Making sense of retail and industrial property segments

By Khairie Hisyam

In our fourth piece on the property industry, we look at the retail and industrial property segments, which have been overshadowed by vocal concerns about the residential and office space markets. Given a potential retail space oversupply in the Klang Valley, we ask if we should be concerned as we compare the decreasing annual take-up rate against incoming supply. We also investigate why the industrial property segment slowed down last year despite a strong uptrend over the past few years.

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With the spotlight firmly on affordable housing concerns and the oversupply in the Klang Valley office market, there has naturally been less attention on other segments of the property industry.

Of the 427,520 property transactions worth RM142.84 billion recorded by the National Property Information Centre (Napic) in 2012, the residential segment dominated by far with 63.8% of the market share. In comparison, commercial (shoplots, office space and retail) and industrial sub-sectors comprise only 9.6% and 2.3% respectively of the market share.

In 2012, both commercial and industrial sub-sectors softened by -5.9% and -4.7% respectively against growth of 9.7% and 6.5% in 2011, according to Napic’s Property Market Report 2012.

While comprising less than 10% of the market share last year, the commercial sub-sector is actually the third most active in terms of transaction volume and second in terms of value, with 41,082 transactions worth RM27.79 billion in 2012.

The bulk of the commercial sub-sector is made up of shops. With 22,389 transactions, shops made up 54.5% of commercial sub-sector volume in 2012 and 49.2% of the value with RM13.67 billion in transactions. However, these actually decreased by 10.4% and 0.7% respectively from 2011 as a result of softening market activity.

Among the three components of the commercial sub-sector, however, purpose-built offices (PBO) remained resilient with an equal number of transactions compared to 2011 yet with higher total value — rising from RM1.14 billion in 2011 to RM1.31 billion in 2012. However, national occupancy rates declined slightly from 83.2% in 2011 to 82.3% as more new spaces entered the market, which also led to a 60.2% drop in annual take-up rate from 6.05 million sq ft in 2011 to 2.41 million sq ft in 2012.

The third component is retail space — in other words, shopping malls. While annual take-up for this segment remained in positive figures, it dropped by 44.4% in 2012 to 3.68 million sq ft compared to 6.61 million sq ft in 2011. Consequently, the national occupancy rate dropped slightly from 79.5% in 2011 to 79.1% last year. With 13.78 million sq ft in incoming supply as at 2012, are we seeing tell-tale signs of a potential oversupply?

On the other hand, the industrial sub-sector appears less exciting. Indeed, not only does it account for 2.3% of market activity but also for a mere 8.4% in value, making it the least active market. Of 9,984 transactions worth RM12 billion — compared to 10,479 deals worth RM11.54 billion in 2011 — 30.8% were in Selangor while Johor contributed another 13%.

However, while national overhang volume for industrial properties continued decreasing in 2012, the cumulative overhang value for Selangor and Johor grew by more than 20% each. This contrasts with previous reports that demand is outstripping supply in certain key areas given that the manufacturing sector is a major contributor to our economy with a 27.5% share of our gross domestic product (GDP), up from 24.6% in 2010, while using about 30% of our total workforce.

Too much retail space?

In the first quarter of this year, the Malaysian Consumer Sentiments Index (CSI) rose for a fifth consecutive quarter to hit a six-year high of 122.9. Real estate consultants Knight Frank Malaysia, in its 1st Half 2013 Real Estate Highlights report, noted that this bodes well for the local retail market given the optimism over employment and financial outlook as well as inflationary expectations.

However, latest information published this morning by the Malaysian Institute of Economic Research (MIER) showed that the CSI dropped by 13.2 points quarter-on-quarter (q-o-q) in 2Q13.

The apparent decline in optimism appears to be tied to the 13th general election, which saw intense campaigning that led to increased optimism earlier this year. “But it seems like this optimism could not be maintained after the election,” Nielsen Malaysia country manager Richard Hall was quoted as saying this week, adding that uncertainty over the global economic recovery is also a factor.

