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Who can win the war on inflation and the battle for growth?
Flattening yield curves and tapering inflation rates through 2H11
indicate that Asian central banks’ tight monetary policy stance is
gradually winning the war on inflation, with the challenge now perhaps
shifting to sustaining growth against the backdrop of weakening
developed economies. Real estate stocks in countries where inflation is
benign and below central bank targets (Indonesia, Taiwan) have
performed well, and are likely to continue to do so in our view.
Interventionist policy to continue to be a factor: Developed countries’
sovereign debt concerns and a reduced U.S. growth outlook are
supportive of our house view of a prolonged period of low interest rates
in developed economies. The incremental flow of capital will likely
continue to be into Asian markets, and we are likely to see regional
policymakers retain an interventionist stance on the real estate sector.
A major 3Q11 call is China. J.P. Morgan’s economists estimate China
inflation to moderate from 4Q11 onwards (towards a 4% annualized
rate), with real GDP growth running at above 9% in the three quarters to
2Q12. The upcoming results season for the China developers should
allow the market to differentiate between those with sustainable business
models and growth (the likely outperformers), versus those without
(these are likely to suffer a de-rating even from current levels and
underperform).
Country calls – prefer emerging ASEAN, and like Taiwan. We
prefer emerging ASEAN markets over China and India, and in
Developed Asia-ex, we believe the Singapore property stocks will
outperform their Hong Kong counterparts in the balance of the year on a
total return perspective. We are also positive about the Taiwan property
sector, especially given a relatively benign macro environment and better
than expected transaction volumes. Within emerging ASEAN we
continue to favor Indonesia real estate in spite of its 30% return in the
past 6 months, as we expect a confluence of structural factors to propel
growth in volumes and raise real estate sectoral productivity.
Investment strategy
Asia real estate securities returns continue to be dominated by the macro backdrop,
with the pace at which policy-makers can regularize monetary conditions,
unequivocally control inflationary pressures in these economies and return to a more
normal positive real rate environment likely to determine the restoration of sector and
stock-specific fundamentals as the primary share price driver. In Table 1 above we
set out J.P. Morgan’s real GDP growth and CPI estimates for the next four quarters.
Developed countries’ sovereign debt concerns and reduced U.S. growth are
supportive of our house view of a prolonged period of low interest rates in these
developed economies. The incremental flow of capital will likely continue to be into
Asian markets, and we are likely to see regional policymakers retain an
interventionist stance on the real estate sector. With significant monetary policy
tightness and weakening global growth outlook into 2H11, countries that can sustain
real GDP growth are likely to outperform, whilst real estate stocks that can maintain
a growth trajectory consistent with expectations should also perform relatively well.
The FTSE EPRA NAREIT Asia index has traded in a +/-10% range of the 1,500
level for the past two years now, and it is difficult to see how the stocks can break
out of this trading pattern without a change in the macro-economic status quo.
We believe the benchmark Developed Asia index will continue to trade within a 10-
15% range whilst regional macro-economic conditions remain as they are. We retain
our expectation of a zero price return from the benchmark FTSE E/N Asia index in
2011.
We prefer emerging ASEAN markets over China and India, and in Developed Asiaex,
we believe the Singapore property stocks should outperform their Hong Kong
counterparts in the balance of the year on a total return perspective. We have also
become more positive about the Taiwan property sector, especially given a relatively
benign macro environment and better than expected transaction volumes (please see
report published by Nick Lai (+8862 27259864), Taiwan Property Industry:
fundamentals not as weak as expected, 2 Aug 2011) . Within emerging ASEAN we
continue to favor Indonesia real estate in spite of its 30% return in the past 6 months,
as we expect a confluence of structural factors to propel growth in volumes and raise
real estate sectoral productivity.
We continue to focus on an active stock selection approach to generate alpha and
have been publishing regular relative value ideas to relay our most current regional
stock calls (see Asian Real Estate Relative Value Ideas report, the most recent of
which is dated 21 July 2011).
