Land market – Bid to win, or bid to try your luck?

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Bid to win, or bid to try your luck…

Developers often enter into land bids with different strategies. They may aggressively “bid to win”, especially when their landbank has been depleted. Other times, they may choose to bid low, just to try their luck, hoping that no one else bids above them. Very often, these strategies will lead to different outcomes for their profit margins.

Key summary:

  • Land is the most basic and important ingredient in a development project. In Asia, as land that is zoned for property development becomes more scarce, we see developers competing more and more aggressively for them, hence driving up land prices.
  • Given its relatively transparent and public data-rich land bidding system, we have chosen the Singapore land market as a case study to analyse and understand developers’ behaviours when they bid for land.
  • Our model (between 2007-2016) suggests that since 2016, developers operating in Singapore have been finding it hard to win land parcels, due to greater competition for land. Combined with the pressing need to replenish their depleting landbank, many developers strategized to go all out to win in their land bids.
  • These aggressive bids have led to higher land costs and lower profit margins for developers, especially in an environment of falling home prices. We estimate net margins fell to ~15% in 2015, down from 22-36% in 2009-12. We expect them to continue lowering to single digits in 2016-17E.
  • Even in the face of potential margin squeeze, many developers are still jumping in to bid for land, as they seek to fulfil “non-economic” or “non-profit driven” strategies such as the need to restock, deploy cash, gain market share, or protect the value of a nearby land which they previously acquired.

 

Always in search of land

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Mankind has always been in search of land

Developers are always in search of land to build new property projects. Land is the most basic and important ingredient in a development project. In Asia, as land that is zoned for property development becomes more scarce, we see developers competing more and more aggressively for them, hence driving up land prices.

Land is relatively more expensive in land-starved cities such as Singapore, Hong Kong and Tier-one cities in China such as Shanghai and Beijing, where they could easily account for 50-60% of total development cost. On the other hand, it is relatively less expensive in city outskirts, e.g. Greater Jakarta, Greater Kuala Lumpur, and Tier-2/3 cities in China, where land could account for only 20-30% of total development cost.

Using the Singapore land market as a case study

Given its transparent and public data-rich land bidding system, we have chosen to use the Singapore land market as a case study to analyse and understand developers’ behaviours when they bid for land.

In our case study, we used 200 winning land bids in the Singapore Government Land Sales (“GLS”) program, from 2007 to 2016.

To analyse developers’ bidding behaviours, we made use of the expected profit margin of each winning bid.

A low expected profit margin of a winning bid implies that the winning bidder is aggressive, because he is willing to win the land despite knowing he may achieve a low profit margin. Either that, or he may be bullish on the market outlook, and expects some form of home price increase during his project launch, thereby protecting his actual margins.

Conversely, a high expected profit margin of a winning bid implies that the winning bidder is cautious, because he is only willing to bid for the land with a high “margin buffer” (as we coin it), to protect itself against the risk of home price drop in future.

How do we calculate the expected profit margin in our model?

The expected profit margin is essentially the difference between the expected launch home prices of the project to be built on this land, which is what the winning bidder expects to sell his units at, and the expected breakeven cost, which is made up of the land cost, construction cost and miscellaneous cost (e.g. stamp duties, professional, financing and marketing expenses related to the project).

To illustrate, we use the recent example of Margaret Drive site (near Singapore’s city centre), which was won by and awarded to MCL Land on 12 Dec 2016.

For land cost, we use the announced winning bid, which was a high $998 psf. We then estimate construction cost at $350 psf*, and miscellaneous cost at $195 psf . Adding them up gives us the breakeven cost of $1,543 psf.

With launch home prices estimated at $1,650 psf (with reference from nearby recent launch prices), we arrived at an expected profit margin of 6.5% (which is low), reflecting aggressive bidding, in our view.

*As a note, our model assumptions for construction costs for Executive Condos are SGD250-300 psf, mass market/ mid-end SGD300-400 psf and high-end at above SGD400 psf.

Declining profit margin trends

From a broader picture, our model shows that the profit margin trends of residential development projects in Singapore have declined considerably, since 2013.

From 2009 to 2012, developers had enjoyed average high profit margins of 22-36%.

However, from 2013 onwards, the profit margins have narrowed to 12-15%, reflecting resilient land cost, and the inability to pass on such cost to end-home buyers, given falling home prices.

Profit margins may not be the only consideration  

Yet, even in the face of potential margin squeeze, many developers are still jumping in to bid for land. We believe they are seeking to fulfil “non-economic” or “non-profit driven” strategies such as the need to restock, deploy cash, gain market share, or protect the value of a nearby land which they previously acquired.

We note that since 2016, the developers’ need to restock landbank has become more acute.

One main reason is that many of them have depleted their landbank, especially post their numerous project launches during peak market periods of 2010-2015.

The other reason is that, since 2014, the authorities had stepped in to cut back land supply, sparkling concerns of insufficient land for development.

With limited new land to buy from, the developers’ business momentum would be affected. Either they have to “bid to win” to regain their momentum, or make the strategy to expand in overseas markets to seek new land to grow.

 

Chart 1: Less land released for development – The Singapore authorities cut back land supply since 2014, leading to greater competition for land at above market land prices

chart1

Source: URA, HDB, DimSum Property

Chart 2: More bidders – Average number of bidders has increased to 11.5 for each Singapore GLS site in 2016, reflecting greater competition for land.

chart3

Source: URA, HDB, Dim Sum Property; NB: Sample size consists of pure residential land sites from the GLS program (and excludes landed land sites, and mixed-development land sites from the program)

Chart 3: Margin squeeze in Singapore – Developers’ average profit margins have declined from 22-36% in 2009-2012 to 12-15% in 2013-15. The downtrend may persist in 2016-17.

average-net-margins

Source: URA, HDB, Dim Sum Property

 

Chart 4: Developers in Singapore have turned more aggressive in their land bids since 2016, as reflected in the low expected profit margin “buffer” (towards -1 STD or 6.4%). Reversely, a high expected profit margin “buffer” means the bids are turning more cautious, e.g. in 2011 and 2014

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Source: URA, HDB, Straits Times, Business Times, Dim Sum Property

Chart 5: Recent winning bids in the Singapore GLS program, and their margin buffers (mostly towards 6.4%, which is -1 STD to mean, reflecting aggressive bids)

table-5

Source: URA, HDB, Dim Sum Property

Disclaimer: The data in our “margin buffer” model represents a simplistic set of assumptions that help us proximate to how developers think and act when they bid for land. In our model, our sample size of 200 winning bids is based on non-landed private residential sites from the GLS programme. We have excluded mixed-development sites and white sites from the GLS programme, as well as en-bloc in the private resale market. In addition, there was a lack of data in 2009 because the GLS programme was partly suspended due to the severity of the Lehman crisis.

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