Monday, December 27, 2010

An Asian Growth Story

Could the construction crane be Singapore's new National Bird?

Orchard Road retail - Louis Vuitton, Giorgio Armani

Some readers may wonder if I see any particularly strong real estate markets during my travels, since I seem to so often be reporting bad news.

How about an Asian country that grew faster than China in 2010, with an unemployment rate of only 2%?

That country would be Singapore. Year 2010 GDP growth is now expected to measure 15% as the result of a manufacturing-led growth spurt in the latter half of the year, second in the world to Qatar. Strong population growth (estimated at 1.8% per year), fueled by the developed world’s most lenient immigration policies, is creating a housing shortage.

A recent joint survey by Price Waterhouse Coopers and the Urban Land Institute ranked Singapore as the top investment destination in Asia.

Singapore also has ambitions to be the “Switzerland of Asia”, and one recent bold move by the government has been to double the area allocated to the Financial District, where CBRE has reported the office vacancy rate falling to 6.7% after brisk expansion of financial and legal firms, including major investment banks. Singapore is already Southeast Asia’s regional banking center, but the doubling of size of its Financial District would make it equivalent in size to Hong Kong's. About 7 million square feet are scheduled to be added by 2015. So serious is Singapore about achieving banking supremacy in Asia that they have been holding job fairs in the U.S. and U.K. to recruit banking talent.

Singapore enjoys the commercial advantages of:

1. A large, world class airport
2. English as the official language
3. The world’s busiest port (as measured by shipping tonnage)
4. An efficient, business-friendly government lauded for the absence of corruption
5. An educated and truly multicultural labor force with ties to many disparate spheres of influence. The three largest ethnic groups in Singapore are the Chinese, the Malays/Indonesians and the Indians, enabling ties to some of the fastest growing economies of the world – China, India and the Middle East.
6. No capital gains tax (except on residences held less than 3 years)
7. No restrictions on foreign ownership of commercial real estate.

Real estate prices fell during the Global Financial Crisis of 2008, but residential prices have been rapidly increasing since the second quarter of 2009. The residential price index for the 3rd quarter of 2010 reflected a 22.9% increase since the same quarter a year before. For those who are tempted to speculate, though, the government’s Housing and Development Board has enacted measures to counteract a bubble from forming, such as:

1. The sale of ten major government land sites to residential developers, allowing an increase in residential supply
2. A 3% tax on properties held less than three years
3. Minimum cash down payments of 20% on second homes (when financed by government-regulated lenders) and the elimination of interest-only mortgage loans
4. Continued restrictions on foreign ownership of landed homes (as opposed to condos)
5. Non-renewal of financial assistance to real estate developers

As for multifamily investment and development opportunities, one must consider that the Housing and Development Board owns 81% of rental units in Singapore, and government policy has the potential to mute increasing housing prices, even during a housing shortage. The luxury rental market should be least affected by competition from the government, nevertheless, as is housing for expatriates and immigrants prevented from receiving government-subsidized housing (restricted to Singapore citizens or permanent residents). At today’s rich valuations, with gross annual rent multipliers of about 29, however, development would spell more opportunity than investing in existing properties. Such a high multiplier can only be sustained with ultra-low interest rates, and one cannot predict how long such low rates will continue to last.

On the commercial side, overbuilding is still a possible hazard. For instance, CBRE has reported steadily increasing "capital values" (a valuation-based average rather than a sales-based average, although one would expect valuations to be influenced by recent sales) in the office, industrial and retail sectors, although office and retail rents have declined since last year. Office rents have started to climb again, though, in response to low vacancies, while “prime” retail seems to still have a problem.

Valuations appear to be quite rich. With an average “capital value” of $5800 per square foot and average annual rent of $373 psf for “prime retail” space ($1 SGD = $.77 USD), notably the Orchard Road area of town, the indicated gross rent multiplier of 15.5 seems unsustainable in the face of falling rents. The reason for the falling rents seems to be overbuilding.  According to CBRE. 1.7 million square feet of space was completed in the first three quarters of 2010, 39% of which was in the Orchard Road area, including the new TripleOne Somerset, 313@Somerset and the Mandarin Gallery. Other new malls in Singapore include City Square Mall, Iluma, Yew Tee Point, and Tampines 1.

The gross rent multiplier for Class A office is as even giddier 21.7. “Prime residential rental properties” are perhaps the most richly valued at the moment, though, with an average GRM of 29.5. As a point of reference, whenever I see market average GRMs pass 14 in the U.S., it is usually a precursor of a market correction.  The down side of "real estate growth stories" is that pricing can become quite inflated by the onrush of new investors who expect property value appreciation to rescue them from low or even negative current returns.

That being said, I did not see vacancies in Singapore that would put this city-state at risk of soon becoming “The Next Dubai.”  Nevertheless, buying at such inflated prices seems antithetical to the investment advice of such legends as Warren Buffet or Sir John Templeton, who famously stated "The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell."