India Market Summary
The BSE Realty Index gains 2.3% in July. The BSE Realty Index snapped
its three-month fall with a 2.3% rise in June as investors turned back to
equity markets to buy oversold property stocks. The index is still trading at
almost half of its 52-week peak level achieved in Oct’10. Over the last 10
months, the sector has been severely hampered by scams, high inflation rate
and consistent interest rate hikes. With no significantly positive catalysts in
sight, the sector is likely to remain volatile for a few more months. We
expect real estate stocks to bounce back once interest rates peak out and
earnings growth becomes visible from 1H12 earnings season.
Residential rentals are outpacing capital values. Cushman’s latest
quarterly data release observes a moderate physical price growth trends in
most major cities with rents (up 10-18% Y/Y across cities ex-Mumbai) now
outpacing the capital value appreciation (+4-7% Q/Q or 10% Y/Y ex-
Mumbai). This trend, in our view, is healthy as rentals being a 100% “enduser"
market is finally catching up to capital value, though there is still a 10-
20% appreciation gap that needs to be bridged on a one year basis.
Private Equity – a new source of funds for real estate companies. As per
news reports, PE deals aggregating over ~US$800M have happened till date
in CY11 and it seems there is additional money on the sidelines to be
deployed. Taking into account PE firms as another source of funding,
especially for mid-sized developers (given difficulties in debt issuance) and
residential projects (easy exit route), we could perhaps explain the gap
between our NAV estimates and share prices given the difference in WACC
assumptions (25-30% for PE whereas 15-18% as per our assumptions).
Investment view: With persistent inflationary pressure, rising borrowing
costs (JPM estimate - another 50 bps hike in FY12) and flat volumes/ pricing
trends, we expect the sector to remain range-bound in the near term.
Transactions are likely to remain subdued given 2Q tends to be seasonally
weaker. Our top picks are DLF (debt reduction initiatives to play as catalysts
over FY12) and IBREL (attractive valuations – adjusted fwd P/B of 0.3x).
Stock performance
Indian property stocks rose 2.3% M/M in July following a sharp 7.2% drop in June.
The sector performance was in line with the regional benchmark FTSE E/N Asia
Index. Property stocks were trading up 10% in first 3 weeks of July. However, RBI
announced an unexpected 50 bps hike in benchmark interest rates (consensus – 25
bps) on 26th July which forced investors to sell-off property stocks. This combined
with U.S debt default worries dragged the index down 7.5% in the last week.
Macro and sector issues
RBI hiked benchmark rates by another 50 bps on 26th July, making it the third
hike this fiscal (125 bps hike in last 4 months) and eleventh hike since the last fiscal.
This would further increase already-high borrowing costs which could have an
adverse impact on developers’ balance sheets. In addition, tightened liquidity
conditions may force developers to sell their inventory at cheaper rates which, in
turn, could affect profit margins. Higher interest rates would also hit affordability of
property buyers. JPM inside view forecasts another 50 bps hike in benchmark rates
for this fiscal as RBI indicated that it will not stop raising rates unless inflation peaks
out in a sustainable manner. The next policy review is scheduled on 16th Sep 2011.
Physical property absorption would remain weak in 3Q CY11 as Jun-Sep period
marks seasonally weak period for real estate in India. Transactions have been muted
over 1Q CY11 as home loan rates are now hovering around 11%, only 75 bps below
GFC levels. Recent 50bps rate hike should put pressure on lending agencies to raise
mortgage rates further which, in turn, could drag down already sluggish absorption
rate. We expect absorptions to come back on track once festive-season starts post-
September, launch activity resumes and interest rates cycle becomes stable.
Office absorption remains healthy – Vacancy levels in general are high at 15-17%
levels across key markets. Hence even though absorption has been improving for a
year now, pricing has not improved. Mumbai has the highest office space vacancy at
24% followed by NCR at 16%. Bangalore however is the only market seeing
reducing vacancy numbers which are now down to 12% vs. 16%, six months back.
Retail absorption has been on steady rise since 2010. Rents have not improved in
almost any location but at the margin, trend is likely to be positive in Bangalore and
Mumbai. We expect retail supply to peak out in 2011/12 especially as government is
expected to announce increase in FDI cap in organized retail (51%, up from 25%).
