TRX a boon for 1MDB but a bane for property owners

THE EDGE WEEKLY ISSUE#1002

THE WEEK OF FEBRUARY 17 – 23, 2014

By: CHARLES YONG

Notwithstanding the challenging financials of its power plants investment, 1Malaysia Development Bhd (IMDB) looks set to book yet another huge gain from its flagship Tun Razak Exchange (TRX) development.

The 70 acres of prime land in Jalan Tun Razak, which was bought cheaply from the government and re-valued several times to produce what some call “paper profits”, may again be re-valued to beef up the sovereign wealth fund’s debt-laden accounts.

One of the most sizeable developments to take shape in modern KL, TRX nestles in the central business district, less than 10 minutes’ deive from the Petronas Twin Towers.  Tracts in the vicinity have recently sold for as high as RM3,325 psf.

Eager for similar returns, 1MDB priced its TRX land at RM3,000 to RM3,500 psf in its recent call for tenders for the initial portion of the land, says Foo Gee Jen, managing director of C H Williams Talhar & Wong (WTW), one of two real estate advisers marketing the initial phase of the project.

The price for a specific plot depends on factors such as size and plot ratio.

“The average size (for the TRX land tendered out) is 1.25 to 1.5 acres, and the plot ratio range from six to 10.5,” Foo tells The Edge.

According to him, the net developable area for the entire 70 acres in TRX is between 50% and 65%.

Thus, based on the current land price of RM3,000 to RM3,500 psf, a back-of-the-envelope calculation yields an indicative market value for the saleable portion of the TRX land at between RM4.57 billion and 6.94 billion.

This is RM2.79 billion (157%) to RM5.16 billion (290%) higher than the RM1.78 billion recorded in 1MDB’s books as at March 31, 2012.

These estimates are likely to undershoot the value that TRX could eventually rise to.

Barring a major softening in the property market, prices are bound to increase further for future stages of development.  Bear in mind that the TRX has a development period of 15 to 20 years, and the call for joint venture partners and buyers last December is only for the first stage, comprising a total of six acres.

Stage 1 consists of four plots of land (out of 34 plots), says Foo.

This initial phase includes four office towers (including a signature tower), up to five residential towers, up to two five-star hotels, and a retail mall.  The whole district has an indicative (GDV) of RM26 billion.

1MDB has said that it plans to continue holding equity interests through joint ventures for the majority of TRX’s developments.  This means even higher profits in the long run.

Such a significant revaluation may prove a boon to the company, which has been engulfed in debt and controversy.  As at March 31, 2012, 1MDB had RM8.38 billion in liabilities.  But the gearing ratio is much higher today as it has racked up at least RM22.69 billion in new debt since 2012 to finance its power business and other investments.

Power is not the only contentious investment made by 1MDB.  To generate income, the sovereign wealth fund lent US$1.5 billion of its own borrowings to PetroSaudi International Ltd, a privately owned oil company, through two bullet bonds expiring in 2015 and 2021 with interest rates northwards of 8% (see timeline).

The “profit rate” from these Islamic instruments provided RM331.58 million of its RM938.42 million income in 2011.  TRX’s revaluation made up the rest.

Opposition leaders claim that 1MDB has provided few details on the investment and on PetroSaudi, and that the loans put public money at risk.

1MDB has re-valued TRX at least twice.  It bought the 70 acres from the government for a mere RM320 million (RM105 psf), according to media reports.  In 2011, it re-valued the land to add RM826.6 millin to its income and rescue itself from the red.

By 2012, the land was re-valued again, to RM1.78 billion.  Under conventional practice, says an accountant, it is unusual for developers to re-value their land held for development regularly.  It is also uncommon for them to record the gains in their income statement.

At such high prices for TRX’s land, the question is, will there be enough buyers?  After all, only two recent transactions have reached such record prices: Singapore’s Oxley Holdings’ purchase of a 3.1-acre parcel in Jalan Ampang last November at RM3,325 psf and KSK Group Bhd’s acquisition of a 3.95-acre tract near Jalan Conlay last December at RM3,299 psf.

However, Foo says that demand has been “very encouraging” and that there are reasons to expect TRX to attract buyers.

Oxley acquired the Jalan Ampang plot before securing the approvals for development.  The TRX plots, on the other hand, come not only with approvals, but with wide-ranging incentives such as tax breaks, allowances, cost deductions and stamp duty exemptions.

These include a 50% deduction on rental payments for 10 years, further deduction on relocation costs, an industrial building allowance worth 10% of qualifying building expenditure, and an exemption of 70% of statutory income derived from the disposal of buildings and from five years of rental.

Foo adds that TRX is also attractive because it is an integrated development rather than a standalone one.  “And the price is also on a net basis.  This means that developers do not have to allocate any portion of the land they paid for to infrastructure.”  He estimates that the Oxley land, on the other hand, has a land loss of (15-20 %).

Because of these special incentives and treatment for TRX, local developers have voiced concerns that the state-backed megaproject would sponge off demand for offices from surrounding area.

“The whole thing is totally unfair because incentives are normally given to attract investors to green field developments that are away from established regions, like in Iskandar, but TRX is right in the KL city centre next to established business districts,” says one property developer.  “It is not right that 1MDB should enjoy this special treatment even if it is government-owned.”

Observers say that TRX is a clear example of the government crimping the private sector, a move which is contrary to its goal of letting the private sector drive the economy.

Bandar Malaysia, the other property project in 1MDB’s pipeline, also seems promising.  It has a GDV of RM20 billion and sits on 495 acres of the current military airport in Sungai Besi.

It was reported that 1MDB has acquired the site from the government for about RM1 billion, translating into RM46.40 psf.

However, 1MDB is also bearing the cost of relocating the military airport for RM2.1 billion, which indicates that the total cost for the 495 acres is RM3.1 billion.  The development of Bandar Malaysia may take some time though, at least until after the current military airport is relocated.

Given the cheap land cost and their strategic locations, observers say TRX and Bandar Malaysia will be the real money spinner for 1MDB, compared to its debt-laden power assets investments that give little room for manoeuvring.

It is, therefore, hard not to view TRX and Bandar Malaysia, which were given to 1MDB on a silver platter, as anything but a backstop for its blunders elsewhere.

However, the collateral damage to the rest of the property sector of (KL) could be heavy.