Market Overview, Outlook for 2007

Implications: >The economy is projected to grow at an average rate of 6% per annum between 2006 and 2010 with stable inflation.
>The finance, insurance, real estate, and business services is the biggest part of the services industry. This sub-sector is projected to register a 6% growth during the 9th Malaysia Plan (2006 – 2010). The size of this sub-sector is about 15% of the entire economy and will increase to 15.8% by 2010.
>The central bank expects inflation to fall below 3% in 2007.

Analysis:

Property Market

Office: Currently there is great demand for commercial investments. This demand will bring values to a more realistic level. We see RM900 psf and a yield of 6% being easily reached in 2007. We will not be surprised to see values leveling off at about RM 1,200 psf for prime buildings.
Retail: The retail property market is in good shape and is getting better. With strong demand from international and regional brands, we see rentals reaching a new high of RM85 psf per month for prime locations in the best shopping centers.
Residential: Developers have taken an aggressive but realistic approach to the fact that there are very little products available at the top end of the market. The figure of RM 2,000 psf for top end residential properties will be achieved by 2007.

There are improved sentiments and confidence in the property sector with strong economic outlook and buoyant stock market performance. Contributory factors largely revolve around the Government’s efforts including the rollout of the 9th Malaysia Plan, third installment of the Visit Malaysia Year 2007 celebrations, relaxation of the FIC and abolishment of the Real Property Gains Tax.

2006 Economic Overview

In 2006, the overall economic expansion was at 5.9% (Q1: 5.5%, Q2: 6.2%, Q3: 5.8% and Q4: 5.7%).

Growth in 2006 was broad-based, with positive contributions from all sectors of the economy.
Exports grew at 10.3% versus a 10.8% increase in imports.
Unemployment remained below 4%, reflecting a situation of full employment since 1992. The services sector expanded 6.5% in 2006. The services sector has consistently accounted for about 58% of Malaysia's GDP in the past three years. Inflation averaged at 3.6% in 2006.

9^th Malaysia Plan 2006-2010
Regional Priorities

The Federal Territories will be allocated RM31.09 billion, or 15.5% of the Federal government development budget of RM200 billion, the single largest allocation. This continues to reflect Kuala Lumpur and the central region as the core area of development, maintaining its role as the focus of business and industry.

The Ministry of Tourism received a much higher budget of RM1.37 billion (0.7%), compared with RM482 million (0.3%) in the 2001-2005 period.

To expand the services sector beyond its current concentration in Kuala Lumpur and the surrounding KlangValley, the government is promoting South Johor Economic Region as a new source of growth to leverage on its prime location. The southernmost state of Johor will receive an allocation of RM10.2 billion (5.1% share) to transform the region into a logistics hub.

Sectoral Priorities:
The services sector is expected to sustain its growth momentum at an average rate of 6.5% annually during the 9th Malaysia Plan. The growth will be derived from the finance, insurance, real estate and business services as well as the wholesale and retail trade, hotels and restaurants sub-sectors.

Tourism efforts will focus on enhancing Malaysia’s attractiveness as a destination for natural and eco-tourism; for culture, entertainment and the arts; for meetings, incentives, conventions and exhibitions (MICE); for international sporting events; as well as for shopping and recreational activities.

The finance, insurance, real estate and business services sub-sector is projected to grow at an average rate of 7% annually. The Malaysian real estate market is undergoing a stage of rapid growth underpinned by healthy economic performance and frequently boosted by the provisions in the five-year Plans.

Kuala Lumpur, being the focal point of the services sector in Malaysia, is expected to benefit from the development plans intended to enhance the services sector.

The development of Phase 2 of the Multimedia Super Corridor, Kuala Lumpur as Malaysia’s financial hub and strengthening Malaysia’s position as a global Islamic financial hub all serve to highlight the many opportunities that could arise in the real estate sector.

Office

Supply – Current & Future
As at the end of year 2006, the overall office space in the KlangValley stood at approximately 61.57 million sf. Of this total supply, 33% is located within the Golden Triangle (GT) area whilst 19% is located in the Central Business District (CBD). The balance is largely distributed in the decentralized areas (DA) of Mont Kiara, Bangsar and DamansaraHeights, and Petaling Jaya.

Office completion in 2006 are limited to ChulanTower (330,000 sf) and The Taipan (130,000 sf) in the GT area.

The future supply of office space in Kuala Lumpur is expected to contribute another 6.646 mil sf over the next 3 years. We view this future supply as ‘moderate’ and with the market still in recovery stage, there is little evidence of any new generation of buildings. Despite relatively moderate new supply this year, we do not anticipate much improvement in the vacancy rates unless there is a pickup in net absorption which has been declining since 2004.

