Sri Lanka Real Estate Market Brief

Volume 1: January 2012 In association with

Research Intelligence Unit

Foreword
The market for real estate assets in Sri Lanka has shown a significant growth phenomenon since 2009 with a marked increase in price levels of real estate assets including bare lands, residential housing, commercial premises and condominium style apartments. Increased foreign investment interest in prime blocks of commercial lands in the city of Colombo, the acquisition and resale of leisure properties by private investors and a general increase in confidence levels of household investors is likely to have fueled the development of Sri Lankas property market during the past 24 months. The changing landscape of Sri Lankas real estate market is likely to be further elaborated by shifting lifestyles of real estate buyers including broader acceptance for apartment style living, further cities becoming accessible and equipped with necessary infrastructure and a growing leisure sector across a number of districts in Sri Lanka. Further transformation is also likely to take place in the city of Colombo which moves to becoming a picturesque and yet commercial city which could emerge as a trade hub for South Asia. A number of emerging opportunities could result from the development of Sri Lankas real estate market for both the institution and the individual. Recent growth trends have shown increasing activity in the construction industry, housing, property sales and apartment projects. Individuals are also likely to have benefited from increasing property prices and appear to continue to invest in tangible real estate assets. The Real Estate Market Brief will be an informative and interesting thought leadership to those who wish to explore the potential of this sector. Reyaz Mihular Partner Head of Advisory, KPMG in Sri Lanka.

Overview of Real Estate Market Brief

KPMG Ford, Rhodes, Thornton & Co., in 2010 made the firms first mark on the real estate market with the launch of a real estate advisory practice encompassing a dedicated team of real estate professionals and working with the aim of bridging information asymmetry between buyers and sellers of real estate assets. Since inception, the team has worked collectively with investors, financiers, land owners and intermediaries helping them to convert strengths and synergies into successful and viable real estate projects. Even though the property market was one of the most mature industries in Sri Lanka, one the main challenges we confronted was in relation to limited published information available in relation to property prices, transactions and the performance of the sector as well as its various sub sectors. The Real Estate Market Brief we believe will address this challenge, making useful information available to interested parties and keeping you more aware and well informed of developments in the real estate sector. Shiluka Goonewardene Principal Financial and Real Estate Advisory, KPMG in Sri Lanka.

Contents
Inner city clues INSIGHT: The modern suburb Sky high: Condominium market overview Interview: Looming opportunity in construction Residential lands in the suburbs 01 03 04 06 07

Image courtesy David Altabev

Inner City Clues

Inner city Colombo is an area where urban dwellers from diverse backgrounds have long lived shoulder-to-shoulder. However, the citys landscape is currently in a state of transition with the government pursuing a policy of transformation that will beautify the Capitals landscape. Unlike most emerging economies, the urban population in Sri Lanka has not increased in accordance with the increase in population over the past five decades and currently, only 15 percent of the population live in cities. Despite issues regarding the classification of urban and rural areas, it is estimated that Sri Lanka has a higher percentage of its population living in rural areas than even Afghanistan. The permanent population of Colombo City is estimated at around 900,000 whilst the floating population is around 500,000. At the time of gaining independence the city was a model Capital in the entire region and it is still widely remarked that even Singapore, aspired to be like Colombo. However, by the turn of the millennium, almost half (49 percent) of the dwellings in the capital were made up of low income settlements. Now at long last the landscape is in a state of rapid transformation. With the current drive to modernize the city, stand-pipes, illegal dwellings and make-shift latrines in the inner city areas are becoming a thing of the past as the city of Colombo reclaims its past glory. Colombo character Price data on land sale registrations and advertised rates reflect several driving factors. Firstly, a defining characteristic of the city (in areas such as Colombo 01, 02 and 03) is the scarcity of private land sale registrations. This reflects the widespread level of state presence in this area as well as the high number of illegal dwellings. Secondly, with the few private property transactions that were recorded at the land registry, the per-perch prices shows tremendous variation from as low as Rs.1 million up to Rs.14 million ( See chart 1.1). This is due not only to the socioeconomic factors but also as a consequence of various legal and regulatory issues that impact the market. For example, building permits are generally only granted to lands of over six perches and as a result smaller plots are much cheaper. Perceptions also impact prices. Lands closer to Galle Road are more expensive than lands closer to the beach due to the stronger security and higher commercial value. However, the overwhelming factor that impacts the land market is the heavy presence of the state and the dynamics within various state bodies, especially in Colombo 01 and 02. For example, according to RIU sources, the D.R Wijeywardene Mawatha and Banking Square areas of Colombo 01 used to be owned by various state institutions like the CMC and the Ports Authority. However, now many such lands are being vested under one state authority the Urban Development Authority (UDA). Many lands in this area have been vested already and others are currently in the process of being transferred to the UDA. Typically the UDAs policy is to give out these lands to investors, both foreign and local, on 66 or 99 year leases which is in accordance with the governments policy, as stipulated in the recent budget. The UDA has recently invited investors, both foreign and local, to engage in discussions for a number of such developments. Ear-marked areas This part of Colombo 01, which houses state and private buildings, including warehouses that date back to the islands former Colonial era when the lake was used to transport goods from the Colombo port, is believed to have been ear-marked as a night-life tourist spot.
Sri Lanka Real Estate Market Brief [ 1 ]

