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Will the Contagion Spread to Asian Real Estate ?

Asia De-Coupling - Myth or Reality. Will the Contagion Spread to Asian Real Estate ?. Some Random Thoughts from the Trenches. Peter Churchouse July 2008. De-Coupling - what do we mean?. A fashionable notion a year ago - Domestic consumption vs exports Absolute or relative terms

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Will the Contagion Spread to Asian Real Estate ?

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  1. Asia De-Coupling - Myth or Reality Will the Contagion Spread to Asian Real Estate? Some Random Thoughts from the Trenches Peter Churchouse July 2008

  2. De-Coupling - what do we mean? • A fashionable notion a year ago - Domestic consumption vs exports • Absolute or relative terms • Wishful thinking - Naive! “ You can’t have it both ways”

  3. Housing bubble Consumer spending Corporate leverage Easy Credit The Greenspan Put Sub prime Commercial Consumer Credit card Auto Corporate Bonds Near Prime Credit Default swaps The Global Credit Merry Go Round Anatomy of a Modern Credit Cycle Prime $1.5 TRILLION

  4. Risk Aversion on the Rise 10 Year BBB US Industrials – spread over US Treasuries

  5. ITRAXX Asia High Yield Index

  6. A Credit Problem Becomes a Global Economic Problem • The hole gets very much deeper • $400bn becomes more like $1.5 trillion • Huge credit contraction will crimp global growth • Inflationary pressures gathering steam • Central banks - rocks and hard places! • Stagflation - not a good environment for financial assets

  7. Asian Real Estate - The positive spin - • Little supply driven concerns - dearth of cranes on horizons • Vacancy rates low • Unemployment low • Affordability good • Consumer debt low • Low real / nominal rates • Corporate balance sheets O.K.

  8. Asian Real Estate - The bear case - • Credit availability is tightening • Stock markets dull sentiment • Inflation rising, rates rising • Rising costs of essentials • Cap rates rising • Construction costs escalating sharply

  9. Hong Kong – What Next? A (hopefully) Educated Guess • Modest supply increase = slightly higher vacancies • Services job growth slows • Tenant resistance • Rentals flatten or roll over in 2009 • Cap rates rise / price fall 10% - 20%

  10. ( July 1997 = 100 ) Hong Kong – What Next? A (hopefully) Educated Guess • Credit availability ok • Prices flat / down approx 10% to mid 2009 • Recovery H2 2009 Hitting the wall • Supply least ever • Middle high end demand will soften • Rates rise, not hugely

  11. Some Distress but Hardly an Implosion Nicholas Brooke Chairman, Professional Property Services

  12. Background • Not de-coupled but regional economies more robust than in 1997 • Greater dependence on institutional investment and longer term debt • Less dependence on exports given stronger domestic consumption • Impact of any downturn likely to be on market specific basis

  13. Hong Kong Offices • Increased office supply in decentralised locations will lead to softening in prices and rents • But strong loyalty to Central remains • Reliance on redevelopment options and, in due course, sites on Central Reclamation • Possible creation of Government enclave on Kai Tak

  14. Site 1 Site 2 Site 3 Site 5

  15. Hong Kong Residential • Two markets within a market • Traders versus upgraders • Average sales price in 2007 less than HK$3 million and average unit area was 53sm • Despite dip, volumes relatively healthy at 64,450 units in first 6 months of 2008 i.e. an average of 10,740 per month

  16. Total Stock of Private Residential Units by Class in Hong Kong (2007) Class D (54,778 units) Class E (22,763 units) Class C(121,404 units) Class A (350,455 units) Class B (519,498 units) Classification of Residential Units by Class : Class A - saleable area less than 40m² Class B - saleable area of 40m² to 69.9m² Class C - saleable area of 70m² to 99.9m² Class D - saleable area of 100m² to 159.9m² Class E - saleable area of 160m² and above Sources: Rating and Valuation Department

  17. Hong Kong Residential • Investment demand centred on MTR proposals • Government seriously considering more flexibility in industrial conversions – starter homes, elderly housing • Impact of new Town Planning Board imposed height limits

  18. Investors’ View on Asia • Japan – standing investments • Macau – luxury residential • Malaysia – villas and high end apartments • China – second tier cities • Singapore – wait, as prices will fall • Vietnam – prices fallen, some good buys • India – opportunities in the hotel sector • Middle East – Abu Dhabi, Qatar

  19. Eric Wong +852 2971 6430 eric.wong@ubs.com British Chamber of Commerce: China Pty – bull market correction Jul 2008 Eric Wong Co-head of Asia Property Research ANALYST CERTIFICATION AND REQUIRED DISCLOSURES BEGIN ON PAGE 96 UBS does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. This material has been prepared by UBS Securities Asia Ltd, an affiliate of UBS AG (UBS).

