initiative to match foreign investors with real estate investment opportunities in the country.

“Dubai’s overbuilding was very obvious. It has more than half as many hotel rooms as Vegas but only 10% of the tourists. Dubai only has about 2 million people of which three-quarters are male. Most of the males are expatriates that come to Dubai to work. As their families are in their hometown, there is a tendency to send money home to buy residential property in their hometown,” said Loh in an email response to KiniBiz.

“Greater KL has more than 6 million people and is growing rapidly as it draws locals from other states and expatriates from foreign countries,” added Loh. “More importantly, the Government’s plans to attract 100 of the world’s largest multinationals to invest in Greater KL by 2020 would help to alleviate the demand for office space.”

Loh further comments that foreign SMEs will also contribute towards demand and that Singapore will comprise an important part of office space demand when the Kuala Lumpur–Singapore high speed rail is completed. “Sustained economic growth will also determine demand by local entrepreneurs and companies for office space.”

“There would be definitely pressure on rentals over the next few years but the situation is not expected to be felt equally across the board. Some will feel the pain more than others,” said Loh. “Those commercial real estate which have good location, accessibility, carparking facilities and are well-managed will retain their tenants. Office space which do not have these sought after characteristics may find difficulty retaining their tenants.”

Are liberal property policies the way to go?

The research house also pointed out using liberal property policies to attract foreign direct investment (FDI) may not be the most effective way to stimulate the economy, as it has not been statistically proven that FDI in real estate complements FDI in manufacturing and services in boosting economic growth of the host economy.

“We are uncertain how a flurry of real estate investments can contribute to the long-term potential growth of the nation. Also, how far should property liberalisation measures stretch?” wrote CIMB Research. “Are we driving too much FDI into the real estate sector?”

CIMB Research further warns that excessive property market liberalisation without proper planning and insight invites the risk of a crash when economic shocks come a-calling.

“While the policies could act as catalysts for the nation’s growth, they could also jeopardise growth should shocks or external factors hit,” said CIMB Research. “It remains to be seen if overinvestment in mega-property development projects can really help to boost FDI inflows and, more importantly, growth.”

Therefore without solid fundamental demand in place as opposed to demand created by liberal policy measures, overbuilding commercial real estate may lead to “painful long-term issues”, said the research house.

These issues include worsening the oversupply situation in Klang Valley, wasting strategic land resources as well as knock-on effects on the financial sector from borrower defaults.

“Should the project be part-funded by government-guaranteed bonds and fail, the losses would hit the government’s balance sheet and exert further pressure on overall public debt,” said CIMB. “A slowdown of these projects will help to lessen the impact on the country’s current account balance.”

‘Liberalise policies for doing business’

But talk of default at this point may come too soon, said Loh of Malaysia Property Inc.

“While it is good for both developers and bankers to be cautious about the impending oversupply of office space, it is very premature to talk about default now especially when the occupancy of commercial office space in Greater KL is still much higher than most other states,” said Loh.

However, Loh echoes CIMB Research’s sentiment that driving economic growth should go beyond attractive property policies. “Liberalising property policies will only mean that office properties change hands but will not increase occupancy.”

“It would be more effective to liberalise policies to do business in Malaysia to entice foreigners to do business here,” said Loh. “We are slowly moving in that direction for ASEAN. Perhaps we can hasten this process or include ASEAN +3 countries.”

Yet the financial sector economist, speaking on condition of anonymity, opined that policies alone won’t cut it in attracting foreign investors. Instead, the economist pointed out that economic growth has to be approached holistically.

Setting overambitious targets?

CIMB Research also called for a proper assessment of supply and demand in the market before committing to such large-scale investments as the mega commercial projects.

In its report, the research house acknowledged the government’s aim of luring 100 MNCs to Klang Valley by 2020 but suggested that the demand projections for Klang Valley office space may be overly ambitious.

“We think that Malaysia is still facing many challenges in designing the ‘right’ policy approach to foreign investment, including addressing investment protectionism in selected key industries. This may deter foreign investors as well as turn away domestic investors,” said CIMB Research, adding that “amid growing competition to house regional HQs, Malaysia may also start to see more home-grown regional companies moving their HQs abroad”.

“Indeed, we are witnessing a trend of Malaysian companies exploring business opportunities abroad, as indicated by higher outflow of direct investments abroad,” added the research house. “Even if we assume that office space demand grows at double its 2012-14 rate between now and 2017, we think that the glut is set to increase, particularly in areas which do not receive government incentives.”

The financial sector economist agreed that the 100-MNC target by the government is “probably” overambitious as put forward by CIMB. “The problem with attracting them is corporate tax rates — unless we give them preferential tax rates, they won’t come.”

We also have to bear in mind the rates in other countries competing with Malaysia for the same investors, added the economist, and that unless we match or do better than these other countries, the investors would not come.

Dropping occupancy puts pressure on rental

In line with dropping occupancy rates in the Klang Valley office market, rental rates have continued to come under pressure, warned CIMB Research.

“Occupancy rates for the three largest property markets in Malaysia — Klang Valley, Johor and Penang — are among the lowest in the country,” said the research house. “There is genuine concern that the entry of these mega projects will be the tipping point for commercial office space and could negatively affect rental yields in the Klang Valley,” said CIMB.

However, while conceding that there will “definitely” be pressure on rentals over the next few years, Loh of Malaysia Property Inc pointed out that the situation is not expected to be felt equally across the board.

“Some will feel the pain more than others,” said Loh to KiniBiz. “Those commercial real estate which have good location, accessibility, carparking facilities and are well managed will retain their tenants.”

On the other hand, office space without these desirable qualities would suffer in terms of tenant retention, added Loh.

In a September update published recently, property consultants Knight Frank Malaysia noted that prime office rentals in Kuala Lumpur have remained stagnant for the first half of 2013 as per earlier expectations that it would stagnate for another year.

As for the wider Kuala Lumpur office market, while it has been resilient against the oversupply situation conditions are expected to remain challenging for the rest of the year, said Knight Frank Malaysia in July.