In that context, incoming supply into the retail space segment totalled 13.78 million sq ft as at 2012. Of that figure, 28.4% of the incoming supply is in Kuala Lumpur with 3.91 million sq ft. The supply amount contrasts starkly with the big drop in annual take-up rate last year from 6.61 million sq ft in 2011 to 3.68 million sq ft.

The question, then, is whether we are seeing a situation where supply is outstripping demand akin to what has happened to the Klang Valley office space market.

‘Retail oversupply in some areas’

Of particular concern is the Klang Valley retail space segment, given that Selangor and Kuala Lumpur are both the biggest and second biggest provider of retail space with a collective 43.9% of Malaysia’s total retail space. Indeed, there were concerns in early 2012 that an oversupply situation may be developing.

“There is an oversupply (of net lettable area — NLA) in terms of total square feet as we now have 7.1 sq ft of mall space per person in the Klang Valley, which is the same as in Singapore and higher than in Bangkok [6.5],” CB Richard Ellis Malaysia managing director Allan Soo was quoted as saying in January 2012. “There is no ideal although we feel that it should be nearer 5.5 sq ft per person.”

As at 2Q13, Knight Frank Malaysia noted that cumulative supply of retail space in the Klang Valley remained at around 44 million sq ft. With an estimated 6.1 million people inhabiting Klang Valley according to the 2010 census, that translates into 7.2 sq ft of mall space per person — higher than almost a year and a half ago.

Is the increased figure a cause for concern?

“That figure can be flexible in the sense that it is dependent on the spending habits of the catchment area,” commented Professor Dr Ting Kien Hwa, head of the Centre for Real Estate Research (CORE), Universiti Teknologi Mara (UiTM).

According to Dr Ting, the type of population in any particular catchment area also needs to be looked at in terms of their spending habits. If a population generally has higher spending power, they can then support a higher NLA per person with their spending habits, he adds.

However, the professor acknowledges that there may be an oversupply in some areas where malls compete for the same population catchment. He points to the stretch along the Damansara–Puchong Highway (LDP towards Sunway Pyramid) where there are numerous malls within a relatively small location.

“Their catchment areas are overlapping with each other. In other words, they’re competing for the same customers with the same type of shopping centres,” explained Dr Ting. “So if you look at it in terms of catchment, obviously there is an oversupply (in certain areas).”

Looking beyond the Klang Valley in a national context however, Napic statistics indicate that as at 2Q13, the occupancy rate for shopping complexes across Malaysia averages at 79.7%, translating into 26.3 million sq ft in vacant existing stock. Additionally, incoming supply and under-construction stock collectively amount to 26.7 million sq ft.

Is this a cause for concern given that the 2012 annual take-up rate stood at a mere 3.68 million sq ft compared to 6.61 millions sq ft in 2011?

Dr Ting of UiTM notes that the fact that some of the existing stock is older must be kept in mind. Malls that are already not doing very well would continue to see low vacancy rates.

“If they are weak, maybe it is because of location or poor design — we already have a whole generation of (older) shopping centres like Kota Raya and those along Jalan Tunku Abdul Rahman,” said Ting. “They are also retail, but of an older generation hence vacancy remains low.”

Therefore, the reality is that some will thrive and some will be closing down eventually, he added. “If they cannot compete for various reasons, they’ll close down and wait for redevelopment.”

“Or maybe the building would eventually be adapted for other uses,” added the professor. “There is one example in Jalan Pahang where there used to be a shopping centre in the area but now there is a Buddhist temple instead.”

Industrial property segment to pick up post-GE13?

If previous reports over the past year are any indication, the industrial property segment is seeing an undersupply situation in certain key areas.  Consequently, over the past four to five years industrial property prices have reportedly shot up.