  20. Easy come, easy go… price rebound unlikely in Q3 Price (Rmb psm) 2008 Time 2006 2005 2007 Source: Hopefluent

  21. Policies targeted developers, buyers less affected 60% 6,000 50% 5,000 40% 3,100 4,000 3,000 2,860 2,600 30% 3,000 2,410 2,270 2,220 2,100 2,000 1,793 20% 2,000 1,856 1,754 1,682 10% 1,800 1,760 1,000 1,700 1,800 1,600 1,410 1,380 1,300 1,200 914 887 846 818 0% Mar-05 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 YoY Growth of mortgage loan Developers loan balance Consumer mortgage loan balance YoY Growth of developers' loan Source: CEIC

  22. RMB bn Metrics the regulators monitor…all exceeded 10% 18% CPI (LHS) (red: exceed target) 9% 16% 8% Interest rate (RHS) 14% 7% 12% 6% Deposit reserve rate (RHS) 10% 5% 8% 4% 6% 3% 4% 2% 2% 1% 0% 0% Jul 07 Jan 08 Mar 08 Sep 07 Jan 07 Nov 07 Mar 07 May 08 May 07 Gov Target 4,000 28% 26% 3,500 24% 3,000 22% 2,500 20% 2,000 18% 1,500 16% 1,000 14% 500 12% 0 10% Jul 07 Jan 08 Mar 08 Jan 07 May 08 Mar 07 Nov 07 Sep 07 May 07 Urban fixed asset inv (RHS) New Loans (LHS) M2 supply (RHS) Source: CEIC

  23. Govt’s supply side objectives – increase supply • More funds allocated to public housing: target Rmb50bn (now: Rmb 3bn) investment a year • More price-capped supply: 7,000 units (priced at 30% below market average) in Guangzhou in 2008 • More 90/70 products: 50% of supply in GZ, SH in 2008 • More confiscation of and penalty on idled land • More investigation of illegal practices • Protect farm land (see 100-day campaign) • Turn land supply into housing supply • Promote first-time home ownership

  24. 1Y Lending >5Y Lending 1Y Deposit 5Y Deposit Mar 6.39 7.11 2.79 4.41 May 6.57 7.20 3.06 4.95 Jul 7.02 7.38 3.33 5.22 Aug 7.20 7.56 3.60 5.49 Sep 7.47 7.83 3.87 5.76 Dec 7.56 7.83 4.14 5.85 Govt’s demand side objectives – curb bubble forming • More mortgage rate hikes • Increase upfront payment ratio • Introduction of property holding taxes • Enforcement of LAT • Foreign purchase restriction • More investment channels Source: CEIC

  25. Govt favours first-time buyers • 6.7% and 20-30% upfront payment for 1st purchase • 8.6% and 40% or higher upfront for 2nd purchase • Last rate hike kept mortgage rate unchanged • Further mortgage tightening may target speculators • Proposed property holding taxes may target large and luxurious units • Transaction taxes may not be so successful as sellers transfer burden to buyers

  26. When will the market recover?

  27. 16 14 12 10 8 6 4 2 0 -2 -4 Jul-04 Jan-05 Jul-05 Jan-06 Jan-08 Jul-06 Jan-07 Jul-07 Jan-04 Jul-02 Jul-03 Jul-01 Jan-02 Jan-03 Jan-01 -VE real rates still supports prices Deposit rate 3 months Inflation Lending rate > 5 years Required reserve ratio Source: CEIC

  28. Indications of a market recovery • Price cuts followed by stable growth afterwards • Significant bounce in volume • Tightening focuses more on developers’ loans • No new policy implementation in next 6 months • Balanced mix of private and public units

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