Key Investments & Tenant Movement
On the investment front, 2006 was very active with numerous major transactions, especially REITs related transactions. The market has begun to acquire interests in REITs subsequent to the revised guidelines issued by the Securities Commission of Malaysia in 2005. Significant offices which have changed hands over the past year showed an increase to RM 2.521 billion (25 properties) from RM 1.931 billion (17 properties) in 2005.

Significant movers in 2006 include IBM’s move from Taman Tun Dr Ismail to 8 First Avenue (120,000 sf) in Bandar Utama and KAF-Seagroatt & Campbell (70,000 sf) from Wisma Goldhill. Those anticipated to move in 2007 include KPMG’s move to 8 First Avenue (120,000 sf) from its current premises in Bangunan Setia 2, DamansaraHeights.

Rental

2006 also saw the continued growth and increase in popularity of decentralized office locations, with KL Sentral being the most popular destination, which saw the leasing of about 152,000 sf under a 15-year lease by Maxis Communications Bhd. Popularity of these decentralized locations can also be evidenced from the successful sale of office space within the decentralized areas. Some examples are as follows:

100% sell out of Solaris Mont Kiara comprising 3, 4 & 5 storey shop offices for Phase 1 and 8 - 10 sty retail & office suites for Phase 2;

PJ8 which have to date achieved an 80% take up rate since launching.

Capital Values
Currently, KL is experiencing an unprecedented level of interest from local and overseas investors for good quality office investments to buy. The following are the principal reasons:

A complete revision of the Securities Commission (SC) guidelines for the establishment of REITs on the 3 January 2005. This almost immediately led to strong demand for investment property from those wishing to set up REITs under the new liberalised tax regime. Demand from this source continues.

A shift in policy whereby government institutions such as the Employees Provident Fund (EPF) and others decided to invest in commercial property.

Mounting worldwide liquidity which led to increased demand from overseas REITs and opportunistic funds.

Our view, which is a subjective view, is that the value of Grade A office space will probably rise to some RM900 psf over the next 3 years and could rise as high as RM1,200 psf before it consolidates and begins its decline in a further 5 years time in 2012. Our argument to support this is as follows:

Currently, it is generally accepted in valuation circles that top-quality commercial investments are valued to reflect a yield of 7%.

There are already numerous institutional buyers who are prepared to accept yields as low as 6% because of the prospect of capital appreciation.

This lowering of yields can also be supported by a real anticipation of some rental growth.

Retail

Supply

The total measured supply of significant retail centre space is currently at 36.34 million sf in 104 centers in the KlangValley. However, not all the space is competitive and a majority is based on old models which are not capable of sustaining in the coming years. This results in a per capita of 6.1 sf per person.

The question is whether there is still room for better centers since so many are poorer models and the successful centers are less than a quarter (23 out of 104 centers or 11.57 million sf out of 36.34 million sf) of the total number of centers in the market. The current successful ones will give a per capita space of 1.97 sf per person.

We believe there is room for at least another 5 million sf of space in various forms and locations, based on the rule of thumb that the equilibrium in the market is for 3 sf per capita, and on the fact that the successful centers work out at 1.97 sf per capita only.

The new supply entering the market in 2007 and 2008 will add another 3.36 million sf, if we take into account only the large ones including The Gardens, KL Pavilion, Sunway Phase 2 and Aeon Bukit Tinggi.

This means the market still has room for another 1.5 million sf, even if all this new space is successful.

Total supply in terms of successful integrated facilities will come to 9.02 million sf net by end 2007. As our earlier calculations have shown, there is still 1.5 million sf available at equilibrium, and this could be in another centre of a large size. However new supply planned but not approved could easily take care of that by 2009/2010 from at least one centre alone, in the suburbs and mid town locations.

Should there be any room left for such a centre in the KlangValley, it will mean a major competition for the new comer and also a dilution of the market. If the economy improves, and tourist figures improve further as well, it is possible that the equilibrium may shift to 4 sf per capita in 3 to 5 years’ time. This however is a broad figure and the analysis of competition must include an examination of demand-supply gap factors as well.

Demand

For 2006, demand was slow however as retailers worried about the potential watershed looming by end 2007 when the major extension malls and KL Pavilion are completed.

Total take up for 2007 will be higher as retailers fill up their books with the new malls opening this year. However there is a difficulty in getting new staff, managers and even supply. Cost of opening new outlets is high as well, and many are restricting their openings to the biggest and ‘safest’ openings like Pavilion and Mid Valley. Based on total new s f coming into the market in 2007, take up will be in the region of 3.5 million sf.

