PROPERTY INSIGHTS. Market Overview. Market challenges across sectors. Citigold Private Client. Malaysia Quarter 3, Prime Office Rental Index

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1 Citigold Private Client PROPERTY INSIGHTS Malaysia Quarter 3, 2014 Market Overview Market challenges across sectors The Malaysian economy expanded 6.4% year-on-year (y-o-y) in Q2, marginally higher than the 6.2% growth registered in the previous quarter. At the same time, the unemployment rate declined to 2.8% in Q2 from 3.1% in Q1. The Overnight Policy Rate (OPR) was raised to 3.25% in Q3 and correspondingly, the average Base Lending Rate (BLR) of commercial banks increased to 6.78%, with most commercial banks revising their BLRs by 25 basis points. The bulk of new office supply in Q3 was in the decentralized commercial areas. While average capital values have remained stable, the increasing amount of available space has put pressure on average rents (Figure 1). Furthermore, the slowdown in the oil and gas (O&G) sector has reduced demand for office space. As a result, competition between landlords has intensified, creating a tenant-favourable market. Although consumer sentiment improved slightly in Q2, inflationary pressure caused by the reduction of government subsidies could negatively impact consumer confidence going forward. The introduction of the Goods and Services Tax (GST) is expected to have a one-time short-term impact on retailers in Malaysia when it is implemented in the second quarter of Figure 1 Prime Office Rental Index Q4 05 Q4 06 Q4 07 Q4 08 Q4 09 Q4 10 Q4 11 Q4 12 Q4 13 Q4 14 Q4 15 The high-end residential market saw a number of new launches in the quarter and the completion of another five projects. Although prices and rents grew marginally in the quarter, tightened funding availability has dampened sales. Nevertheless, more scheduled launches are expected in the last quarter of the year. Sentiment going forward however is uncertain, given the rumours that the government might increase the real property gains tax (RPGT) and stamp duty to further control speculative activity in the housing market.

2 Trends & Updates Economic Overview Economy expands 6.4% y-o-y in Q2 The Malaysian economy continued to post healthy growth with a 6.4% y-o-y expansion in Q2, similar to the 6.2% growth registered in Q1 (Figure 2). Economic growth in Q2 was supported by exports and private-sector investments, which outpaced the slower growth in domestic demand. While private domestic demand continued to register growth of 8.1% in Q2, public-sector expenditure declined by 2.1%, reflecting the Government s lower spending on emoluments, supplies and services, as well as fixed assets. The construction sector grew by another 9.9% y-o-y in Q2, after the strong growth of 18.9% in Q1. This was driven mainly by the residential sector, in particular, the construction of high-end residential properties in Johor and Klang Valley. At the same time, growth in the real estate and business services sub-sector remained strong at 7.4% y-o-y, underpinned mainly by the business services segment. The unemployment rate declined to 2.8% in Q2 from 3.1% in Q1, and total employment increased by 0.1 million to 13.6 million in Q2. The increase was attributed to stronger hiring in the manufacturing, services and mining sectors. Inflation moderated slightly in Q2 The inflation rate fell marginally in Q2 to 3.3%, from 3.4% in the previous quarter. The slight moderation was due to lower inflation in the food and non-alcoholic beverages category. Furthermore, inflation in the housing, water, electricity, gas and other fuels category, which increased in Q1, declined 3.3% in Q2, reflecting the slower increase in rentals across most types of properties during Q2. However, inflation is still expected to remain above its long-run average due to higher domestic cost factors. Figure 2 GDP growth (y-o-y) and unemployment rate Source : Bank Negara Malaysia, Department of Statistics Malaysia, DTZ Research Monetary conditions remain supportive of economic activity In Q2, because the OPR was maintained at 3.0%, the average overnight interbank rate was also stable. The three-month interbank rate however continued to rise as interbank lenders preferred shorter-term lending in line with the shift in their deposits toward shorter maturities, as well as the expectation of a further increase in the OPR. Indeed, in July 2014, Bank Negara Malaysia (BNM) raised the OPR to 3.25%, with most commercial banks revising their BLRs by 25 basis points. Consumer Sentiments Index (CSI) passes 100-point benchmark Consumer confidence improved during Q as Malaysian Institute of Economic Research s (MIER) reported that the Consumer Sentiments Index (CSI) rose 3.3 points to 100.1, passing above the 100-point benchmark since its fall in Q Ringgit appreciated against the US dollar by 1.8% The Malaysian Ringgit and most other regional currencies appreciated against the USD as sound regional growth prospects and the highly accommodative monetary policy in the US sustained investor interest in regional financial markets.

