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The spike in growth of the construction and real estate industries that Sri Lanka has achieved over the last decade or so has been phenomenal. The reason for this growth and where it’s headed are questions that usually arise in the minds of those that observe this upward trend. The following interview with Reza Magdon Ismail, the founding Director/CEO of Trivium, an emerging real estate industry player, focuses on the growth and potential of the construction and real estate industries in Sri Lanka:
Q: What are your views on the current state of the construction and real estate industries in Sri Lanka?
A: The post-war building boom saw a slight slowdown with the change of government in 2015. The first quarter of 2017 shows that the overall GDP growth has contracted slightly to 3.8%, however, the construction sector grew by 16% in this quarter and also reached an all-time high in the 4th quarter of 2016. So I think the lost momentum is back and we have even seen evidence of this, through increased interest from clients for our construction management services.
In terms of the real estate industry, there has been unprecedented growth primarily fuelled by a sharp rise in condominiums over the last eight to nine years. This was driven by strong macroeconomic fundamentals such as the scarcity of land within Colombo and its immediate suburbs, coupled with increasing demand for urbanisation. Sri Lanka’s urbanisation rate stood at 18% against the global average of 50%, as published by the World Bank in 2016. This indicates that there is still a lot of potential for growth, especially in the suburbs and townships.
Q: What are your thoughts on the current industry trends and which segments show significant growth potential?
A: Most of the investments in the recent past have been in the luxury and high end condominium segment; which may result in a temporary oversupply in the next two to three years. We see significant potential and growth in the mid-market offering, particularly within the Rs. 15 to 30 million price range. This is driven by increased affordability of this segment amongst a growing middle class; supported by the forecast that the country will achieve middle income status (as per the World Bank classification) with a per capita GDP of $ 4,000 within the next two years.
Along with this demand we have seen a number of smaller developers entering the market with hopes of capitalising the opportunity to make a mark in the industry. An asset class within the condominium segment we feel there is a gap in is the serviced condominium segment. Although there has been much investment in city hotels within Colombo, there is a large segment of consumers who prefer the concept of serviced condominiums, which provide greater flexibility in terms of a living experience than the typical hotel. There are a few serviced condominium type developments within Colombo. However, none of them can be identified as purpose built serviced condominiums, hence we see an opportunity for developers willing to exploit this niche.
Condominiums also happen to be the most efficient way to invest in real estate because you can fund a lot of your cost through pre-sales, unlike commercial properties where vast sums are invested during construction and returns are only seen in five to six years. As our estimates over the period of 2012-2016 indicate, condominiums show an annualised return of 12%. This is against the returns in alternative asset classes for the same period; such as 7.5% in the Colombo Stock Exchange and the Commercial Bank 1 year FD rate of 10%. Given this dynamic we have seen a lot of buying for investment.
Apart from this, there is also significant demand for low-mid income housing units driven by the increasing demand of rural to urban migration. It is encouraging to note the National Housing Development Authority has been partnering with some of the larger private sector developers to fulfil this demand and sales of these projects have been resounding. Also, the GOSL is facilitating investment in this segment by providing income tax holidays to developers who participate in these projects where the sales price of a unit is less than Rs. 5 million.
Other sectors that we feel have major potential in and around Colombo are A grade offices and Retail driven by the increasing commercial activity in the city. As a result we are seeing big names like Shangri-La and John Keells Holdings PLC putting their money behind very large mixed development projects. We must also recognize, the Chinese funded Port City development; it stands to change the real estate landscape in the country and will further encourage participation from major large scale and long-term investors.
Q: In your opinion, what are the key challenges and restraints hindering this industry growth?
A: Too much bureaucracy and red tape in getting projects approved. The longer the approvals take, the higher the costs of investment. Building regulations and zoning plans need to be improved because, even if you are in a specific zone and meet all requirements, there is no way to ensure you get approval as regulations are vague and not implemented properly. This discourages investment. Quicker approvals mean more willing investors.
Similarly, developers need to take responsibility to ensure compliance. Profitability should not come at the cost of quality and safety. Developments in certain areas around Colombo don’t comply with the building code and residents have been compelled to seek intervention against illegal constructions. In developed markets like Singapore there are stringent regulations, checks and balances where a single violation can result in blacklisting.
Another challenge we face that discourages investment is ad hoc and inconsistent policy decisions taken by regulators. For example, in March 2016, the GOSL raised the minimum investment criteria for housing related BOI registered businesses to receive duty free concessions on imported materials from $ 500,000 to $ 5 million. It has restricted the ability of small/mid-scale developers to source quality materials from overseas and allow the larger scale developers, who already enjoy economies of scale, to benefit from further sourcing advantages. While the argument maybe that these restrictions are in place to protect local manufacturers then the concessions should not be made available to a select few. In addition, to encourage a protectionist attitude such as this towards an industry that is already faced with high construction costs is a detriment to all stakeholders.
Q: What should developers do to meet the expectations of consumers in the current context?
A: Given the increased competition, developers need to look beyond ensuring their developments are of good build quality, they need to focus on the life cycle of the development beyond its completion. Location is the primary factor that influences buyers but value addition and price are also major selling points. Therefore, developers need to focus on value engineering in order to provide price competitive products as well as designing products that are harnessed to add value to consumer lifestyles and needs.
The construction industry has been slower than most to adapt to the terms of implementing technology and innovation. Less than 1% of the construction sector budgets are spent on R&D, but in other sectors it’s as high as 5%. Cost and time overruns are something inherent in our industry with larger capital projects generally being 20-30% over cost and time. Therefore, we see an industry that is ripe for disruption and the adoption of newer technologies is essential in order to provide price efficiency and remain competitive.
Q: Do you have plans of entering into any of the other areas of real estate development that you mentioned earlier?
A: Yes we do, the focus of our next project is in the Serviced Condominium category where there is major undersupply. Taking in to account the needs of the modern millennial traveller the product will create a functional, efficient and flexible living experience. It will also provide residents with unmatched connectivity, allowing them to book taxis, order food and arrange meetings and courier facilities; all at the click of a button. We will also create an environment for residents to network and connect both professionally and socially. Additionally, we will be providing project investors real time data in terms of occupancy, rentals, yields and maintenance etc. The product is called ‘Addapt’ (www.addapt.lk) and the concept will be a first for Sri Lanka.
Q: There has been some chatter about a real estate bubble. What are your thoughts on this?
A: Our firm position is that the entire industry uptrend is, as I mentioned earlier, based on strong fundamentals. Real estate bubbles form when there is excess leverage/credit in the market. From our experience, most of the property buyers in the market over the past years have been cash buyers (investors who purchase without leverage). In addition, our lenders are also very conservative and risk averse when it comes to funding developers as well as buyers, with conservative loan to value ratios with maximums of around 70%. So honestly, we feel there is no substance at all to this chatter. Of course, like in any competitive industry there are bound to be winners and losers, which is why we are focusing on ensuring that the products we develop look beyond the construction lifecycle by adding value to the services post construction, which will ensure their success.
