SRI LANKA’S CONDO MARKET NEEDS POLICY FIXES

Condo developments transforming Colombo’s skyline have also given way to fears that the market is overheating. One of the major players in the sector weighs in on fears of a bubble and how to transform the city into a vibrant destination

Depending on who is commenting, the outlook for Sri Lanka’s condo market can be described as an opportunity, overheated or a bubble. Overall, investors trust the long-term benefits of real estate, however, few have been able to conclusively predict how the condominium market will perform.

As an asset class, condos have provided a safe heaven, with inflation-hedged returns, for almost a decade. Versus residential property, condos have been attractive due to their affordability and potential for rental returns.

However, the Central Bank’s assertion that it is closely watching leverage levels in the condo market has threatened the sector’s attractiveness as an investment asset class, adding to worries that have been building about overheating in real estate in general.

Anand Sundaram is the chief executive of Colombo City Centre, a Beira Lake-fronting development including a mall, residences and a hotel. A joint venture of Abans and Singapore’s SilverNeedle, Colombo City Centre (CCC), a $170 million investment, is due to open its mall in February 2018 and has sold 65% of available condos to-date. Sundaram contends that fears of a bubble are completely overblown. He, however, suggests many policy tweaks to make Colombo attractive for real estate investment and as a place to live.

There are issues and reasons for international investors to not come now, ranging from political and currency stability to other factors

Here are excerpts from the interview…

How are rental yields in Sri Lanka?
Demand outstrips supply today for rents, so investors are making a killing. Yields aren’t declining yet. This will change when the CCC and Altair are complete because the quality of these apartments is on the next level. There are 5,000 apartments slated in the city. In Beira Lake and Galle Face alone, there are 2,000 apartments. When all of those are available, it will possibly lead to lower demand. But, that tipping in is happing around 2021. By this time, the port city would have picked up, because their target is to complete the reclamation by 2019. By 2021, they will be getting the first building up. If that’s the case, a large number of people will have to be brought in by 2019.

I’ve heard remarks by the Central Bank governor about the condo market. I’ve tried to reason it from his point of view, but I’m unable to see it.

How much leverage is there in the sector?
There is not much leverage. At the new luxury developments, between 5% and 7% of condo purchases have a mortgage. At CCC, it’s 5%. So, hardly anybody is taking a loan to buy a condo. The developers are also big players. If they take a loan, it’s to reduce the cost of capital because equity is 22-24% versus debt at 12%, so it makes sense to take on some debt to reduce the cost of capital.

Very few economies have the potential to grow 6% a year. Sri Lanka is one, India is one, and then China and Indonesia. But sometimes, you are not able to see this potential because you are here. In three more years, you will see a completely transformed city because of the pace at which it is growing.

There are issues and reasons for international investors to not come now, ranging from political and currency stability to other factors. But, it’s not for the want of this economy not having promise.

Is there a bubble?
Look at the scenario that’s unfolding. The port city is expecting 20,000-30,000 foreign passport holders over the next 10 years. So there is a need for people to come from outside the country to live here for some time. There are other government initiatives to attract investment to large ventures, as well as to build SMEs, which will lead to a lot of job creation. That will create more demand for quality accommodation in the city. Most planned new developments will be completed between 2018 and 2022. I’m not sure how the far-flung condo developments are going to work. However, it’s unlikely that prices in the central business district (CDB) will collapse. This is the case anywhere in the world; the CDB always stays at the top.

The challenge will be for far-flung complexes that aren’t differentiated and positioned clearly. Why should someone live there considering the traffic? If people are going to work in the CDB and live somewhere else, is it worth a two-hour commute for a 15km journey?
Look around the country, see how many developments are happening; everyone is crying murder, but yet every day there is a new development. That should give you an insight into why people are investing. They are not being arm twisted into investing.

Can construction costs of condo projects be lowered to levels in India?
Tiles and ceramic bathroom fittings, and some components are on the negative list, meaning we cannot import these free of tax. But, these don’t affect the cost of construction by much.

India has a large manufacturing base, but in Sri Lanka, everything is imported. When you add freight, transport and intermediaries profit margins, it becomes that much more expensive. To reduce costs, more manufacturing has to be done here.

As a developing country, we can’t be paying costs you’d associate with a rich economy to build real estate.

For a build of this quality, one-third of the cost is structure, one-third for interior finishing and the remaining one-third is services. That’s a rough breakdown. Interior and services are 100% imported, and even for the structure, things like external glazing and hinges, the hardware is not manufactured here.

Services are essential; those are the nerves of the building. They are mainly heating, ventilation and air conditioning. There are fire-fighting systems, smoke detectors and sprinklers linked back to the building management system. Every room has a sprinkler. Of course, elevator access control systems and close-circuit cameras are also included. These have to be failsafe.

As a real estate developer, what would you wish was better organised?
The focus on small and medium-sized businesses and manufacturing automatically increase peoples’ wealth. It will generate investment and attract foreign know-how, create jobs, and lead to consumption spending.

In this economy, government spend is high and consumption is very low. Focusing on SMEs can change this.

The second is to incentivise foreign travellers to consume in the country. Like Singapore did 20 years ago, make it attractive for people to buy stuff here. We can do that also by granting VAT refunds. Globally, 20% of tourist spend is on shopping, and encouraging this will create so much more consumption and have its own trickle-down benefit.

There are 5,000 apartments slated in the city. When all of those are available, it will possibly lead to lower demand. But, that tipping in is happing around 2021.

