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.

Excursion: Island Dreams or Penang's Real Estate Market

Tackling all these exciting questions on where the local property market is heading, let me come across a few articles on the real estate market and development of Penang. Certainly, I am preparing the final account on if we are heading into a bubble, but I also thought that this small excursion might be most interesting to investors. First of all, let me locate Penang for you. As said before, it is a state on its own, which consists of two parts. One would be the old Island of Penang and the other part is located on the northwest of the Peninsular of Malaysia. Take a look on the map.

Location of Penang State/Island

I mentioned already that this year should become an election year for Malaysia and the blossoms of this are usually quite irrational demands of the public to politicians. Some of them have been described before in regard to real estate investment and increasing prices. The blame by citizens mainly went to foreign investors, who unfortunately only cover 2 % of all real estate unit sales in Malaysia. Consequently, there is no ground for these accusations. Penang is not quite different, but let me first provide a little introduction.

Rare Ethnic composition

Penang is a state in the northwest of Malaysia and most famous for the Island of Penang, while the state also comprises areas on the mainland Peninsular of Malaysia. With a total of only 400 sq mi, Penang is home to about 1.5 mil. people. Based on this data, we can calculate a population density of 3,800/sq mi. For Penang Island, the density is even higher, after all it can claim the title of the most populated island in Malaysia, including the highest density. In comparison to other parts of Malaysia, Penang has a rare ethnic setup, which favours the local Chinese Malaysians with 45 % over 43 % Malay and other races. For more information check the pie-chart. I will not elaborate on political and other implications, but let us acknowledge that this composition usually favours the opposition.

FDI for Malaysia by region in 2011

The state is currently led by Lim Guan Eng, who is with the opposition party DAP. During the past years, he has been praised for his achievements, while lately a lot of criticism was pushed by the mainstream and government close media in Malaysia. Elections are close, as I said before. Nevertheless, Eng can claim the largest share of foreign direct investment (chart) for his state and is said to have increased the transparency within government policies and politics, namely public tender. Economy-wise, Penang as island and with a historic harbour was a centre of trade along the Straits of Melaka, but became a modern business hub in our days. Especially E&E manufacturers, but also ICT and healthcare have spread on the island and in peninsular industrial parks. Just to name some well known manufacturers, we would find Siemens, Bosch or Braun from Germany among them. Besides, Penang is still a centre for the production of semiconductors and attracted a lot of investment in regard to solar panels. Once Malaysia has been the leading manufacturer for semiconductors globally with Penang at its core, which is probably not widely known. As Q-Cells stands for solar power, we also see most well known semiconductor and microchip brands represented such as Intel, Infineon, Fairchild and also Siemens' daughter Osram in regard to optic semiconductors. Finally, some major E&E names are found here, including Sony, Dell and Motorola. I do not intend to provide a full list, but I am sure this offers a fair idea. PenangInvest states that about 29 % of the total local workforce are employed in the E&E industries, which might be growing since Bosch announced in June 2011 a major investment of more than USD 690 mil. for an integrated solar panel plant. Penang has a strong economy and is attracting more and more  Chinese foreign direct investment, too. When I met the responsible Deputy Chief Minister Dato' Mansor last year, he was just about to hop onto a plane to China. It is worth keeping an eye on this state and also to observe the coming election. (Penang Invest 2011: Penang Bounces back with Bosch Solars RM 2.2 bill and for more information Penang Invest)

Real Estate Market Penang - What is happening?

George Town

I won't move on talking about the beauty of the island, tourist attractions such as the new Spice Gardens Experience or George Town, please follow my link for these information. My particular interest is focused on the real estate market, since I am currently researching on these topics. In my past posts, I have been naming Penang one of the Malaysian real estate hotspots. It might not surprise that the prices have been going up. Certainly, the island has its charms and since Malaysia offers permanent resident status or at least long-term visas for retirees under the Malaysia My Second Home Programme, we also see a number of foreigners settling down on Penang. Also in this context, I read about comments that residential property in Penang became too expensive and locals cannot afford a house anymore. Well, let me say it this way, these ol' chaps from abroad are required to buy homes valued at USD 150,000/RM 500,000 and above. Perhaps this could have caused some price hikes, but honestly, with only 2% - 3% of unit sales to foreigners it is not likely. Anyways, let us take a look at the island property market.