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Who can win the war on inflation and the battle for growth?
Flattening yield curves and tapering inflation rates through 2H11
indicate that Asian central banks’ tight monetary policy stance is
gradually winning the war on inflation, with the challenge now perhaps
shifting to sustaining growth against the backdrop of weakening
developed economies. Real estate stocks in countries where inflation is
benign and below central bank targets (Indonesia, Taiwan) have
performed well, and are likely to continue to do so in our view.
Interventionist policy to continue to be a factor: Developed countries’
sovereign debt concerns and a reduced U.S. growth outlook are
supportive of our house view of a prolonged period of low interest rates
in developed economies. The incremental flow of capital will likely
continue to be into Asian markets, and we are likely to see regional
policymakers retain an interventionist stance on the real estate sector.
A major 3Q11 call is China. J.P. Morgan’s economists estimate China
inflation to moderate from 4Q11 onwards (towards a 4% annualized
rate), with real GDP growth running at above 9% in the three quarters to
2Q12. The upcoming results season for the China developers should
allow the market to differentiate between those with sustainable business
models and growth (the likely outperformers), versus those without
(these are likely to suffer a de-rating even from current levels and
underperform).
Country calls – prefer emerging ASEAN, and like Taiwan. We
prefer emerging ASEAN markets over China and India, and in
Developed Asia-ex, we believe the Singapore property stocks will
outperform their Hong Kong counterparts in the balance of the year on a
total return perspective. We are also positive about the Taiwan property
sector, especially given a relatively benign macro environment and better
than expected transaction volumes. Within emerging ASEAN we
continue to favor Indonesia real estate in spite of its 30% return in the
past 6 months, as we expect a confluence of structural factors to propel
growth in volumes and raise real estate sectoral productivity.
Investment strategy
Asia real estate securities returns continue to be dominated by the macro backdrop,
with the pace at which policy-makers can regularize monetary conditions,
unequivocally control inflationary pressures in these economies and return to a more
normal positive real rate environment likely to determine the restoration of sector and
stock-specific fundamentals as the primary share price driver. In Table 1 above we
set out J.P. Morgan’s real GDP growth and CPI estimates for the next four quarters.
Developed countries’ sovereign debt concerns and reduced U.S. growth are
supportive of our house view of a prolonged period of low interest rates in these
developed economies. The incremental flow of capital will likely continue to be into
Asian markets, and we are likely to see regional policymakers retain an
interventionist stance on the real estate sector. With significant monetary policy
tightness and weakening global growth outlook into 2H11, countries that can sustain
real GDP growth are likely to outperform, whilst real estate stocks that can maintain
a growth trajectory consistent with expectations should also perform relatively well.
The FTSE EPRA NAREIT Asia index has traded in a +/-10% range of the 1,500
level for the past two years now, and it is difficult to see how the stocks can break
out of this trading pattern without a change in the macro-economic status quo.
We believe the benchmark Developed Asia index will continue to trade within a 10-
15% range whilst regional macro-economic conditions remain as they are. We retain
our expectation of a zero price return from the benchmark FTSE E/N Asia index in
2011.
We prefer emerging ASEAN markets over China and India, and in Developed Asiaex,
we believe the Singapore property stocks should outperform their Hong Kong
counterparts in the balance of the year on a total return perspective. We have also
become more positive about the Taiwan property sector, especially given a relatively
benign macro environment and better than expected transaction volumes (please see
report published by Nick Lai (+8862 27259864), Taiwan Property Industry:
fundamentals not as weak as expected, 2 Aug 2011) . Within emerging ASEAN we
continue to favor Indonesia real estate in spite of its 30% return in the past 6 months,
as we expect a confluence of structural factors to propel growth in volumes and raise
real estate sectoral productivity.
We continue to focus on an active stock selection approach to generate alpha and
have been publishing regular relative value ideas to relay our most current regional
stock calls (see Asian Real Estate Relative Value Ideas report, the most recent of
which is dated 21 July 2011).