3 Overall, the Ringgit appreciated by 1.8% against the USD. The Ringgit also appreciated against the Euro (2.6%) and Japanese yen (0.3%), but depreciated against the Pound Sterling (-0.6%) and Australian Dollar (-0.2%). The Ringgit s performance against regional currencies was mixed. Residential Healthy supply in the quarter The quarter saw a healthy amount of new supply with the completion of another five high-end residential projects, adding a total of 574 units to the market. This was similar to the 543 units completed during the same period last year. For the first three quarters of 2014, a total of 1,892 units have been completed. The new completions in Q3 were mostly located in the city centre, namely Brunsfield Residence@U-Thant (93 units), Madge Mansions (52 units), One@Bukit Ceylon (354 units) and an unnamed high-end residential development at U-Thant by Bandar Park Sdn Bhd (12 units). Only one development i.e Kenny Hills Residence (63 units) is located outside the city centre. Another 4,604 high-end residential units are expected to enter the market by the end of 2014 (Figure 3). Amongst the major developments expected to be completed in Q4 are The Elements (1,040 units) by Elite Forward, Sky Residence-Phase 2: Celesta & Divina (450 units) by SP Setia and Icon Residence (260 units) by Mah Sing Group. Marginal growth for prices and rents in Q3 In Q3, the high-end residential market in Kuala Lumpur saw marginal growth in both capital and rental values. Average capital values increased 0.7% q-o-q, from RM758 per sq ft in Q2 to RM763 per sq ft in Q3 (Figure 4). At the same time, average rents increased from RM3.59 per sq ft per month in Q2 to RM3.61 per sq ft per month in Q3. Cooling measures and schemes from impending Budget 2015 could affect housing prices going forward Similar to the previous quarter, the housing market was sluggish in Q3. The effects of the cooling Figure 3 Future supply of high-end condominiums in Kuala Lumpur Figure 4 Rental and price indices of high-end condominiums in Kuala Lumpur (Q = 100) measures implemented earlier in the year were already evident with a decline in the number of transactions as well as the postponement of some new project launches. In Q3, new notable launches included Novo Ampang, a serviced apartment project by Alfranko Development offering 421 units of generally small sizes of between 682 sq ft to 865 sq ft. Indicative prices at the development ranged from RM1,200 per sq ft to RM1,600 per sq ft. Another launch in Q3 was Dorsett Residences at Bukit Bintang, a fully designer-furnished freehold development by Mayland Group, which offered 252 units of sizes between 652

4 sq ft and 1,333 sq ft. The indicative launch price at the development was RM2,000 per sq ft. However, due to BNM reviewing curbs on overall household lending to cool the property market as well as to reduce financial risk to the banking sector, sales at new launches were relatively slow over the last couple of quarters. Nevertheless, more scheduled launches are expected in the last quarter of the year. In addition, the rumours that the government might increase the RPGT and stamp duty may further dampen sentiment in the short term. Developers and buyers are both likely to adopt a wait-and-see attitude until the situation becomes more certain. Retail No completions in the quarter No new retail malls were completed in Q3. Going forward, approximately 4.5 million sq ft of retail space in both the city and suburban areas are expected to be completed between Q and 2017 (Figure 5). This is expected to exert supply-side pressure on the vacancy rates of retail outlets. Some malls are undergoing extensions, with Sunway Putra Place expected to be completed in Q4, followed by Glomac Damansara, Pavilion and KLCC (Table 1). Figure 5 Retail new supply (NLA) in Kuala Lumpur, sq ft (million) Malaysians to moderate spending Inflationary pressures have already been felt following the fuel hike and the abolition of sugar subsidies in This pressure has increased in the second half of 2014 pending further subsidy rationalization. Nevertheless, consumer spending should remain relatively resilient, with some moderation due to the anticipation of stronger inflationary pressures in the economy plus the soon-to-be implemented GST. While the GST is expected to exert additional pressure on households, it could also bring forward their consumption or profiteering activities in order to avoid the 6% tax payment. The implementation of the GST in April 2015 is expected to have a short term impact on retailers in the country. As the purchasing power of the middle to lower-income groups will be affected, this could follow through to impact retail sales. Retailers have also been struggling to cope with increases in other input costs, such as electricity and labour, over the past two years. In addition, online shopping is gaining Table 1 Selected upcoming retail malls in Klang Valley Name of Development Sunway Putra Place (expansion) Glomac Damansara Pavilion (extension) KLCC (expansion) Est area (NLA, sq ft) 620, , , ,000 Est year of completion momentum in Malaysia, especially amongst the urban middle class. More convenience stores and smaller shops to be opened Notwithstanding the expected moderation of consumer spending and retailer demand due to the implementation of the GST, convenience stores and smaller shops are expanding in Malaysia. 7-Eleven has

