Boom or Bust?

CAIRO - 27 September 2018: Home ownership is a goal for the majority of Egyptians, for both cultural and financial reasons. The real estate industry in Egypt has advanced in offering new business models to many countries, to the extent that many believe that the “off plan sales” model was created initially by the Egyptian market. Today it is followed by the UAE, among other countries.

Real estate ads imply that it is the only business in Egypt. Away from the stock market, there are actually few available investments in Egypt, especially for small investors, with Egyptians used to seeing real estate as the only repository of value.

But with currency devaluation and lower affordability, the market is witnessing resale stagnation, signaling that the real estate market is no longer a short-term investment (buy and sell before delivery). As a result, the state of illiquidity combined with nominal value pricing increases every day.

In other words, this illiquid state is a result of clients not being able to afford bulk cash sums. And while this may benefit developers in the short term (because demand is only concentrated on new sales), as the situation persists, buyers who purchase for the purpose of investment will no longer be able to do so. To test this theory, we need to take a closer look at mechanisms of the local industry.

Off-plan Sales

Developers purchase a plot of land whether in cash or installments, then start to work on project branding and marketing campaign in order to sell units that are not yet built but will be delivered in few years (average four years).

Through this model, developers can add a project to their portfolio that will receive billions of cash-in by raising just the cost of the land plus marketing cost of launch. This model has in fact made the new developers’ access to industry easier.

The model could suit countries with a stable inflation rate, which is not the case in Egypt after the currency devaluation.

Why? Because developers sell units by targeting a certain profit margin with an estimated cost of construction allocated over years of construction. As a result of devaluation, many real estate developers experienced a loss in their profit margin after being hit by construction cost hikes in addition to clients’ inability to stick to their cash commitments due to lower affordability.

Demand

There are no adequate or accurate statistics available for client segmentation by income, which contributes to inaccurate estimation of clients’ credit quality in Egypt.

According to international standards, installments of any household should not surpass 28 percent-36 percent of their income. Mortgage institutions are the authorized entities to ensure applying this criteria worldwide.

It is worth noting that mortgage contribution in Egypt is very minor (it does not exceed 2.5 percent) because it is only available for delivered units. Of course, at least for now, we cannot estimate the real income of many households, but the government has to authorize a separate entity that gives permission for clients before starting to pay any unit’s installments to the developer.

A regional investment bank based in the United Arab Emirates recently noted that demand has been strengthened by purchases from Egyptian expats, who earn in dollars and have seen the local purchasing power of their savings doubled as a result of the flotation.

This increasing number of expat buyers, which is also reported by different developers, is a good sign that may counter (for the short term) the real estate market stagnation.

Supply

Real estate sector has been the main component of GDP growth in Egypt since 2005 because it feeds more than 95 industries and employs more than 5 percent of labor force, according to a recent AmCham report.

Egypt is witnessing a huge developmental era, which is why a lot of businessmen are trying to enter the real estate market without preparing an adequate feasibility study. It is critical that the Egyptian Financial Regulatory Authority consider the previous experience of those who offer to buy plots of land for development.

Additionally, it should keep an eye on their credit rating and ensure that they have cash ready to see them through any market turbulence.

Land Cost and the Revenue-sharing Model

Normally, land cost on average should not exceed 15 percent-30 percent of the project’s cost. In Egypt, EFSA sells lands for more than 40 percent of the project’s cost, applying a rigid revenue sharing model which is a huge obstacle for any developer to sustain their business.

Currently, almost all developers’ land contracts are tied to escrow accounts that guarantee minimum payment each year to EFSA despite the changes in market conditions.

However, this might be a good strategy to filter and tighten developers’ budget when it comes to single project’s construction and land payments, instead of encouraging off-plan sales.

Real Estate Taxes

Real estate tax signals the government realization that investing in real estate is unhealthy for the economy in the long run. Taxes imposed on real estate transactions would make sense if we considered these profits as normal capital gains as any other running business.

Despite the difference in the service offered, annual property tax could be considered as mantainance fees that developers impose on their clients. Also, the tax imposed on resale transactions is similar to admin fees imposed by the developer side on clients when selling a unit.

Toward Equilibrium

Theoretically, demand represents almost 50 percent of the offered units each year. But when taking affordability into consideration, we should classify demand by income. By doing so, we will find that there is a supply shortage in low segments (Segment C and its sub-categories) and illiquidity in middle segments (Segment B and its sub categories). That’s why real estate developers (representing the supply side) want to penetrate class C as it is still a blue market.

How? EFSA can contribute to higher GDP growth rate by allowing real estate developers to penetrate this market with affordable prices attractive to segment C. This can be achieved through more flexible construction specifications such as increasing the number of floors allowed, lowering green area percentage, and so on.

Additionally, the government can gain revenues by offering developers targeting segment C partnerships in land share with 20 percent-30 percent of the project cash-in. Besides current government development projects, this can accelerate the development plan and increase GDP growth.

Ahmed Ezz El-Din is Co-founder of Finance View Egypt. He is a financial analysis and budgeting controller, CFA instructor as well as an academic instructor.