India Market Summary
The BSE Realty Index gains 2.3% in July. The BSE Realty Index snapped
its three-month fall with a 2.3% rise in June as investors turned back to
equity markets to buy oversold property stocks. The index is still trading at
almost half of its 52-week peak level achieved in Oct’10. Over the last 10
months, the sector has been severely hampered by scams, high inflation rate
and consistent interest rate hikes. With no significantly positive catalysts in
sight, the sector is likely to remain volatile for a few more months. We
expect real estate stocks to bounce back once interest rates peak out and
earnings growth becomes visible from 1H12 earnings season.
Residential rentals are outpacing capital values. Cushman’s latest
quarterly data release observes a moderate physical price growth trends in
most major cities with rents (up 10-18% Y/Y across cities ex-Mumbai) now
outpacing the capital value appreciation (+4-7% Q/Q or 10% Y/Y ex-
Mumbai). This trend, in our view, is healthy as rentals being a 100% “enduser"
market is finally catching up to capital value, though there is still a 10-
20% appreciation gap that needs to be bridged on a one year basis.
Private Equity – a new source of funds for real estate companies. As per
news reports, PE deals aggregating over ~US$800M have happened till date
in CY11 and it seems there is additional money on the sidelines to be
deployed. Taking into account PE firms as another source of funding,
especially for mid-sized developers (given difficulties in debt issuance) and
residential projects (easy exit route), we could perhaps explain the gap
between our NAV estimates and share prices given the difference in WACC
assumptions (25-30% for PE whereas 15-18% as per our assumptions).
Investment view: With persistent inflationary pressure, rising borrowing
costs (JPM estimate - another 50 bps hike in FY12) and flat volumes/ pricing
trends, we expect the sector to remain range-bound in the near term.
Transactions are likely to remain subdued given 2Q tends to be seasonally
weaker. Our top picks are DLF (debt reduction initiatives to play as catalysts
over FY12) and IBREL (attractive valuations – adjusted fwd P/B of 0.3x).
Stock performance
Indian property stocks rose 2.3% M/M in July following a sharp 7.2% drop in June.
The sector performance was in line with the regional benchmark FTSE E/N Asia
Index. Property stocks were trading up 10% in first 3 weeks of July. However, RBI
announced an unexpected 50 bps hike in benchmark interest rates (consensus – 25
bps) on 26th July which forced investors to sell-off property stocks. This combined
with U.S debt default worries dragged the index down 7.5% in the last week.
Macro and sector issues
RBI hiked benchmark rates by another 50 bps on 26th July, making it the third
hike this fiscal (125 bps hike in last 4 months) and eleventh hike since the last fiscal.
This would further increase already-high borrowing costs which could have an
adverse impact on developers’ balance sheets. In addition, tightened liquidity
conditions may force developers to sell their inventory at cheaper rates which, in
turn, could affect profit margins. Higher interest rates would also hit affordability of
property buyers. JPM inside view forecasts another 50 bps hike in benchmark rates
for this fiscal as RBI indicated that it will not stop raising rates unless inflation peaks
out in a sustainable manner. The next policy review is scheduled on 16th Sep 2011.
Physical property absorption would remain weak in 3Q CY11 as Jun-Sep period
marks seasonally weak period for real estate in India. Transactions have been muted
over 1Q CY11 as home loan rates are now hovering around 11%, only 75 bps below
GFC levels. Recent 50bps rate hike should put pressure on lending agencies to raise
mortgage rates further which, in turn, could drag down already sluggish absorption
rate. We expect absorptions to come back on track once festive-season starts post-
September, launch activity resumes and interest rates cycle becomes stable.
Office absorption remains healthy – Vacancy levels in general are high at 15-17%
levels across key markets. Hence even though absorption has been improving for a
year now, pricing has not improved. Mumbai has the highest office space vacancy at
24% followed by NCR at 16%. Bangalore however is the only market seeing
reducing vacancy numbers which are now down to 12% vs. 16%, six months back.
Retail absorption has been on steady rise since 2010. Rents have not improved in
almost any location but at the margin, trend is likely to be positive in Bangalore and
Mumbai. We expect retail supply to peak out in 2011/12 especially as government is
expected to announce increase in FDI cap in organized retail (51%, up from 25%).
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