"Forest City": $100 billion bet next to Singapore

Ghost city or $100 billion paradise adjacent to Singapore? Chinese developers build gigantic "Forest City" in Malaysian Special Economic Zone. 10 km of coastline! 2 bedroom apartments for < $200k.

The mental model is Shenzhen: a city that barely existed 25 years ago, across the border from Hong Kong. Population today: 10 million.


 

Bloomberg: The landscaped lawns and flowering shrubs of Country Garden Holdings Co.’s huge property showroom in southern Malaysia end abruptly at a small wire fence. Beyond, a desert of dirt stretches into the distance, filled with cranes and piling towers that the Chinese developer is using to build a $100 billion city in the sea.

While Chinese home buyers have sent prices soaring from Vancouver to Sydney, in this corner of Southeast Asia it’s China’s developers that are swamping the market, pushing prices lower with a glut of hundreds of thousands of new homes. They’re betting that the city of Johor Bahru, bordering Singapore, will eventually become the next Shenzhen.

“These Chinese players build by the thousands at one go, and they scare the hell out of everybody,” said Siva Shanker, head of investments at Axis-REIT Managers Bhd. and a former president of the Malaysian Institute of Estate Agents. “God only knows who is going to buy all these units, and when it’s completed, the bigger question is, who is going to stay in them?”

The Chinese companies have come to Malaysia as growth in many of their home cities is slowing, forcing some of the world’s biggest builders to look abroad to keep erecting the giant residential complexes that sprouted across China during the boom years. They found a prime spot in this special economic zone, three times the size of Singapore, on the southern tip of the Asian mainland. ...

A decade ago, Malaysia decided to leverage Singapore’s success by building the Iskandar zone across the causeway that connects the two countries. It was modeled on Shenzhen, the neighbor of Hong Kong that grew from a fishing village to a city of 10 million people in three decades. Malaysian sovereign fund Khazanah Nasional Bhd. unveiled a 20-year plan in 2006 that required a total investment of 383 billion ringgit ($87 billion).

Singapore’s high costs and property prices encouraged some companies to relocate to Iskandar, while JB’s shopping malls and amusement parks have become a favorite for day-tripping Singaporeans. In the old city center, young Malaysians hang out in cafes and ice cream parlors on hipster street Jalan Dhoby, where the inflow of new money is refurbishing the colonial-era shophouses. ...

You'd be hedging too if you were a Chinese billionaire

Ill-gotten gains + giant real estate bubble in China + limited liquid investment options = windfall for top international cities such as Manhattan, LA and London.

If the RMB were allowed to float, the short term effect could easily be a decline relative to the dollar, as Chinese investors rush to diversify their portfolios.

NYTimes: ... The explosion of wealth in China has created myriad new billionaires eager to diversify their holdings with real estate investments in the United States. Often, they are looking to give their children a plush crash pad for boarding school or college, or a place to live in when they start careers and families. Many wealthy Chinese are also looking for places to invest where they can preserve their wealth and avoid the rising inflation in major Chinese cities like Shanghai and Beijing.

... The old way of doing business is no longer enough, Ms. Field said. “We as Americans always expected anyone to adapt to our business style, and they did,” she said. “That is no longer true with the Chinese. There are too many of them, they have too much power. We truly must adapt to their style of business in order to do deals.”

... Chinese billionaires continue to buy high-end properties in buildings like the Time Warner Center, 15 Central Park West and the newest, One57. But in May and June she saw something different: an “almost overwhelming volume” of calls and sales driven largely by interest in apartments ranging from $3 million to $6 million — what Ms. Lenz calls the “middle market” in Manhattan.

Chinese buyers are also no longer paying all cash as they were a few years ago. In recent months, several Chinese buyers have financed their purchases, some with United States-based loans, Ms. Lenz said. They seem to be leveraging in New York so they can also buy properties in Los Angeles, London or other cities, she said.

On her trips to China, Ms. Field has noticed a change in the conversation among potential clients. “When I first went over there five years ago, my presentations all had to be about return,” she said.

“Everyone was looking for returns. Two years ago, return questions almost dried up. Now it is all about wealth preservation. They are anticipating a bubble” in China, she added.

LA Times: no bottom yet for housing

The article Should You Buy A House Now? runs with the figure below, which pretty much summarizes the situation. They should have printed these statistics repeatedly in 2003, 2004, 2005, 2006, 2007 together with patient explanations of what price to income and price to rent ratios mean. Maybe that would have slowed down the bubble. Then again, maybe not :-(

Bay area housing market begins to crack

It's about time! See Calcuated Risk for further discussion. (Note this data covers some regions which are quite far from the bay itself.)

Standard bubble wisdom: they last longer than you think is possible, then pop faster than anyone expects.

I've been calling the bay area bubble since as far back as 2004 / 2005 (actually, from before I started this blog!). I expect the last bubble market to pop will be Manhattan, but pop it will.

