Writedown Math May Sully Developers' Books

Source : The Business Times, November 15, 2008

Bottom lines have already started to shrink in current reporting season

SMALLER home developers have already started cutting prices and this will raise the pressure on other listed property groups to make writedowns. This will whittle bottom lines, which have already started to shrink during the latest quarterly reporting season.

Back in 2001, developers such as CapitaLand and Keppel Land made massive writedowns on their Singapore residential landbanks. Some were made for sites that had breakeven costs below the achievable selling prices. In short, the provision quantums were based on the the difference between breakeven cost and selling price.

So too, this round, as we see achievable selling prices slipping below breakeven costs at certain sites, the writedowns could follow - although developers may drag their feet through Q4. But next year, they may have little choice as more widespread evidence of falling home prices emerges.

A seasoned valuer told BT that he would peg valuations for selling prices of top-end homes as at end-2008 at about 10-15 per cent below end-2007 levels. However for high-end residential land itself, the decline would be higher, at 15 to 20 per cent.

Past property slumps have lasted at least six to eight quarters - so we are in for a rough ride ahead. High-end sites may need to be written down a lot more than mass market sites. The run-up in home prices in 2006-2007 was much more concentrated on the high-end segment, unlike the bull run in 1995/96 when every segment - mass market, mid and high-end - galloped.

Developers who snapped up land at the market peak in 2007 and early 2008 will face much greater pressure for writedowns than those who bought in the early stages of the bull cycle, say, in 2005.

Developers who sold homes on deferred payment schemes may also worry if they have gone on to recognise profits on such units - beyond the initial 20 per cent payment collected from buyers - based on the extent of the project's completion. What happens if these buyers default and return their units? We could potentially see developers having to un-book some of the sales and and profits on such units - until they find new buyers.

Office revaluations

Evidence of office rents slipping has also begun to emerge. Potential investors also demand higher yields on office acquisitions today than 12 months ago. These two factors point to lower office valuations.

Some believe that valuations of office buildings should not decline much next year even if office rents fall because as leases come up for renewal, the new rental rates will still be much higher than the low rates which were locked in previously.

A seasoned valuer disagrees, pointing out that valuers estimate the capital value of an office block based on current market rents being fetched in the building, and then dividing it by a capitalisation rate (which would be the yield that potential investors demand). Even using a discounted cashflow model for valuation, capital values for office blocks are set to decline because future rents are coming off and an adjustment for higher capitalisation rates has to be made given the riskier economic environment.

His estimate is that end-2008 Grade A office capital valuations would be around 10 per cent lower than the end-2007 level. Bigger drops can be expected in 2009 as the economy deteriorates.

Downward revaluations of investment properties like office blocks would hit developers' bottom lines under Financial Reporting Standard 40 for most property groups. The major exception would be City Developments which, upon adoption of FRS 40, has continued to state its investment properties at cost less accumulated depreciation and impairment losses.

Most property groups's bottom lines are likely to deteriorate going ahead, whether they choose to start making residential provisions and downward revaluations of office investment properties in their Q4 2008 report card or delay it till 2009.

However, a seasoned property analyst is not bothered by such writedowns and losses. Property counters are already trading at huge discounts of over 50 per cent to revalued net asset value. The market seems to be pricing in extreme declines of around 50 per cent in property values. The bad news from provisions and writedowns has already been factored in. Developers' indebtedness and cash positions may be the things to watch out for.