There has been
a debate lately about whether the real estate sector is going through a bubble
that will end in disaster (as advocated by some economists) or is growing
normally and responding to real demand (as advocated by developers). To answer
that we need to look at the bigger picture of the sector and assess the bubble
concern from a strategic standpoint, forecast how this issue will unfold and
identify how best to deal with it.
Looking at the
bigger picture of the sector, there are six key points that are worth
highlighting.
First, real
estate is a very important sector for the economy, where real
estate properties represent around a third to half of Egyptian families’ wealth
at middle and high income classes and even more than that for lower-income
classes. In addition, real estate companies publicly listed on the Egyptian
stock exchange have witnessed a double-digit growth in their revenues
supporting their market capitalizations. On a macro level, the real estate
sector has been growing at more than 20% lately and its overall contribution to
GDP has exceeded 10%.
Second, the
real estate market is not a single homogeneous sector across the country, where
geographically that market is split between first homes in Greater Cairo which
is dominated by large and mid-scale developers, second homes by the beach,
which has a wide mix of developers and other areas across Egypt which are
mainly developed by individuals. Most of the discussions about real estate
focus on the first and second categories while the rest of the market doesn’t
get enough coverage. Another way to look at the market is by segmenting it by
class, which applies mainly to first homes in Greater Cairo, where market can
be divided into luxury, upper middle, middle class, lower middle and social
housing. The first two categories are problematic now, while the remaining
three receive less attention though being quite healthy and profitable in most
of the areas.
Third, the real
estate upper-end market is going through a bubble, where the
increase in real estate prices for properties offered by developers in
upper-end projects is far higher than the rate of increase in costs. A survey
conducted by Aqarmap in 2017 shows that more than 40% of purchases are either
for investment or for children which is another form of investment. Increase in
real estate prices fueled by investment objectives and not real demand for
relocation or upgrade is the textbook definition of a bubble. The bubble is
further exacerbated by the severe devaluation of the pound where real estate
serves as a good store of value at times of devaluation historically, yet with
inflation rates higher than property price increases, the real return is
negative.
Fourth, symptoms
of the real estate bubble are crystal clear, where large-scale developers are
facing saturation in the upper-end segment primary sales which has always been
the bread and butter of said developers. As a result developers are forced to
focus on middle-income projects, offering smaller units to appeal to this
segment which still has a real demand. To appeal to the middle class and amid
slow primary sales, developers are offering extended payment terms exceeding 10
years in some cases with zero down payment, while buyers interested to sell
their already purchased units are facing a slowdown in the secondary market.
Fifth, real
estate bubbles are not new to Egypt. The market has witnessed a few ones before, though it never
crashed, with the worst being a multi-year slowdown in primary sales and a
freeze in secondary sales without decline in nominal prices of units. In this
case owners prefer to keep their units and not sell at a loss thanks to very
low leverage giving the market the room to absorb shocks.
Sixth, there
are new dynamics in the current real estate market. An example is
the significant increase in lands supplied by the government with the aim of
collecting as much funds as possible to shore up budget deficit. In addition,
the government and its related entities are venturing into a few large-scale
co-developments with private developers, significantly increasing the supply of
units on the market. With the pressure to pay the land cost in a short period,
developers are offering numerous projects simultaneously on the market and at a
quick pace to collect cash to pay land installments, especially at a time where
most mid- to small-scale developers are dependent on self-financing of their
projects through off-plan sales as bank financing has dried up for the sector
in general. From the buyers’ point of view, though outstanding mortgages are an
insignificant LE 8-9 billion in total, extended payment terms of more than 10
years reflect an increase in leverage in the market, which puts pressure on the
buyers, some of whom are buying for investment purposes.
When the bubble
does burst, recent market dynamics will make it more painful, resulting in a
freeze of primary sales for upper and upper middle-class segments that are
already overloaded with properties, while the secondary market for similar
projects already sold will go into hibernation mode for a number of years.
Though nominal prices of properties will increase, the rate of increase is
expected to be less than the inflation rate, leading to a negative return for
owners, some of whom are under pressure to pay back installments. These
investors may resort to fire-sale properties bought for investment purposes.
Small developers will suffer severely due to their undercapitalization and lack
of market recognition, and some will likely crash. Large scale developers will
need to dig deep into their pockets to keep afloat.
What does this
mean to the different stakeholders?
For families, there is a
need to decrease the portion of wealth allocated to real estate as it is
expected to witness real negative returns in the coming years. Besides, buyers
would do better to focus on mature projects by solid developers even if this
will mean paying a premium.
For developers, there is a
need to study projects deeply and ensure their cash flows are reasonable.
Developers also need to ensure they are properly capitalized with long-term
funding that can allow them to absorb the stress of the bubble burst.
On the
government level, there is a need to scrutinize projects pre-launch to ensure
developers have enough capital to execute the projects and that such capital
would be tied to the project through an escrow account dedicated to the
project, handling all cash inflows and outflows of the project. Additional support
will be needed for current developers through targeted bank financing packages
to avoid crash of current developers and projects.
That said, real
estate will continue to be an important sector for families and for the overall
economy, but it won’t be an easy ride for the unprepared.
Omar El-Shenety
26 September 2018
This article was published in Egypt Today