CAIRO - 26 September 2018: 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 seven 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 percent lately and its overall contribution to GDP has exceeded 10 percent.
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 percent 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 is Managing Director at Multiples Group, leading the investment banking practice of the firm across the region. He is also Adjunct Faculty at the American University in Cairo, teaching investment analysis and financial modeling.
FILE - Omar El-Shenety
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