However, Napic’s Property Market Report 2012 showed that the segment softened by -4.7% last year after growing 6.5% in 2011. Additionally, while the national overhang volume for industrial properties decreased by -1.3%  in 2012 against 2011, the overhang volume in Selangor and Johor grew by 25.2% and 22% respectively. (Napic defines overhang as units completed and available in the market but not sold within nine months of completion.)

The question, naturally, is why the market softened despite strong growth in preceding years.

It appears that jitters over the then-looming GE13 had a hand in slowing down the market. “From 2012 to the first half of 2013, the industrial property market had softened due to the ‘wait and see’ attitude and people holding back on their investments pending the general election,” said VPC Alliance (Malaysia) Sdn Bhd managing director James Wong, adding that reduced foreign direct investment in manufacturing for 2012 — RM13.1 billion compared to RM16.7 billion in 2011 — is also a factor.

Additionally, decreasing supply also softened the market, said See Kok Loong,  director of real estate and property agency Metro Homes. He explained that in the past, townships would incorporate an industrial component alongside residential and commercial whereas now many avoid building industrial structures in the area for better living quality.

“Another reason for the softening in 2012 is also because manufacturing activities are past their prime in Malaysia due to the lack of cheap labour and being too dependent on foreign labour,” said See. “Furthermore, business is now more global and buyers can always do global sourcing; most manufacturers have turned into trading firms instead of producing (their own) products.”

As an example, See notes that a shoe factory owner in Seri Kembangan confided to him that it is cheaper to source for supply in China as it is cheaper than producing locally. “So acting as a trading firm is better (in that sense).”

See added that as for the new 3-in-1 or 4-in-1 factories, small and medium enterprises (SMEs) would need time adjust to and absorb them before the next generation of demand comes in.

That appears to explain the increased overhang in Selangor and Johor, considered the main hotspots for the segment in the country. Now that the elections are behind us though, does that mean business will return to what it was before the GE13 nervousness kicked in?

Wong feels the outlook for 2H2013 will be better.

“After the general election, the industrial property market is in recovery mode. The first quarter for the industrial property market was quiet,” said VPC’s Wong. “After the general election, industrial sales have picked up and a few notable transactions of industrial properties appeared in Bursa Malaysia Announcements.”

“We foresee a continuing trend of existing REIT players acquiring more industrial and logistics assets to expand their portfolios. Upcoming REIT players are expected to boost industrial properties,” elaborated Wong. “Tiong Nam Logistics Holdings plans to launch a real estate investment trust with an asset value of around RM1 billion which it will float in the second half of 2013. There are also more companies accumulating industrial properties with good long term tenancies as industrial properties as an investment asset commands a higher yield compared to other investment properties.”

See of Metro Homes shares the sentiment, saying that with GE13 concluded, businessmen can gauge the political situation for the next five years and therefore go back into investment.

“The challenges are that we need good government policies to support the manufacturing base and also move toward high-value manufacturing as we no longer a low-cost producer,” said See.

Wong elaborates further on the challenges for this sector despite positive outlook here onwards, noting among others inadequate skilled and unskilled labour as well as decreasing foreign direct investment as hurdles.

“Based on Bureau of Labour and Employment Statistics Report for June 2012, Malaysia recorded the second highest wages among the Asean countries with minimum wages of USD20/day in Malaysia, whilst minimum wages in Philippines is USD10/day, Thailand is USD9/day, Indonesia is USD5/day, Vietnam is USD3/day and Cambodia is USD2/day,” explained Wong of VPC. “Also, industrial prices are cheaper in the neighbouring ASEAN Countries such as Indonesia, Thailand, Vietnam and Cambodia.”

As for See, he feels that the second half of 2013 would remain challenging for the industrial property segment. “This is especially because prices have gone up significantly in certain mature areas like Balakong, Kota Damansara, Serdang etc.”

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Yesterday: Drowning in office space?

Tomorrow: Prescriptions for the property industry