Likewise, the Gangarama Lakefront area has been ear-marked for linear park and promenade developments and already several international deals are known to be in the pipeline. According to RIU one such project rumoured to commence shortly is the US$400 million shopping and residential complex in the Lakefront area. RIU sources indicate that the UDA received US$23 million for a 99 year lease of the two acres

of land on Sir James Peiris Mawatha. Adjoining this development, another linear park development for recreation and night life is expected to start early next year. Meanwhile, the Galle Face area of Colombo 02 has been ear-marked for further tourism development and the recent deal with the international Shangri-La Group which bought a six acre block of state land in Colombo's 'Galle Face' beach front for US$125

million to build a 500 room hotel, shopping and apartment complex according to LBO, represents a further move in this direction. Exodus In order to make space for these new developments, iIlegal and encroached dwellers in these areas are likely to be urged to move out of the inner-city to areas which lie on the outskirts of the city. Those with legal deeds might also have the option to move during this process of inner-city transformation. As a result of these policies, the future land market in the inner city area is likely to be drastically transformed towards an exclusively high-end area, and we can expect to witness a decline in the current disparities as discussed above. Consequently, the private land values in Colombo 01 and Colombo 02 can be expected to experience significant appreciation. Meanwhile, areas that will be accommodating the transferred dwellers, are likely to face a price adjustment in the medium term. In the current climate, investors predominantly from China and India are set to give a complete makeover to the Colombo 01 and 02 areas over the next two years. There are many attractions for foreign investors such as tax holidays and capital repatriation which coupled with a boom in the tourism sector, can make Colombo city one of the best investment propositions in the region and perhaps the world. Local investors are also known to be showing strong interest in acquiring these lands from the UDA in order to develop high-end recreational attractions. Given the air of expectation, those that do hold private property in the inner city areas are likely to witness significant appreciation in prices.

Chart 1.1: Scarcity of Land Registrations and Price variations (Rs) within Colombo 01
14000000 12000000

Price per perch

10000000 8000000 6000000 4000000 2000000 0

2005

2006

2007

2008

2009

2010

2011

2012

Price per perch Registered Rates

Year of Registration

Source: Research Intelligence Unit (RIU)

Land registration prices, in Colombo 1 areas, like Main Street, can fetch values of around Rs.9-10 million per-perch whilst Sea Street sells at around Rs.8 million. Five million rupees may currently buy you one perch in Colombo 3, four million for Colombo 4 and Colombo 6. Parts of Colombo 5 like Thimbirigasyaya market at around Rs.3.5 per perch whilst properties in Colombo 8, Borella, average at around Rs.4.4 million. The Research Intelligence Unit forecasts double digit growth in the post 2013 period.
Source: Research Intelligence Unit (RIU)

Sea Street: Rs. 8 Million per perch

Main Street: Rs. 9-10 Million per perch

[ 2 ] Sri Lanka Real Estate Market Brief

INSIGHT: The modern suburb of Maharagama

Taking a closer look at the of Maharagama Urban Council area which is situated some 15 kms from the commercial Capital, a gradual increase in the price levels over the past three years is observed. However, the trend is not uniform and there is no close distinction between the prices of properties with houses and offices and those that are just bare lands. The chart below is based on an independent sample of property registrations and corresponding prices in Maharagama.