What can the government fix to benefit the real estate sector?
We need to improve the last mile link from the airport to the city. The other improvement needed will be connectivity to other developments being built, like the port city, Cinnamon Life and Tata’s project in Colombo.

Right now, access to the peripheries is difficult. You can’t develop real estate in those areas. Access to infrastructure is critical for real estate success.

What can it do for the condo market?
There are some countries where you invest $200,000 and you can get permanent residency. We need to introduce such arrangements here and encourage people to buy a second home. That will help the real estate market boom and generate FDI.

Second, get the zoning right. Where do you meet friends, where do you find restaurants and where’s the activity? You can learn from Singapore. Those guys have done it brilliantly; there are lots of high-rises, but also lots of parks, walking paths and cycling tracks that encourage movement. The urban planning here has to be on a different level.

You need a political will and clarity of vision for the people to support that vision. It can be done here. There are lots of open pockets of land in this country and people inherently like green and large spaces, so it’s possible to create parks.

Any polices that need addressing?
Yes, the liberalisation of some existing tenants and customs. As a foreigner, I see that the entire city shuts down on Poya days. I understand that, traditionally, people worship on Poya days, but I don’t see that being reflected in reality today. Someone needs to take a stand. Yes, taking on a religious construct isn’t easy, but if it’s a democracy and if there is a larger mandate, it can be done.

Sri Lankans also love their drink. It’s not that they get dunk and fall all over the place, but it’s a lifestyle. Getting a liquor permit is not easy. Some arm of the government thinks that, if you give a permit, everyone will be drunk and on the streets. I don’t know the rationale behind that.

The city also shuts down by 8.30pm; why? Because of the problem of everyone having to travel long distances. Can we fix it? Can we put up a few housing colonies so that people don’t have to travel that distance, and make sure there are polices that support a longer entertainment time for people?

Life begins at 7.30pm in most other cities in the region. To be able to do that, restaurants, liquor licenses and the license to trade late are all required.

If we don’t change the city and peoples’ mindsets with progressive rules and regulations, the place will be dead again by 8.30pm. That does not bode well for a city aspiring to be a buzzing place.

Tell us a bit about the Abans and SilverNeedle partnership.
This is a 50:50 joint venture, and both investors want to complete this before moving to the next project.

Sixty-five percent of residential units are sold. We’ve signed up around 70% of the mall, but I want to sign around 85%.

To spice it up, we need to think of different directions. Brands are unwilling to enter the economy because of various laws that hold them back. For example, you can’t own real estate in a company unless there is a controlling local partner. This is limiting people from coming—maybe they don’t want to partner, but prefer to come on their own.

When I speak to retailers from India or Singapore, this is one of the problems they foresee. I was talking to a few Michelin star restaurants, very high-end ones, but they can’t enter.

CCC’s mall will open in February 2018. But, if we don’t get more brands into the country, then all future malls will look similar.

How is the mall coming along?
In a mall, the trade mix is carefully managed. You are clear that this shop is for this trade and at this price point, so it’s done carefully. We are currently only leasing space, as we can then control the customer experience.

If someone leases it from us, we would have to agree on the brand, the offering and the price point. We’ve got about 15 debut brands.

Once the mall starts operating, the price of the residential units will go up. It makes eminent business sense to wait until the mall is trading. A square foot starts at $320, and goes up to $450 for residential units.

What is the return on investment?
It’s early stages and we are on target. We are worried about the rupee slipping and its impact on costs, so are trying to take some steps. We will know it only once the project is completed.

Only some steel and cement are sourced here, while everything else is imported.

The best model is Singapore; they’ve done it brilliantly. REITs will funnel FDI into the county. The diaspora wants ties back to the country. If there are REITs, there is a high probability that they will invest.

What’s a good ROE?
It depends a lot on the business and the cost of funds. Someone borrowing dollars will do so at 4% or 6%. On the dollar, the risk-free return is very low. On top of that, there is a risk premium and a currency risk, too. So, when you keep adding it up, that’s where the problem is—it’s not the base expectation, it’s to do with the risk premium. If one goes wrong, I need a buffer, and the project completion time extends because everything in this country has to be imported. That’s when the ROE goes haywire. Mall leases are in rupees.

With retail, it’s less of an issue because the dollar has already been spent and consumption will happen largely in rupees.

Do you recommend real estate as an investment asset?
The returns have been phenomenal. I know people who have had 22% rental returns annually on their initial investments. If you leave out arbitrages, I think real estate will continue to deliver more than most other assets. In any developing economy, real estate is a good investment option.

If the government introduces real estate investment trusts (REITs), even a mall can be invested in by owning a share of the REIT.

We don’t need private equity in real estate, we just need the laws and norms to be ironed out. There are some issues on exits and holdings, which means the net yield is low in the hands of the REIT buyer.

When you buy a plot of land, you need to register it and there is stamp duty. That takes away from the profit. When the REIT issues a dividend, there is a tax that reduces profit. Those are things that need to ironing out. Differential treatment is justified. If you own a part of a building and sell it, should the buyer have to pay stamp duty? He should not have to because it’s like a share. You don’t pay stamp duty on share transactions.

The best model is Singapore; they’ve done it brilliantly. REITs will funnel FDI into the county. The diaspora wants ties back to the country. They are not going to invest in real estate because of maintenance and the hassle; but if there are REITs, there is a high probability that they will invest.