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Web-only Exclusives
November 30, 2000

From Our Correspondent: Hirohito and the War
A conversation with biographer Herbert Bix

From Our Correspondent: A Rough Road Ahead
Bad news for the Philippines - and some others

From Our Correspondent: Making Enemies
Indonesia needs friends. So why is it picking fights?

Asiaweek Time Asia Now Asiaweek story

SEPTEMBER 24, 1999 VOL. 25 NO. 38

Property Poker
Malaysia is playing for high stakes as it looks for solutions to a massive real-estate glut
By ARJUNA RANAWANA Kuala Lumpur

    ALSO IN ASIAWEEK
Putting on the Kid Gloves
Hyundai is no Daewoo, which is probably why Seoul is giving it a break

A Few Kind Words
Some things the chaebol did right

Petroleum Power
Will rising crude-oil prices halt Asia's turnaround?

Property Poker
Malaysia is playing for high stakes as it looks for solutions to a massive real-estate glut

'We Have Too Many Banks'
The Philippines' new central banker looks ahead

As Prime Minister Mahathir Mohamad beamed, fireworks poured down from the top of the world's tallest building. Lasers emblazoned the Malaysian flag draped around the glass-and-steel structure. The sounds of an orchestra filled the air. It was August 31, the 42nd anniversary of Malaysian Independence -- and the formal opening of the Petronas Twin Towers. Cash-rich state oil company Petronas already occupies all 88 floors of one wing. The other 88-story tower is nearly half empty. Meanwhile, a few kilometers away, another showcase project, the $184-million Vision City started in 1995, stands forlorn. The development has been scaled down, but the structures remain unfinished.

So, what's to celebrate? Plenty. After five quarters of negative growth, Malaysia has declared itself out of recession as GDP expanded 4.1% in the April-to-June period. Mahathir's maverick currency controls seem to be working -- the International Monetary Fund now says they may have been the right medicine for the country after all. Industrial production and exports are up, foreign reserves are a comfortable $31.3 billion, the current account is $9.2 billion in the black. But -- and there is always a but: The recovery may unravel because of a huge property overhang. Some 11 million square feet of Kuala Lumpur office space -- 23.6% of the total -- are currently vacant. Eight new buildings (including two at Vision City) will add 2.6 million square feet of new space by the end of 2001.

It is the same story for retail space and hotels (residential property is the sole bright spot -- more on this later). The ongoing recovery may help attract more tenants and buyers, but the overbuilding has been so massive that demand is not likely to catch up with supply for years. By December, for example, Kuala Lumpur and the rest of Klang Valley will have 84 shopping centers with 24.6 million square feet of space. "This gives a ratio of over five square feet of shopping space for every individual in the Klang Valley area," says Allen Soo of Kuala Lumpur property consultants Regroup. Before the Asian Crisis, shopping centers made money when the ratio was about two-and-a-half square feet per capita.

The problem is that developers borrowed big to build their projects. If their properties are not making money, they cannot service their loans, which account for 25% of the financial system's total lending. The real exposure to property of the banks may even be higher, if you count the large number of industrial, mining and service firms that borrowed to build their headquarters (those loans are classified under manufacturing or mining to get around central-bank restrictions on property lending). If those loans go bad, there goes the financial system -- and the fledgling recovery.

Analysts wonder how long the government can hold up this house of cards. Danaharta, the state asset-management company that is cleaning up the banking system by buying its non-performing loans, has acquired $10.3 billion worth of shaky bank assets. About $4.6 billion are classified as property loans -- that's 18% of total property lending (not counting borrowings of the construction sector and loans to build corporate headquarters). The crunch will come when Danaharta forecloses on the collateral assets and sells them before the end of the year, as it promises. Developers may find their properties valued far lower than what they borrowed to pay for them, if Danaharta is forced to unload the assets at steep discounts.

That's possible. Because of the glut, office rentals have plummeted. Prime space in the Golden Triangle business and commercial district can be rented for less than $1 per square foot -- from around $1.30 in early 1998 and $1.80 before the Crisis. Outside the city center, new offices can go for as little as $0.40 per square foot. Prime retail rentals are also down to $2.50 per square foot, from the peak of $12 in 1997. Hotels are badly hit too. Kuala Lumpur's plush Ritz Carlton has cut prices to $58 a night, including taxes -- anywhere else, guests would pay three times that. Still, the Ritz barely manages to keep half its 248 rooms occupied. Across Malaysia, hotel occupancy has dropped to 55%, down nearly a tenth from already worrying numbers in 1998. At least three new five-star hotels are nearing completion in Kuala Lumpur.

Who will buy foreclosed assets at or close to book value? Don't count on foreigners. Mahathir has vowed that he will not permit a "recolonization" of the country. Danaharta says foreigners can put in bids, provided the 30%-ceiling on foreign ownership of property is respected. Some investors are nibbling. Sources say Pyramid Mall at the Sunway Lagoon Resort outside Kuala Lumpur may be sold to a Singaporean-led consortium by the end of this month. It will be the first big sale since late last year, when the Marriott Hotel, upmarket shopping mall Star Hill Center and Lot10 Mall were sold at a 60% discount as part of a debt-restructuring agreement. Also sold to local investors at a knock-down price: the Pernas International building.

Nicholas Tan of Merrill Lynch associate brokerage Smith-Zain expects more private-sector deals. "Because the recovery is more certain now, venture capital is asking for lower hurdles," he says. "At the same time, the possibility of earnings via rents is getting better. When the expectation gap between these two narrows, more deals will be made." Currency controls -- the ringgit is pegged at 3.80 to the dollar and is no longer legal tender abroad -- are also helping. Malaysians cannot use the local currency to buy overseas assets. "The money is there and has to find a home," says Tan. Most investors are turning to residential property, especially houses under $40,000. The government reports a 1.5% increase in home sales in the first quarter of 1999.

What will help even more is a halt in new construction. Despite the recession and a central-bank lending ban on commercial property, many projects are continuing. Some, like Vision City (named after Mahathir's Vision 2020 program to turn Malaysia into a developed nation by 2020), is too advanced to be completely scrapped. The owners, Malaysia's well-connected Rashid Hussein Group and South Korea's troubled Daewoo, have already scaled back as much as they can -- only three, instead of four, office towers will be built. (One nearly completed building has been sold for an undisclosed price to local group Industrial Bank.) Work has slowed on the 780,000-square-feet shopping mall while the construction of a luxury condominium has been put on hold.

Mahathir's pet project Putrajaya, the new administrative city 40 kilometers south of Kuala Lumpur, is going full blast. The prime minister has already moved his office and official residence there. Other government workers will transfer in the next three years or so, leaving more vacant buildings in Kuala Lumpur. The empty government premises will be turned over to state-owned Putrajaya Corp., which is expected to lease the properties to private tenants. Marketing old buildings is a tough sell, even in a recovering economy. Witness the mostly empty Menara Dayabumi, the graceful headquarters in central Kuala Lumpur Petronas has vacated.

A shakeout seems inevitable, which is what happened during the last property downturn in 1987. That period of cleansing and knock-down sales laid the groundwork for a boom several years later. Except that developers (and the government, with its prestige projects) then went overboard and gorged on easy credit as the good times rolled on and on. Malaysia has managed to put off the day of reckoning while it focuses on cleaning up the banks. But Danaharta cannot warehouse its acquired property assets for too long -- it must sell them so fresh capital can be injected into the banks that previously owned the non-performing loans. When the property crash comes, Malaysians can only hope the banking system and the economy have been strengthened enough to withstand the shock.

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