Hardy Jamaldeen (right) with Archie Warman - Pic by Shehan Gunasekara
Sri Lanka has undergone a tumultuous political upheaval over the course of the last year, and with it, investor confidence in the island nation has been in a state of flux. With several factions vying for power and espousing their own ideas for improving Sri Lanka’s economy at every opportunity, the first eight months of the year were uncertain times for the business community. However, with uncertainty comes opportunity, and over the past two years you will be hard-pressed to find a firm that has seized that opportunity better than Steradian Capital.
Two years since their entry into the Sri Lankan property market, the real estate investment firm has made steady strides. Founding partners Hardy Jamaldeen and Archie Warman have expanded their portfolio with residential, commercial and, more importantly, affordable housing properties. They sat down with the Daily FT to discuss their experiences in the Sri Lanka real estate market, what they feel the new regime needs to do to boost investor confidence in the country and just what exactly they’ve been working on over the past two years, as well as a sneak peek into what we can expect in the future. Following are excerpts:
By Madushka Balasuriya
Q: What attracted you to Sri Lanka as a real estate investment opportunity initially?
Archie Warman: At the beginning, I was the investor and Hardy was the co-investor, selling Sri Lanka to me. Our first foray into the Sri Lankan property market was in the North of the island, beachfront land, in Pooneryn, 18 nautical miles from Tamil Nadu, with gin clear water and soft white sand. The price difference between beachfront land in the South and the North was 100x and we thought this price difference would bridge given political changes, sentiment and time. We intended to remain in London whilst taking a long-term view of our investment in Pooneryn. However, when we started doing more due-diligence on the SL real estate market, our plans changed. We realised that there was a lack of clear structures or platforms set up in Sri Lanka to attract overseas investment – a position we felt we could fill. Secondly, timing; our timing and Sri Lanka’s timing; we felt that it was the right time to enter the market. Thirdly, the market itself; we noticed early on that the market was in its infancy; a lack of private equity money, REITs (Real Estate Investment Trusts) and funds had made the market quite illiquid. Our target is to build up quality assets, with long-term income attached to them. With the market maturing, these assets will be sought after and we could exit at a premium. Last but not least, we tried to seek solid advice and struggled to find any. We realised there was a gap in the advisory market. I am a RICS chartered surveyor and Hardy is a FCCA-qualified accountant – who else can offer that level of qualification in the market – the answer is not many. Having run a fund in London focused on commercial offices, retail warehousing, retail and London residential, we had the advantage of operating in a highly liquid market and we could see the bottlenecks and the areas of opportunity. We saw that interestingly in terms of the land in Sri Lanka, everything was valued on the basis of just land, pure land value. As opposed to land, building, and the value of the income stream; there was no real value from income streams attached at all here at that point. We just had to persuade our wives. This was the start of Steradian Capital Investments Ltd. (www.steradiancapital.com).
Hardy Jamaldeen: When we came here we noticed very clearly that there was a really good opportunity and that we had the skill set to fill a void in the marketplace between Archie and I. So we thought that this is the kind of space (an emerging market) where we could give our high net worth investors (HNWIs) a chance to come and invest. The investment game is all about credibility and trust. We have built that up over the years with our investors. Our plan was to get through a pilot stage investment process where we invest mostly our equity alongside a select few other investors to showcase what we can achieve in a new environment. We have been happy with the progress we have made at stage one and our investors can actually see the progress we have made, thereby creating a track record of operating in Sri Lanka. Stage two is to scale up and do some really exciting work and we are just about to embark on stage two.
Q: How does a long-term income stream being attached to property affect your valuation?
HJ: In terms of property valuation, to me, the most important component is the long term income stream supported by a good lease agreement and a strong covenant. The components that go into valuing a property are the market price of land, cost of building, and the value attached to the income stream that the asset is capable of generating. If a property owner has a long-term income stream from a single occupier or a multiple group of occupiers with a strong balance sheet and reputation, this will help the property owner structure ways to take equity out of the property and make it go further for you. The owners can take great comfort knowing the income stream and can start to negotiate with banks in a structured manner. If you had an idle asset with fragmented leases, owners and banks could not take a more aggressive stance. Pension funds, other local funds will look to this asset class as it has the ability to payout regular dividends by buying assets of this nature. In Sri Lanka, retail investors have had the luxury of getting paid high rates of interest on FD’s and haven’t had the need to look to alternative asset classes. However, at present, interest rates are relatively low and retailers will start to look at such asset classes when they are presented in an easy to invest wrapper. Answering your question directly, the commercial property market will move into a yield-based pricing over time and thus become the most important component when valuing property.
Q: You have been in Sri Lanka two years now, how volatile a period has it been?