It must hurt to think that a house you purchased a year ago might be worth a third less today, with still further to go.

SF Chronicle: Across the nine counties, the median price paid for resale homes, new homes and condos in June plunged 27.1 percent from a year ago to $485,000, dipping below the half-million-dollar mark for the first time in four years, DataQuick Information Systems of La Jolla (San Diego County) reported Thursday.

Among resold homes, bank-repossessed foreclosures - which usually are discounted - accounted for 28.7 percent of all existing-home sales, up from just 3.5 percent in June 2007. Solano County, with foreclosures at 57.7 percent of all resales, had the highest percentage; San Francisco, at 3 percent, had the lowest.

Affluent areas such as Marin County and San Francisco, which until now had resisted most price erosion, saw existing single-family home median prices fall by about 11 percent. Including new homes and condos, the Marin County and San Francisco medians fell about 12 percent to $846,000 and $726,750, respectively.

"This is pretty grim; double digits across the board," said Christopher Thornberg, principal at Los Angeles' Beacon Economics. "It was eminently predictable if you had a realistic view of the world. I heard a lot of people say the Bay Area was never going to see prices fall, San Francisco was untouchable; in San Mateo, it was impossible; San Jose, not with all the tech money, blah, blah, blah. But prices at the peak relative to people's incomes never made any sense."

Note the 27% figure for change in median price is a bit tricky to interpret: it's alway possible that the composition of units sold has changed, with a lot of owners of high end homes sitting on them, refusing to accept the current market price. In that case the average price decline would be less than 27%. It is typical in a real estate crash for sellers to remain in denial for some time, during which the big decline is in number of transactions rather than actual price levels. It's only after the sellers have capitulated that the big price drops occur. In light of that, it's rather ominous that only 7,178 new and resale homes changed hands in June - the lowest June figure since 1993 :-)

Equities vs real estate

Which is the better long term investment, equities or real estate? The conventional (but not necessarily correct!) wisdom for a long time has been real estate, although this may be changing with the current housing bust. Note here I mean property as an investment, not as a primary residence, which has different considerations such as saved rent, etc.

Something that complicates the discussion is that typical investors are much more familiar with the use of leverage (e.g., 10% down) in buying a house than in buying stocks. The discussion below does a good job of clarifying. I'm not sure you can buy a long-dated 5 year index call at 80% strike for 28%, but that's probably the right ball park. Note the writer is in the UK.

Related posts here (see first figure below), here (second figure below) and here.

Re: the property v equities argument

Property has naturally outperformed in the last 7 years as its a much easier asset class for an individual to leverage. So its no surprise that through the final phases of the credit bubble its done much better as much broader class of people can borrow against it.

However, over a much longer time period the relative returns havet been much different. Each has had their relative booms and busts (.com bubble, property bubble etc)

The question now is which will do better as we go from a decade of excessive leveraging to a long period of de-leveraging.

Its hard to argue for property in that context, especially as its "earnings yield" is maybe 4.5% at best after all costs, while that of the average equity is more like 8% now

You can leverage an equity investment just as much as property without the hassle of finding a tenant, the stamp costs, the illiquidity etc etc

Assume a 5 year investment horizon. Imagine you had 100k of equity that you wanted to leverage 5 times into a LT investment

A) Buy a property. Borrowing 80% of purchase price, Investing 20% of your own equity and 8% for stamp. Equating to 28% cash investment upfront all-in

OR

B) Buy a 5year call option to buy the Eurostoxx @ 80% of where it is now. This will cost 28% as well

Economically you have the exact same exposure to leverage...if the value of either asset is 50% higher in 5 years you come out with 5.35x your original outlay (ie 150% / 28%)

Cool...


Advantage of the property investment;

1- You dont see the value of the investment every day, you just optimistically assume its going higher!

Advantage of the equity Option;

1- Your maximum loss is the 28%. [If the property falls > 28% and u sell u lose > 28%]
2- Its more liquid, you can sell anytime of the day Mon-Fri
3- You dont have to find a tenant or risk cashflow issues if it becomes hard to rent or int rates suddenly spike.

The first figure below, which covers 1980-2005 (i.e.,extending almost to the peak of the real estate bubble; see second figure below), shows that equity returns have exceeded real estate returns even in the hottest markets.

Housing bubble: dynamics of a bust

The first figure is from today's WSJ and incorporates data from Q4 2007. The second figure appeared in the Economist some time ago and was discussed previously on this blog. Does anyone care to predict the future for bubble states like California, Florida and Arizona using the Japanese data as a guide?

Lower interest rates will not re-inflate the housing bubble (although they may affect the rate at which it deflates; note the BOJ dropped real interest rates below zero in the wake of their bust). People understand now, as they did not just a few years ago, that home prices can go down. This change in ape psychology (try putting that in your macro model!) makes all the difference.

