Property development recovery

Ravi Randeniya

Many are astonished by what has happened in the property development market in Sri Lanka. Why did land and property prices keep on increasing for many years?

What are the reasons for the sudden bursting of the bubble in property development? When will there be a recovery in prices of residential houses and luxury apartments in Colombo? Will land prices and rental rates also go up again and when?

These and many other questions have sprung up since recently in the minds of many concerned parties and the public at large and this article aims to shed some light to these matters. We posed this questions to Premier Pacific International (Pvt.) Ltd, the only property developer who was accorded an Excellent Rating by the Institute for Construction Training and Development (ICTAD) and give the responses which are based on a recently concluded marketing intelligence exercise. Premier Pacific Topaz (Pvt) Ltd Managing Director Gobind Daryanani and Director Nimal Perera provided some useful information.

Q: Why did property prices increase remarkably over the past several years up to 2007?

A: Statistically, there is an un-bridged gap between the demand for residential accommodation and its supply. This could be attributed to more than doubling of the population since independence and more than halving of the size of the average family unit in Sri Lanka during the same period.

Accordingly, the number of households has increased over four-fold sinceindependence but the number of residential units has not maintained such a momentum. Therefore, there is a wide gap between demand and supply of residential accommodation. Consequently, prices of houses and apartments moved progressively upwards over time until the unsatisfied demand is met. Up until two years back, there were significant increases in prices since the demand for residential accommodation was much higher than its supply.

Q: How did the bursting of the property development bubble come about?

A: The main reasons are the following.

a) Due to the phenomenal increase in price of land, houses and apartments in Colombo and consequent prospects for super profits, many new organizations entered property development and those already in business increased their capacity of operations. Property development become the number one business at that time because it is a low risk, high profit and relatively short period investment opportunity in Sri Lanka. Property development becomes everybody’s business including that of banks and construction contractors. Consequently, there was a remarkable increase in the supply of individual houses, housing schemes and more particularly and more recently luxury and semi-luxury apartments. This sudden increase in supply of residential accommodation reduced the gap between demand and supply and consequently the prices.

b) Within the past two years, the number of foreigners living in Sri Lanka, particularly in Colombo, declined significantly in all segments including the expatriate community, business visitors, aid workers and even tourists. This reduced the demand for residential accommodation in Colombo particularly for luxury apartments.

c) Increase in interest rates to an all-time high level made it almost impossible for Sri Lankans to take loans to purchase residential properties. Purchase of houses and luxury apartments by foreigners particularly Sri Lankans living overseas declined due to the crash in global property prices and at the same time, the appreciation of value of Sri Lankan Rupee against most major currencies.

To sum up, the increase in supply of houses and apartments concurrently with the decline in demand for same caused the housing bubble to burst. Recent world recession and global financial crisis made matters worse.

Q: Why was the market for commercial space relatively adversely unaffected during the recent decline in the property development market?

A: The market situation with regard to office and other commercial space has been quite different to that of residential apartments. Traditionally, office space has not commanded attractive price levels.

However, with the boom in the residential and apartment development market, commercial space did benefit from improvement in price levels, both for outright sale and lease rental, the latter being the preferred choice of most customers. The following provide an insight to the market for commercial space.

a) From a historical perspective, it could be said that a limited number of large companies controlled an unduly large segment of the commercial sector and many companies operated for decades, while some for over a century. Many companies owned the premises they operated from and also had land space for expansion.

The demand for commercial space and consequently the outright sale prices and long-term lease rental rates were relatively low and did not attract many large-scale investors for development of office space. When the situation changed, in response to market demand, the World Trade Centre (WTC) twin towers and a few other medium-rise buildings came into being thereby giving a signal that Sri Lanka was ready to emulate the business capitals in the world in providing high-class office space.

The WTC is by far the best office building in Sri Lanka. Unfortunately, Colombo Fort which had the pride of place as the highest value for the land and prices for buildings and rental rates (except Pettah of course) lost its glamour and fame due to many reasons including that of security concerns. This provided an opportunity for commercial space in other parts of Colombo to develop.

b) The most prestigious area for business development besides Colombo Fort was that of the golden mile from Galle Face Green to Kollupitiya junction in Colombo 3 along Galle Road. The same fate as Colombo 1 befell on the golden mile because it is also within the high security cordon area. Thereafter, the segment along Galle Road from Colombo 3 to Colombo 4 became the most high-demand commercial area. Even within that stretch, the landside of Galle Road in Colombo 3 became the ideal area for office and shop space. The area near the Kollupitiya junction on the land side of Galle Road commands the highest land price.

The location is the most important factor for success of any property development project and it is more so for property development for office space and other commercial activities.

c) The lease rental rate which was somewhat stagnant at around Rs.50 per square foot a few decades ago turned to around Rs.100 per square foot before the turn of the century and soon moved to Rs.125 then Rs.150 and later to Rs.200 per square foot after the dawn of the millennium. Now, with the downturn in the global market, the lease rental rates have declined and currently stand within the range between Rs.100 - Rs.170 per square foot.

d) The supply of office space in Colombo did not increase to any appreciable extent up to the end of the 20th Century because outright sales prices as well as long-term lease rental rates did not provide super profits unlike in the case of residential houses and luxury apartments.

Consequently, there is a wide gap in supply of office and other commercial space in relation to its demand which has progressively increased over the years.

This gap between supply and demand is the reason for surge in lease rental rates since the turn of the century. Even though many companies prefer to lease space rather than to purchase, with the development of condominium concept, many customers now consider outright purchase even though the larger part of the segment still prefer lease.

e) It is a blessing in disguise that the demand for office space has increased at a time when apartment prices and demand have declined. Recent market surveys reveal that on land-side of Galle Road between Colombo 3 and 4, office space has been sold for over Rs.20,000 per square foot, a price level unheard of in the past.

At present, the demand is quite steady at prices between Rs.15,000 and Rs.20,000 per square foot. With regard to office space along Duplication Road on Colombo 3 and 4, the lease rental rates range between Rs.125 to Rs.160 per square foot when such space is complemented with the essential facilities and services.

The rental rates have a strong relationship to the ratio of rentable or usable space to total available space which includes space covered by common areas, service areas, car parking areas and facility areas. The rental rates indirectly reflect the total space available whether it is termed at the lowest denominator as carpet floor area or the other extreme as total floor area of the building offered.

Q: What is the outlook for property development within the next couple of years?

A: It is cautiously optimistic that a recovery towards normalcy could be anticipated forthe following reasons.

a) The era for super profits in property development projects seem over. The gap between demand and supply has reduced. Artificial skyrocketing of land prices due to a few buyers clamoring for the same parcels of land seem over.

The market has corrected itself at a much lower price level than during the past period of boom. The meltdown of the entire world economy has also caused the necessary price adjustment in the Sri Lankan economy.

b) The decline in prices of real estate products has not only taken away the super profits but also brought prices to a near cost price level. This has moved away investors to other segments of the economy. The decline in demand for real estate products has been counteracted by concurrent decline in supply due to the fact that no new property development projects have taken-off in recent months.

Eventually, there will be an improvement in the market after the full effect of the market correction is complete. Thereafter, demand will pick up. At present there is an uneasy lull in the market. The buyers seem to adopt a “wait and see” approach.

To be continued