HJ: In terms of the political environment it has been very volatile but the fundamentals of the property market have remained unchanged. We have been mooting changes to the Land Act, VAT on sales of apartments on projects above $ 10 million, and removal of 15% tax on lease rentals to foreign companies, to name a few. We are looking forward to the unveiling of the budget and hope that positive changes will enable us to attract more investment into Sri Lanka. The conceptual aspects of the previous regime were very good but their execution and implementation was not as effective as it could have been. A lot has changed no doubt. During the last two years we could have easily got distracted, yet we stayed focused and carried out eight investment transactions and two advisory pieces.
AW: A lot of people talk about 2015 as being a lost year, we saw this as an opportunity and, realising that few were transacting, used this to our advantage. We obtained some fantastic entry prices and this will stand us in good stead going forward. We’ve now set ourselves up quite nicely.
HJ: The pricing when we came in was very reasonable and we identified the areas that we wanted to go into. Our ethos is very straightforward – do it better than what’s there in the marketplace, and do it in a space where there’s demand. For example, we will not touch the high-end apartment market.
Q: Why is that?
HJ: It’s way oversupplied in the current context. Now the need is for housing young professional couples. Would they love to have their own property? Yes. Can they afford certain amount of debt? Yes. Have they got cash for a deposit? Yes. But everything that is being built at the moment is out of their reach. The lower mid market is definitely the sweet spot for housing development in and around Colombo.
AW: Not enough is being built for them in Central Colombo, where you’re 10-15 minutes from the CBD (Central Business District). Urbanisation will be a major factor over the next decade, and Colombo and greater Colombo are well placed to be the main beneficiaries. Added to that, there is the old adage that Colombo kicks out about half of Sri Lanka’s GDP. We want to build up a following, a fan base, so our finished product is sort after.
HJ: We’re thinking, for young professionals, housing from reachable distances into the CBD. That’s very important. So we’ve got a five-and-a-half acre site in Ja-Ela and we’re going to do 160 units there, it’s about 200 meters from the expressway and it’ll take maybe 35 minutes in the morning to get in. Land price there is roughly Rs. 250,000 a perch. Now they’re talking about a metro from Katunayake to the CBD and Bopitiya being one of the stations. These kinds of locations, where professionals can easily get in and out of the CBD, will be sought after.
AW: I think it is important to add also that we make sure our investors are brought into Sri Lanka and handled in a very transparent, credible manner. We don’t want fly-by-night investors to come into the SL property market; our investors are seasoned and in it for the long term. Our concept is to look after the fundamentals. Shift the benchmark in terms of quality and the financial aspect will follow. Our investors can identify with that.
HJ: That’s very important for us. And that’s also an important facet as to how we’re helping this country, by bringing in top calibre investors. If these investors are handled well, we can achieve the ‘snowball effect’. First they come in for property, they trust us and come with us. We give them a safe and profitable journey, a good story, and then they will start looking at alternative investments in Sri Lanka as well. Sri Lanka really needs to give a positive PR message to the globe to increase FDI.
Q: How has the regime change affected your capability to attract such high calibre investors?
HJ: Definitely the change of regime has been positive, there’s no question. The human rights overhang has been handled well thus the western investors were keen to come in pretty quickly after the 8 January presidential elections. But since then, the interim budget brought in taxes that have been hugely detrimental to investor confidence. For example, the retrospective super gains tax. One of our investors was in Colombo when the super gains tax was announced. He said, “it was unethical and illegal,” and went on further to say that retrospective taxes are a terrible practice, and that there is “no difference in principle between taxing people on income that was not legally taxable at the time it arose – or at higher rates than were then in force – and fining, imprisoning or even executing people for so-called ‘offences’ which were not legally offences at the time they were committed.” He did not expect the new SL government to resort to this obnoxious practice and expected them to have more respect for the rule of law.
AW: The mansion tax as well. That sent shivers down our investors’ spines. It’s a real killer because you say that in London and everyone runs a mile.
HJ: Another potential investor was visiting, and his comment on retrospective super gains tax was a very sharp one because we had policy makers giving him comfort behind closed doors, and he said: “I’m a fund manager and what I hear and what I see in the press is what I believe, because that’s the policy statement that you have released. Income Tax was introduced in the UK as a one-off tax 200 years ago to fight a Napoleonic war and it still remains to date.” So retrospective taxation has had a huge damaging effect. So yes, on the one hand the benefits of the human rights situation are coming in but we are making mistakes with things like retrospective super gains taxation for sure. And along with the mansion tax, these things are not the right sort of tunes foreign investors want to hear. If they (Government) could streamline the regulatory environment to make things more clear; sort out the Land Alienation Act, take away punitive taxes on the leases where foreigners have to pay 15% tax on short leases, and streamline work permit issue, because foreigners find it very difficult to get a work permit, if you iron out these things, I think you will see exponential growth in FDI.