2008 will see a rise in demand for new outlets but with less openings effective demand translated into uptake of space will be below 1 million sf. There will be no new space in the market of significant size in 2008.

As a property sub-sector, the retail market can be said to be growing positively in terms of its tenant demand over the last 2 decades as retailers continue to expand and take market share.

Occupancy Rates

Although there is an oversupply situation, average occupancy is high at about 86% for 2006 and some centers even have a waiting list. This is because in the poorer centers, rents are low and upper or remote spaces in these centers are leased to trades that do not require high traffic.

This means that the rest are underperforming, and the high average occupancy in the rest of the 108 centers would be attributed to poor tenant mix and in most cases, activities other than true retail are supporting the centers as well.

The waiting list is in the four (4) successful centers, namely Suria KLCC, Mid Valley, Sungei Wang and 1 Utama. In all 4 cases, new tenants can only secure space at lease renewal or rent review times and this is usually 3 years apart. Of these, Sungei Wang is unique as it the most successful strata titled shopping centre with multiple ownership and much of the tenant mix is determined by market forces.

The retail industry is such that winner takes all and therefore these four centers continue to dominate the retail scene even though more new ones are coming up. The attractions all these have include location, critical mass and strong tenancy mix.

Saturated Market

Currently the market is moving very fast to a new level of saturation and competitiveness. With the opening of the new centers this year, the turnover per sf will certainly drop, as a result of dilution of market share for each shopping centre and with it, each outlet.

This means that a new centre trying to secure new tenants from 2008 onwards will face a lot of difficulty and may have to drop rents to below market rates, increase costs of marketing including advertising and rent free periods and rental concessions. On top of this the centre will have to be of a better concept, design, trade mix, and quality in general. At the current cost of construction, this will push margins down on the development.

Wholistic Differentiation is Critical

The market has also come to a point where only new concepts will make sense, so conventional ones will need to be really superior in everything to beat the competition. This means that new centers must consider creative options either better in design or in total concept.

Our opinion is that both the ‘hardware’ and ‘software’ elements have to be new and superior, i.e., it must be a wholistic differentiation, not just looking nicer in style.

Trend-driven Market

Today’s market is younger and more demanding, so fashion has to be more targeted, not just ‘me too’ with all the usual brands. Any new centre in the city must therefore be a clear leader, both in its aspirational qualities as well as its fashion trends. Anything less than trendy will mean losing the competition entirely. Again this means doing the same job better than the competitors and making sure the differentiation is complete, and represented not only in the centre but the merchandise as well. In a price sensitive market, it is difficult to achieve this with most brands as they are controlled so the answer is probably in the niche market where there are less chances of a price war by tenants. This however, may either mean a higher end centre, where the target market is restricted, or a very young centre where the target market is not loyal. This suggests a risk in terms of concept for newer centers.

Residential

Market Overview

Primary Residential Market (New Launches)

2006 saw the launch of 8,838 units of new residential properties in Kuala Lumpur and Selangor (NAPIC 2006).

Secondary Property Market

In the secondary market, year 2006 kicked off at a lackluster pace with real estate agents indicating a less than robust market. The soft market at the start of year was attributed to a less positive economic environment, amidst petrol and interest rate increases which dampened in an already listless market.

The mismatch in vendor and purchaser requirements continued with the latter on the lookout for what they conceive as reasonably price houses, in particular landed residential properties. With a lot of properties to choose from, investors are now spoilt for choice with an array of new products coming on-stream. Investors have become a lot more discerning and have higher expectations before committing to a property. Bargain hunters looking for the best deal in town were said to be successful with some deals closed at prices just below market in scattered locations around the KlangValley. Nevertheless, prices and rentals stayed firm across the board with selling prices largely at market.

Interest was again mostly local especially for sale transactions and foreigners for rental properties. Nevertheless, the expatriate market for rental properties has seen a slight dip as some MNCs seem to be cutting down on housing allowances realizing that the same type of accommodation can be secured at a much lower budget than before. The range is now between RM5,000 to RM10,000 and some MNCs have reduced the allowance to below RM5,000.

Optimism returned in the second half of 2006 largely attributed to heightened consumer sentiments with the rollout of the 9th Malaysia Plan and the improving performance of the local bourse towards year end.