Perhaps the most attractively valued sector at the moment is the industrial sector, where rents continue to increase and the GRM average is just 12.7. Manufacturing has led the way in the increase in GDP; leading industries are electronics, chemicals and biomedical products. The port itself creates substantial demand for warehouse space.

For those counting on continued 15% GDP growth, the forecast from Singaporean economists for 2011 is considerably more subdued – about 4 to 5%.

Saturday, December 25, 2010

Appraisal in the Dominican Republic

 Beachfront with view of San Pedro de Macoris

The subject property was a 59-acre parcel of raw, waterfront land situated about 45 minutes east of the rapidly growing capital city of Santo Domingo, ten kilometers east of the upscale beach town of Juan Dolio and a couple of miles west of the grimier city of San Pedro de Macoris, an industrial port city remnant of the days when sugar refinement ruled the economy.

The Dominican economy is booming. Tourism has almost reached pre-recession levels and is increasing at a rate of about 5% per year. Demand is also strong for exports of sugar, tobacco, and gold.

The town of Juan Dolio has prospered as the result of a new highway linking it to Santo Domingo, allowing affluent professionals to actually live above a white sand beach while efficiently commuting half an hour to their jobs and enterprises in Santo Domingo, a city of four million residents. New residents in Juan Dolio are more likely to be locals than foreigners, who nevertheless also have a presence there.

This land was part of an overall 252-acre project that was entitled for two 30-story residential towers, a Greg Norman golf course and a marina, among other residential uses. The first phase of the project, consisting of 52 private villas (priced at about $1.75 million each) and the golf course, was under construction on the date of my visit. A marina, sewage treatment plant, and electrical generation plant have not started yet.

The land is owned by a partnership managed by the most successful developer of upscale residential communities in Juan Dolio, including several sold-out condo towers. They pioneered the concept of developing condo towers at the beaches of the DR (Dominican Republic), and have a track record of successful condo development.

When tasked with conducting a market value appraisal, of course, the present owner is not considered in the analysis. Most appraisers are directed by their professional associations or their governments (particularly the U.S. government) to estimate the market value of a property as if it was placed on the open market and someone else is buying it. For lending purposes, that makes sense, as the only scenario a lender needs to consider is the “what if we have to foreclose” scenario, in which the property would indeed be sold to someone other than the current owner. The lender can make exceptions for particularly strong borrowers, but the appraiser cannot.

As is often the case, the property owner ordered his own appraisal from a well-known international appraisal firm,  who estimated a value of $25,625,000, or about $434,000 per acre, which seemed like quite a steep value for so much raw land outside of town, even if it did front the sea. The entitlements are formidable, but is the demand there? The town of Juan Dolio, 10 kilometers west, seems to be undergoing excessive high-rise condo construction, and at least two projects have already failed. Would likely buyers, who are more likely to be affluent professionals from Santo Domingo than foreigners, be willing to commute even further to live in a high-rise?

The actual setting was also slightly less than ideal. Most of the waterfront consisted of protected mangroves, and what little beach there is has been fouled by the mangroves, as can be seen in the above photo. Then there is the view of the decaying electrical plant in the city of San Pedro de Macoris, responsible for frequent electrical blackouts in the area. Of course, when Phase 1 of the project is complete with the golf course and the marina, the views will be much better, but I was hired to do an “as is” valuation.

The only comparable sale I could find subsequent to 2007 was an entitled waterfront parcel on the north shore (near the Playa Grande golf course) which sold this year for $40,000 per acre. The north shore is more dependent upon tourism, however, and not quite as accessible by highway. Nevertheless, I did find listings of other waterfront parcels, entitled and unentitled, at prices not much higher than that, including a 97-acre beachfront parcel ten minutes east of San Pedro with 250 meters of white sand beach, a coral reef, and a private river, situated next to the Bahia Principe La Romana resort, listed for sale at about $51,000 per acre. La Romana is the next major tourist city east of San Pedro.

In the end, I estimated a value substantially less than that of the international firm, whose analysis did not present any land sales subsequent to 2007 and reconciled higher priced listings without any discussion of utility availability or the likelihood that the sales price would be lower than the listing price.  Then again, I was hired by the lender and not the property owner.

An amusing incident happened at the Santo Domingo airport on the way home.  All flights bound for the U.S. are subject to secondary hand screening at the gate.  Card tables are set up and security guards comb through all carry-on luggage.  A young lady went through my luggage and then said "Shake your body".

That's just what I did, but I apparently misunderstood her accent.  She then said, "No. I check your body" and then proceeded to pat me down. 

It brought back a memory from another Latin American airport in which a woman chased after me shouting "Cher!  Cher!"  I didn't turn around because I have no interest in Cher and wish she would just retire like she keeps on promising to.  Apparently the woman chasing me was a security guard needing to see the claim check for my luggage. "Sir, Sir" was what she meant to say.