Below is historical data compiled by Yale economist Robert Shiller showing that home prices have not on average provided attractive real returns (right hand axis is inflation adjusted returns for same house sales over time; previously discussed here -- the real rate of return was 0.4% between 1890 and 2004). This is yet another example in which market participants (home buyers) made decisions based on faulty assumptions that might have been easily corrected by a modest amount of research. So much for efficient markets!



Here's some detailed data from Case-Shiller and OFHEO indices (also from WSJ; note OFHEO only tracks conforming mortgages so has less sensitivity to the high end of the market):



Finally, it is worth noting that the subprime mortgage meltdown is merely a symptom of the real estate bubble. If home prices continue to fall we will see (as we are already beginning to) higher default rates in so-called "prime" as well as subprime mortgages.

WSJ: ...I assumed, for the sake of calculations, that California prices fell 8% last quarter from the third quarter, a huge number by historic measures but not out of line with Zillow's data. For Florida and Arizona I assumed declines of 5% and 5.5%. You could use other, more modest estimates for the recent declines: They won't change the outcomes much. I also assumed personal incomes in these states rose in line with recent and historic averages."

The results? In all three markets, the prices are well off their peaks when compared to incomes. But they remain far above historic averages.

Median prices in California peaked in 2006 at 13.3 times per capita incomes. Hard to believe, but true. They may be down now to about 11.1 times.

But that's still way above the ground. Throughout most of the 80s and 90s they ranged between six and seven times incomes.

Just to get down to seven times incomes, prices would have to fall 37% tomorrow.

Those who bought at the peak of the cycle may be pinning their hopes instead on "incomes catching up" instead. But they had better be patient. Even if house prices stayed exactly where they are, it would take around 10 years for rising incomes to bring the ratios back into any sort of alignment.

How far to fall?

Bad news for holders of mortgage-backed securities! It looks like an average 15% (nominal -- larger in real dollars) price decline is required before price to rent ratios are back to historical ranges. Actually, that guesstimate assumes a 5 year "orderly" adjustment. The real figure of merit is that rent to price is down to 3.5% from a historical range of 5 to 5.5% How would you like to own an overvalued asset that returns only 3.5% (leaving you on the hook for property tax, maintenance, insurance, etc.)?

Via CalculatedRisk: From Morris A. Davis (Department of Real Estate and Urban Land Economics, University of Wisconsin-Madison), Andreas Lehnert, and Robert F. Martin (both Federal Reserve Board of Governors economists): The Rent-Price Ratio for the Aggregate Stock of Owner-Occupied Housing

Abstract: We construct a quarterly time series of the rent-price ratio for the aggregate stock of owner-occupied housing in the United States, starting in 1960, by merging micro data from the last five Decennial Censuses of Housing surveys with price indexes for house prices and rents. We show that the rent-price ratio ranged between 5 and 5-1/2 percent between 1960 and 1995, but rapidly declined after 1995. By year-end 2006, the rent-price ratio reached an historic low of 3-1/2 percent. For the rent-price ratio to return to its historical average over, say, the next five years, house prices likely would have to fall considerably.

Housing bubble

I mentioned the bay area housing bubble in the last post, and was asked to elaborate. Coincidentally, the Economist just posted this survey on property worldwide.

I can't claim to be an expert on this topic, but here goes...

I think there is clear evidence for a bubble in places like the bay area, Boston, NYC, LA and some other cities. The metric I find most compelling is price to rent (P/R) ratio, which is analogous to price to earnings (P/E) for equities. This is at an all time high in many cities, although not nationwide. The other metric which is very inflated in certain markets is price to average (family) income. Some of this data is available at the Case-Shiller-Weiss (CSW) Web site. (That's Robert Shiller, of "irrational exuberance" fame.) The bay area is particularly hard to understand, since something like 250K jobs were lost since the peak of the tech bubble in 2000, and there has actually been net migration out of the area. Rents have actually dropped slightly, but property values continue to increase.

On the behavioral front, I think a lot of people jumped into real estate thinking it was one of the few "safe" investments after the stock bubble burst a few years ago. One sure sign of a bubble is that people buy with the expectation of near-term price increases. I keep reading that units in developments in places like Florida and LA are often unoccupied - the owners have purchased them as investments with the intention of flipping. These speculators are going to get burned when interest rates rise, but until then they get to brag to their friends about their big gains. (Sound familiar?)

I mentioned in a previous post that bubbles can persist for surprisingly long periods of time, even after a fairly wide consensus has emerged that things are overpriced. I claim this has a lot to do with the timescales and effectiveness of arbitrage in a particular market. See here for related discussion in the Economist, and here for derivatives related to real estate prices.

Finally, let me note that I must not be very smart, since I thought the bay area was already overpriced 10 years ago, and should have bought something back then...