[B][SIZE="5"]Talking up the market?[/SIZE][/B]

by Ku Swee Yong

04:46 AM Apr 29, 2011

This year started off strongly for Government Land Sales (GLS) en-bloc sales. Under the GLS, seven residential sites, including two for executive condominiums, were launched and sold, generating over S$2.5 billion for government coffers.

With the residential market hot from robust sales volumes and continued strong interest from developers, I am concerned that some of the estimates for break-even and launch prices quoted in the media or published in financial reports might be adding fuel to the fire.

For example, the Bartley Road GLS site was awarded to the top bidder at S$621 psf per plot ratio early this month. One of the media reports estimated that the developer's "break-even cost could be around S$1,000-1,050 psf". Assuming the developer targets a profit margin of S$150 psf, it would mean that the 99-year leasehold residences might be launched for sale at S$1,150-1,200 psf.

Taking into consideration that the Bartley Road site can take a gross floor area of about 660,000 sq ft, we can assume good economies of scale and bargaining power for the procurement of materials.

In a mass market location such as Bartley Road, we see from Table 1 that construction costs should be about S$251 psf. Total costs for this project are summed up in Table 2.

Going by the example above, the conservative break-even cost is S$372 psf above the land price, close to the S$380-430 psf estimate using "rule of thumb" that was quoted in the media.

However, items 4 to 6 are overestimated. Permits and professional fees for large projects may be as low as 5 to 8 per cent. Marketing fees are usually 2 to 4 per cent of the total sales value and, in a large project like this, the expenses are usually at the 2 per cent level: 1 per cent for agents' fees and 1 per cent for advertising, show flat, brochures and so on. The interest expenses stated above are a conservative estimate given that most developers today opt for floating rate packages from below 2 per cent per annum all in. Developers also pay down the principal of the land loan when they collect progress payments from buyers of the units.

In the last two years, developers have launched projects within nine to twelve months of securing the GLS sites. Due to the progress payment mechanism, developers are not likely to incur interest expenses on the construction costs given that the initial payment of 20 per cent or S$240 psf (assuming selling price of S$1,200 psf) is enough to take care of almost the full construction costs of S$251 psf. Therefore, if a project was substantially sold prior to construction starting, there will not be a need for construction financing and the loan for the land can be paid down as the construction progresses beyond foundation stage.

Also, most developers aim for a Return on Investment (ROI) of 15 to 20 per cent. In this Bartley Road example, assuming a 60-per-cent loan on the land costs, the invested equity should be about S$240 psf on land. Loading the full costs of items 2, 4, 5 and 6, the investment requires S$370 psf. An ROI requirement of 20 per cent would merely add S$75 psf to the break-even price, meaning that the developer can sell out the whole project and achieve a 20 per cent profit if they sold with an average price of S$1,070 psf. This is S$130 psf below our assumed average selling price of S$1,200 psf (but our marketing costs have been conservatively loaded up based on this selling price assumption).

If the Government's efforts to maintain price stability are to succeed, we would need media articles and analysts' published viewpoints to accurately reflect projections of break-even and launch prices. Otherwise, the danger is that we over-estimate break-even prices, we over-state replacement costs and we exaggerate projected launch prices, adding to the hype and froth in the market.

[I]Ku Swee Yong is the founder of real estate agency International Property Advisor, which provides services to high-net-worth individuals. He is author of Real Estate Riches: Understanding Singapore's Property Market In A Volatile Economy, available in bookstores from June.[/I]