The situation was fired up by environmentalists' claims on dangerous and excessive hill slope developments, but right behind these arguments locals complain about high prices all over the island. When I read the news, I heard about some handpicked regions in Penang, which were obviously premium-priced. Nevertheless, mentioning these spots, I would claim them to be some of the most attractive ones on the island, e.g. the famous Gurney Drive. (The Star 7 June 2012: Island paying for its charm, pg. 4) The article mentioned that Penang has seen  prices going up by 25 % - 30 % during the last 5 years and depending on the region. This kind of development would mean that we saw an average annual growth rate of 5 % - 6 %. I believe most investors would not feel shocked. First of all, we are talking about an island property market with its own rules and limited land to develop. Furthermore, we should acknowledge that Malaysia so far has not been hit badly by the economic downturn or a real estate crisis. In this environment, it is absolutely normal to see rising prices. For more perspective, I compiled a few news on annual growth rates of different island residential property markets during the last 10 to 15 years. Surely a simple comparison but at least an indicator. (The Star 7 June 2012: Island paying for its charm, pg. 4)

Islands growth rates tend to be high

 The Cayman Islands saw for over 15 years an annual increase of about 12 % in average, while recently the prices dropped. What about Canada's islands? Prince Edward Island and Yukon also rose by more than 10 %, year to end July 2011. Some channel islands in Europe take it up to 25 % during 2010 with continuous growth rates since 1993. After the Olympic Games in Greece 2004, the island of Crete recorded annual increments of 30 % - 40 % until 2008. A quick look at my chart reveals a likely truth. In times of economic growth, most islands rather outperform and all of the mentioned islands also outperformed Penang. However, the steady growth on the island over the last 5 years also presents a great potential. On the one hand, we still experience prices and growth below sought after island locations in other regions. 

Sector prices for sel. States

Besides, if I compare the price spread from last year according to the chart on the right, Penang is still far behind Kuala Lumpur and even behind Selangor in regard to premium residential real estate. News articles mentioned that in prime areas the prices for houses went from about RM 500,000 (USD 150,000) to more than RM 800,000 (USD 250,000). Most arguments are still based on end 2011 data, which is reflected in the chart on the right. Therefore, I assume that still about 60 % of all residential property is below the RM 500,000 mark. Even rising property prices in Penang mainland, I would call signs of normalisation, since most of Malaysia asks for the average residential property/house between RM 300,000 - RM 600,000. (The Star 5 May 2012: Priming, pricing KL property for the future) From this perspective, peninsular Penang prices are hitting RM 500,000 for houses only recently. (The Star 7 June 2012: Island paying for its charm, pg. 4)

Summing it up, I tend to call the development of real estate prices in the whole state of Penang rather healthy. As a matter of fact, the price spread is compared to Selangor or Kuala Lumpur not yet focused on premium property above RM 500,000. I have to admit that the direction is set and if the economy grows further, we will see higher prices during the coming years. While I understand the criticism of local Penangites, they also should start to understand the principle of demand and supply. Penang has little land to develop, but many people who wish to buy houses. Simple economics, the price will go up. On top, Malaysia's economy is still growing amidst the European turmoil. Real estate prices follow the current national economic trend and development, probably I could even say they mirror the GDP growth rate. Again, I would call it a realistic or healthy scenario, although I don't have the exact annual growth rates of real estate prices in Penang. Just take the average of 5%-6% real estate price growth and Malaysia's GDP average growth rate of 4,5 % during the last 5-10 years, it goes along quite well. (Dept. of Statistics Malaysia: GDP by State)

Penang is an interesting case for real estate investors and also an attractive investment zone. I should mention that the state government is mulling a RM 1,000,000 minimum price for all foreign investors, but only entered public consultation on this matter and did not implement it yet.  (NST 18 May 2012: A storm in a RM 1 mil teacup?)

Stay tuned for my final post on Malaysia's property market and if there is a bubble or maybe not!?