Year 2007 would once again witness the completion of several new residential projects which would definitely impact on its surrounding existing developments. This is particularly more relevant to stratified properties for rent in places like PJ or Mont Kiara, as the tenant market may not be large enough to accommodate all these units and the competition becomes stiffer. Damansara Heights, Kenny Hillls, Taman Tun Dr Ismail, Mutiara Damansara, freehold properties at Section 16 and Section 17 in PJ, Ampang Hilir and Cheras areas closer to the city centre, are but some of the areas which are expected to remain strong with continued demand for good properties in these areas.

Upmarket Residential Properties

Developers also continued to push prices into new territory for launches of landed and non-landed properties in the suburbs

The launches of such up-market properties in prime localities are expected to continue into 2007. Planned projects from major players which are generating significant interest include:

Luxury Serviced Residences & Condominiums

Supply
The existing supply of luxury serviced residences and condominiums (priced in excess of RM500 psf) in the KlangValley comprises only of 36 developments with a total of about 4,146 units.

A total 9,219 units within 44 developments are expected to be complete within the next 4 years.

Serviced residences (which are essentially residences built on commercial land) are generally located within the KL city area more as a result of the commercial zoning and concentration of commercial lands in the city centre versus residential land.

In spite of the seemingly large new supply of 5,827 units in the KLC area to what appears to be a saturation of these property types, most register good take up rates in excess of 70% before completion. Sales were observed to have slowed down over the past year, but with very limited developable lands left, we believe that natural market forces will see the absorption of these unsold units over time.

Of the total future supply, only 10 developments are priced in excess of RM800 psf while milestone developments breaching the RM1,000 psf mark are limited to select developments in the KLCC area (within and fringing the Petronas Twin Towers) such as The Troika, The Binjai, One KL and The Avare.

Of these, The Troika has recently raised the bar by pricing unsold units at RM1,500 - RM1,800 psf (formerly priced at RM1,000 psf). These developments are all located within the Golden Triangle and are reflective of the premium attached to being located within the KLCC area and also within the heart of the city centre.

2006 saw fewer launches within the Golden Triangle compared to preceding years. These include One KL and Ampersánd @ Kia Peng.

Several other projects within the Golden Triangle that have not been officially launched yet or are at various stages of proposal / planning. Significant ones include residences within Four Season Centre, The Oval, PlatinumPark, The Crest Kuala Lumpur, Cecil Chao Centre, Hampshire Residences and Lavender Night.

We understand that the market leader will be the residences at the Four Seasons Centre which are being soft launched at RM2,000 psf with an initial 20% discount i.e. RM1,600 psf.

Occupancy Rates: Existing Supply

An observation of occupancy rates of these luxury developments shows relatively high occupancy rates of between 80 - 95%. Anecdotal evidences suggest a predominance of expatriate community and young executives living within these city developments.

This suggests that at this price range and location there is a healthy and buoyant tenancy market supporting the current supply of units. This further suggests that the market is not saturated as yet and so far as the Golden Triangle is concerned and it shall remain strong for the medium term based on incoming supply.

Outlook

Since the market has expanded exponentially, minor periods of oversupply are significant but not entirely alarming. The local market has had a good record of self regulation and in the medium term, we are optimistic that good quality properties will continue to produce above average dividends and demand for such properties will be sustainable.

Currently, buyers are being drawn from a variety of sources including the Middle East, Europe, Singapore and Hong Kong. Malaysian prices have been seen to lag well behind Hong Kong and Singapore; and in Bangkok, political unrest has led potential investors to look elsewhere.

The availability of local end financing coupled with singe land ownership laws have served to attract an increasing number and variety of foreign buyers including, recently, Koreans. The general mood of the market is bullish and we anticipate record turnover this year.

Undoubtedly, a KLCC location is essential in order to achieve prices in excess of RM1,000 psf with a good view of the Petronas Twin Towers, a clear path to the Park and Suria KLCC shops and excellent finishes, prices should maintain at above RM1,300 psf. Developers have taken an aggressive but realistic approach to the fact that there are very little products available at the top end of the market. The figure of RM2,000 psf will be achieved by year-end.

Hospitality Sector

THE MALAYSIAN TOURISM MARKET

Tourist Arrivals & Receipts

Enjoying a brisk upward trend in the last two years, the tourism sector – the second highest revenue earner behind manufacturing in Malaysia - is expected to register further increases: from 16.4 million arrivals in 2005 to an anticipated 20.1 million in 2007, in tandem with a huge government push for Visit Malaysia Year and attractive incentives for tour operators under Budget 2007. To this end, tourist receipts are projected to hit US$11.3 billion in 2007 alone, with an annual growth rate of around 8.4%. Initial government forecasts up until 2010 are for tourist arrivals to hit 24.6 million with total receipts of US$17 billion (RM59.4 billion).