5 announced its plan to add 600 outlets between 2014 and 2016, while new entrant Circle K plans to open an additional 500 outlets by Tesco Stores (M) Sdn Bhd is also likely to open its first convenience store (C-store) by the end of 2014 in partnership with Lembaga Tabung Angkatan Tentera (LTAT), to tap on opportunities for the smaller store format. Office Bulk of new supply in decentralized commercial areas While only two office buildings were completed in the first half of 2014, in Q3 alone, four separate office buildings were completed. This translated to slightly over 2.0 million sq ft of office space. The bulk of these developments were in the decentralized commercial areas, while only one office building, Menara Hap Seng on Jalan P. Ramlee (300,000 sq ft), was in the Golden Triangle area. Newly completed office buildings in decentralized areas in Q3 included Bank Rakyat Twin Towers (980,000 sq ft) and NU Towers (450,000 sq ft) along Jalan Stesen Sentral as well as Sentral Vista (256,000 sq ft) in Brickfields. With the addition of this new supply, office stock increased by 3.0% q-o-q to 72.1 million sq ft in Q3. Between Q and 2018, approximately 14.7 million sq ft of office space is scheduled for completion (Figure 6). In Q4 alone, supply in the decentralized areas will be highest with over 1.0 million sq ft of office space expected to be completed from the Q Sentral project. In addition, another 5.7 million of office space is expected to be completed in This large supply is thus expected to exert downward pressure on occupancy and rents. Figure 6 Office development pipeline, sq ft (million) Figure 7 Prime office rental index (Q = 100) Rents fell while capital values held up in Q3 Average office rents in the prime locations of Kuala Lumpur were stable for the sixth consecutive quarter, i.e. between Q to Q1 2014, at RM6.13 per sq ft per month but registered a marginal increase in Q to RM6.15 per sq ft per month. However, average office rents in Q3 declined to RM5.98 per sq ft per month, the lowest in the past four years (Figure 7). Landlords are more flexible on rents in order to retain tenants in the face of availability of more competing options. On the other hand, after an increase in Q2, average capital values held flat in Q3 at RM850 per sq ft. Capital values for prime office buildings ranged from RM680 to RM1,000 per sq ft in Q3. Although net absorption improved from negative 164,100 sq ft in Q2 to approximately 797,900 sq ft in Q3, overall occupancy declined to 83% (Figure 8). The occupancy rate is likely to decline further due to the mounting new supply in coming years.

6 Tenant-favoured market going forward Of late, a trend of companies moving to office space in integrated developments with retail outlets or hotels has become more pronounced. Not only do these integrated developments provide more car parking lots, but their accessibility as well as green mark certifications (such as Multimedia Super Corridor (MSC) and Green Certified) have helped increase their appeal. In spite of the demand for such office space integrated with other amenities, as office supply outstripped demand, there are a variety of options for tenants. Thus going forward, it is expected to be a more favourable market for tenants. Figure 8 Office net absorption, sq ft (million) and vacancy rate

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