AW: The 15% tax on foreign leaseholds is very important to the property market. One, it’s sending the wrong message to international companies looking to setup office here, who will employ locals and put money into the system; and two, it stems any incentive of a long leasehold culture which naturally leads onto long-term income in the property sector here.
Q: How confident are you that these issues will be addressed adequately?
HJ: We have a lot of confidence in the Prime Minister (Ranil Wickremesinghe) and think that he has the vision to put this country on a fast track and make real progress. We have had indications that it will be put right, and we hope that a clear message will be delivered during the budget. The Prime Minister has said to give time until the budget, and that they would put a roadmap in place. So we’re all patiently waiting. I call this the lost year, because November 2014 was when the presidential race started and we’re asking for time till the next budget for a roadmap, so the country has been running on autopilot for the last year. This is where we think we have really done well as a company; whilst all this was going on in the background we have gone and kept doing more and more.
AW: But really we still view ourselves as being in our infancy, and executing these pilot projects accurately. We want the regulatory environment to be ironed out, that’s when we can take on some really aggressive positions. If the regulatory environment is ironed out we can raise a larger fund. And that’s when we can really start contributing to develop Colombo and the suburbs. Sort out the legislation bottlenecks and the REITs and private equity money will come.
Q: You put a lot of emphasis on fixing regulation. How important is it?
HJ: What people don’t realise is, you can scream and shout about bringing manufacturing in, you can scream and shout about foreign direct investment, but there are certain things that are so interlinked that if your property law is not correct – because with investment into a country the biggest amount of capital that will be deployed will be land and property – then already the first stumbling block has been hit. You’ve got to make sure that land law, accounting policy, immigration policy, exchange control regulations, incentives and planning regimes all fit together. These cannot be implemented in isolation. A good example is the Land Alienation Act implemented by the last government. They failed to classify the difference between a long lease and a short lease for accounting purposes. So a local owner of property that would lease a land to a foreigner for 99 years would get stung with income tax. If the local owner sold the property outright to another local person or entity there would be no tax as it will be seen as a capital gain. This creates a two tiered market and stalls progress.
AW: Sri Lanka needs to change its island mentality. We are in a global race and we are competing against all nations. One of the first questions will be, can we buy land and position our company accordingly? The answer is no – well I will just go elsewhere then.
HJ: So when you’re fixing the regulation you need to have the right incentives to bring them in, you need to make sure the people are available, you need to make sure that land and property are easily accessible, then you need to make sure the accounting laws support the Land Alienation Act. At the moment it’s all so disjointed it doesn’t work. That’s why not as many investors are coming in at the moment. But when you streamline these few bottlenecks, I’m telling you for a fact that we will really start to motor along.
Q: Regardless of the hurdles, you’ve done well over the past two years. Can you elaborate on some highlights?
HJ: The first project we did was in Hulftsdorp. We went around courts and we saw people working out of their cars, so what did we do? We built an office building and it let within six months. It is now yielding us 12%. Then we’ve done a boutique hotel in Weligama, W15 (www.w15.lk). It’s ten suites and our pilot project into leisure, which is now operational. We have a great beach lounge; it’s probably the best spot on the Weligama beach. And again what we’ve done is created something better than the marketplace. We’re launching this on the 14 November. Then we’ve gone onto Alexandra Villas or AV15 (www.av15.lk) – a 24-room property just off Marine Drive – and we’ve just started taking bookings, but it’s at a very soft open stage.
AW: The buy in price on Marine Drive versus Galle Road was mispriced in our view. Galle Road was trading at Rs. 12 million a perch and we transacted on Marine Drive at Rs. 3 million. Property is a simple game in our view – get the fundamentals right.
HJ: So those three are completed and then the next project for us is Mulberry in Dematagoda – again an underserved area with a high density of people. In this location current trading in unregulated apartments is in the region of Rs. 12-13 million; they are very poorly built and structurally dangerous. But it’s close to a lot of good schools, and very well connected to Maradana Road and Baseline Road. A lot of people like to remain in that area and those away from Colombo would like to have an apartment in this address simply because they’re able to get their kids into good schools. So we’ve targeted this, which is 121 units, and we’ll hopefully break ground in the second week of November. Then there is Pooneryn – this is where it all started – we effectively bought an area between Jaffna Lagoon and Palk Strait. It’s like a sand pit about 18 nautical miles from India, we have two beautiful plots of land there. The idea is leisure at some point, with India being in such close proximity. It’s a bit like the Maldives there, with flat seas so completely unkept that you wouldn’t know it’s there.
AW: Then of course there’s Olive Residence which will be on Baseline Road. We bought a big site – 229 perches on Baseline Road – it is the main arterial route through Colombo. How many land parcels are there in Central Colombo, in areas of high density, well suited for affordable housing? We don’t think many and we think we have a gem. Again we believe we got the fundaments right and bought well. And the product is for what has the most demand: affordable housing.
