Malaysia's Real Estate Market - Sounds good, but what about the bubble?

I surely let you wait on this last post, but I hope that it is worth it. 

Some people might argue that it all sounds too good. Domestic demand is strong and growing, foreign investors might move in, while some locals shout about the high prices. All in all the indicators seem to present a healthy picture. However, there are regions where the prices developed in rather irritating ways, e.g. Kuala Lumpur, parts of Selangor, Johor and Penang. (Thean Lee Cheng 5 May 2012: Where is the market heading?)   

No Gordon Gekko in Malaysia

Let me start with the last comment. Irritation has been strong with locals, who are having money, wish to buy a house, but cannot afford it in the spots, they look for. We have discussed that matter earlier. The economics and simple math do not cause any confusion for this question, but politics in an election year do. People are shouting out their frustration and hope that the government can protect them from market forces. Even worse, they wish to get houses above their living-standard in prime areas for medium area prices. Obviously, there is no way to rule out the principle of supply and demand, which is even for the government impossible. Furthermore, the blame on foreigners and also a new law demanding foreigners to buy only property above RM 1,000,000 will not offer any solution. With about 2 % of all unit sales to foreigners, the market is not driven by foreign, but domestic demand. At least once in a while, we do not provide ground for the ugly foreign capitalist/investor argument. Since most politicians have been aware of this situation, we did not experience any response to Malaysian’s request for higher prices if foreigners buy. I would call this a promising investment environment. (Thean Lee Cheng 3 March 2012: Malaysia a real-estate shopping destination)

US subprime crisis

At this point, it is still right to ask, how we can see rising prices that the mentioned rates, if foreigners are not buying in huge bulks yet. Basically, domestic players have been engaging in real estate deals and hope to make their fortune by buying especially in luxury residential projects during the construction phase. Even though these buyers are not capable of buying the real estate, many bought more than one unit, they are betting on rising prices. If the market supports their gamble, these buyers would sell off after the prices surged and they would keep the difference. For many of these private buyers, it would be a small fortune. Obviously, this gambling has quite some downsides. What happens, if they find nobody to buy the property? What happens, if the prices are dropping? Well, quite easy to respond, we would experience default and most likely non-performing loans. If this issue becomes systemic with too many players in a bear market, a subprime crisis like in the US would be possible. 

So there is some bubble risk?

Gambling Problems?

Probably this would lead us to the current bubble risk, but from the little data I have, there is hardly any evidence for systemic threats. Some people would lose their hard earned money, because they engaged in a game, which can always turn ugly. If you invest in stocks, everybody knows that it can go down any time. Same for the real estate market, but for Malaysia the speculation potential is rather small and limited to certain regions. Malaysian Banks were also in line with international standards for their capital requirements, which was mentioned during the last few weeks. As a matter of fact, they believe to be able handling some blows. A breakdown again is rather unlikely from a smaller default. On top, the national bank, Bank Negara, called for caution as soon as they recognised this speculative trend. In their eyes, local banks have the responsibility to check carefully during the approval of loans if applications are based on sufficient funds and income. New guidelines have been introduced and are accepted for most banks. 

Bank Negara Malaysia

So far, a bank would mainly consider the gross income of a household in regard to a loan, but not the net income for every month. After all, we are paying taxes, energy, water, gas, insurances and probably the private school for your kids every month or so. It makes sense to deduct these costs, before banks decide on loan approvals. From my point of view, Bank Negara has done a great job in preventing and taking a little heat from the market, while not interfering with growth as the new guidelines deter black sheep already. Please check my articles for more details. (Adeline Paul Raj 4 May 2012: Bank Negara's loan guidelines begin to have desired effect, Daniel Khoo 24 April 2012: Bank Negara defends rules, New Straits Times 14 May 2012: Banking Guidelines: Bank Negara's stand apt)

In pace with current developments, market regulators have been acting cautious and with a sense for an open investment environment, but before we totally rule out any bubble, let us take one more perspective. I tend to be careful.

Where is the market heading?

There are quite a number of economic models in this world, but only recently economists were analysing the issue of bubbles properly. For this reason, we are now able to locate a market situation in this model following Dr. Jean-Paul Rodrigue of Hofstra University. Four phases are mentioned, where investors from different backgrounds act and cause pricing hikes as well as the bubble effect. In the beginning, there is a move of "smart money", which simply understood future potentials. Since this is mainly not recognised until results become obvious, this phase is called "Stealth". For Malaysia, smart money has already moved in and was achieving decent profits over time. In the following "Awareness Phase", institutional investors realise the potential based smart money examples and their enormous informational advantages over private investors. Interestingly, this phase also has been passed to some extent. A lot of money from institutional investors from Asian countries and to much smaller extent western economies is invested in Malaysia by now. The third phase's name says it all " Mania". It brings the public into the game. This is the time, when price hikes are most likely, because of all the emotions, hopes and dreams connected to investor's decisions and activities. Here I need to stop and go back one step. It is true that with no doubt, the public started to become overly aware of financial gains in the local real estate market. Rodrique pointed out media attention, enthusiasm and greed as points on this ladder of increasing prices. For us, we can consider that we have reached some point at the beginning of all this. Hazrul Izwan in an article of MPI pointed out that in mid 2010, he could see some signs of this "Mania Phase", but then the prices went down and everything cooled off. Following him, we would have climbed the dangerous ladder of the "Mania Phase" quite a bit again. (Malaysia Property Inc Jan 2012: property quotient)

My take is a little different. Rodrique mentioned a first sell off in his model, which happens during the "Institutional Phase", including a price slump. Probably, we have experienced this slump during 2010. However, we still have been heading into the "Mania Phase", just that we are at the very beginning. Here, I can agree again with Hazrul, since he also assumes us being at an early "Mania" stage. People started to invest again, there is also some greed in the market, but it is not yet pushing the whole market to any limits. Looking at the housing price indices and the 10 average housing price development over time, we are about 2.5 % in plus. This indicates at best an early "Mania Phase". (Malaysia Property Inc Jan 2012: property quotient)

Not yet!

Finally, I feel confident to answer the question on a possible bubble in the local real estate market. In many ways, we are always heading to a bubble, but investors need to assess at which stage of the bubble we are. Rodrique's model can give us an idea and furthermore, the regulators, such as Bank Negara, are providing hints on the health of the investment environment. For now, I believe that the bubble is still a good two to three years away. Furthermore, with sufficient control by regulating bodies and in a slower economy investments will not push quickly for new highs. We might even have more time.

Stay tuned for my next insights into another important sector of Malaysia's economy. With Felda Holdings approaching the largest IPO after Facebook, we should have a look into the local plantation sector.