Q: Compared to other investment opportunities in the region, what are Sri Lanka’s key selling points that you guys highlight to potential investors?
AW: I always love flying over Colombo because you see all the greenery around, as opposed to places like Qatar and Dubai where there’s just sand. I always say, you (Sri Lankans) have such a head start on these guys, so much natural beauty and resources that are waiting to be utilised. Added to that, you have a great history and are a proud nation.
HJ: We sell ourselves on the basis that we’re on the ground here. There’s a real opportunity for growth in the country. It’s beautifully geographically located and we are very, very hopeful that the regulatory bottlenecks will be streamlined. And then how we sell ourselves is that, even in this environment over the last two years, we have proved that we can swim and keep our heads well above water and manage through. If we get the extra kick that’s a fair wind that’s going to give us better returns. It’s exciting times when a country could grow from $ 3,000 to $ 6,000 over the medium term. This presents interesting opportunities which we could capitalise on and this fact is well embraced by potential investors.
AW: Yes and in addition there are very few people with our combined qualifications and knowledge working together in Sri Lanka. It’s a pretty unique thing in itself.
HJ: You know we’ve had situations where companies like Keppel Land have come in here and struggled, they are probably Singapore’s premier real estate company.
AW: And what message is that sending to the rest of the Asian market?
HJ: This is a tricky place if you don’t know your way around. We need big players like Keppel Land to come here and be successful and that is the only way we can attract similar companies into our space.
Q: How different is the real estate market here from in London?
HJ: Very different, it’s dog-eat-dog here. Property Law is very clear and established in London; there are no exchange controls in place so fund movements are a lot more fluid. Banks have got significantly better-structured debt products. On the development side we need to be much more hands-on to deliver a quality product out here. The quality of workmanship needs improving in SL. We are spending a lot of time and energy doing this with our contractors. It’s also a significantly more mature market (in London) so everything, all the information that you need is at your fingertips, one has data bases galore in the UK. However, for example over here, I know the rent I’m paying but I don’t know what my neighbour is paying. All that information is readily available on a deal-by-deal basis in London. You have the world’s best property companies advising you in London so you get good advice.
Q: You don’t really get real estate agents as such here, do you?
AW: That’s actually another facet we’re looking at. We’ve started up another company, like Foxtons in the UK. It’s called Hardy-James (wwww.hardyjames.com) and we will be launching that slowly. We’ve got a team working and putting the structures together. Because again we feel that that’s an area that is really lacking here – there’s no shop front so to speak. Everyone’s a broker but there’s nobody really doing it on a professional basis and looking after the client. Trust and honesty – this is key to us.
When we came in here it was quite a daunting thing, for me. You know I’m used to walking into an estate agent’s office and asking for a list, and in about five days’ time my wife and I would have found somewhere to live in. But you can’t do that here. Once you’re here for two years you know the system, but the system’s not easy; it’s incorrect. I’ll be honest, the agents just seem to get bashed around.
Q: Going forward what do you feel will be the most important segment for you?
AW: There’s a massive market for affordable housing. How many people can afford to buy Shangri-La? Which I actually think is an excellent product. We are talking in the small thousands in my opinion – maybe ten thousand – whereas affordable housing has genuine demand for owner occupation. I think the Government should offer incentives to developers operating in this sector. Our four areas of business are affordable housing, student residential, commercial offices, and leisure. For me the most interesting aspect is, if we can build up assets with income growth over the next seven years, we will be in shape for the new wave of investor – the private equity players and the REITs. Hopefully by then the average man on the street here will be able to invest in a REIT on the Colombo Stock Exchange. He might not be able to buy a flat but he’s got £ 1000 and he can put that into a property fund. And that’s the key. At the moment the spoils are only enjoyed by the HNWIs of Sri Lanka and the institutions. In addition, I know we harp on about it but the legislative issue, if you can iron out those bottlenecks, the rest will follow and you will get the internationals coming here, setting up their offices, which will filter down into consumer spending power.
HJ: See for us the next step is to build a big office block in the CBD. Our target is if the REIT legislation is sorted out we will set up a REIT and if the bottlenecks in regulation in our space are streamlined we will go in for a larger fund and aggressively start to develop our sites. These are all the pilot stage projects we’ve done over the past two years and now we’re ready to get aggressive. How aggressive we get depends on how the regulatory environment is streamlined. Ultimately we’re doing a service for the country. We’re bringing foreign direct investment, we’re bringing in employment and we’re developing neighbourhoods. There’s a real need for affordable housing so we’re doing it. We’re contributing, but we feel we’d contribute significantly more if the regulatory environment is streamlined.
Pix by Shehan Gunasekera