Property registration prices (Rs per perch) in Maharagama (2009-2011)

2500000

2000000

1500000 Lands Houses 1000000

500000

1-Jun-2008

18-Dec-2008

6-Jul-2009

22-Jan-2010

10-Aug-2010

26-Feb-2011

14-Sep-2011

1-Apr-2012

Source: Maharagama Urban Council/Collated by Research Intelligence Unit (RIU)

In order to understand the market better, we need to look at our data by separating land registrations into difference areas, or wards, within Maharagama. This municipal area in Colombo District is a population of

some 300,000 is characterised by wards that have department stores, super markets, clothing shops, food and beverage outlets and other modern facilities that cater to the needs of the population as well as

wards that are under-developed and semi-rural in orientation. This is clearly reflected in the data where the urban and residential ward areas tend to fetch notably higher prices than the mixed and fringe areas.

Average price (Rs) per perch by Ward in Maharagama

800000 700000 600000

Residential Areas Mixed Developments Urban Areas Fringe Areas

Average price (Rs) per perch

500000 400000 300000 200000 100000 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

18 17

Wards in Maharagama

Source: Maharagama Urban Council/Collated by Research Intelligence Unit (RIU)

Sri Lanka Real Estate Market Brief [ 3 ]

Condominium Market Overview

Whilst some asset classes in Sri Lanka have been met with mixed fortunes during late 2011, the overall trend in the luxury real estate segment has been positive. The findings of the Research Intelligence Unit suggest that the positive incline in the market for condominium properties in and around Colombo city remains buoyant. Our position based on primary and secondary data is supported by the Central Bank of Sri Lanka, which in its latest Annual Report refers to the demand for houses and urban infrastructure as expanding rapidly with population growth and urbanization. They, the Central Bank, further note that the private sector continued to play a vital role in the housing sector construction of condominium housing is the increasing trend, with corporate property development being encouraged with various direct and indirect fiscal incentives, mostly under BOI status, and the growing interest of expatriate Sri Lankans to invest in the real estate sector. Levels of interest in this sector are certainly high. According RIU sources, around one quarter of apartments in two new high-rise projects scheduled for construction by one of Sri Lankas main condominium developers have been reserved even before construction has started. Out of the 226 apartments built in the first phase, only ten remained to be sold. Generally, our research points to high occupancy levels across the board in most condominium property with an average pre-construction sale ratio of around 50 percent. Some of the more prestigious developments like the Empire, Emperor, Lumiere and Trillium tend to sell around 80 percent of their units by completion of construction. Meanwhile, the established buildings like Royal Park and Iceland Residencies have very few apartments available for sale or re-sale. However, caution too needs to be exercised with respect to two fundamental market determinants. Firstly, there are a finite number of expat Sri Lankans living in the west who are in the condominium market and since the end of the civil war, this segment has been at the frontline in picking up luxury apartments. The peak levels of expat interest in Sri Lankan real estate maybe fast approaching or even possibly behind us in which case the rate of demand growth will slowdown. India, for example, has a far larger number of expats living in the west but the country is currently experiencing a dip in the condominium market due to the factors that are more related to the domestic economies of foreign countries and factors such as the cost of borrowing.

Square Foot Area - 3 Bedroom Apartments

4000 3500 3000 2500 2000 1500 1000 500 0

Square Foot Area

Source: Research Intelligence Unit (RIU)

Name of Condominium Building

[ 4 ] Sri Lanka Real Estate Market Brief

Secondly, any perceived risks involved with doing business in Sri Lanka also tend to play a significant role in the minds of potential expat buyers. On balance, we can note that on the supply-side, developers have been actively expanding the number of condominium projects that silhouette the landscape. For the most part, RIU research indicates high levels of occupancy with pre-sales moving fast enough to encourage further entry of players and projects. What we have also noted is that the top-tier projects have tended to perform much better in this regard than the condominium projects that are comparatively more affordable. One reason for this is that the income levels in the Western Province and Colombo in particular are far higher than the national average and the mean average income is twice over the median average income level in the district. This illustrates that there is an increasing number of high-net-worth individuals (HNI) living in Colombo now. However, RIUs long-term position is somewhat conservative for this segment of the real estate market as past bullish sentiments have not always been reflective of long-term stability. For example, we can note that large scale, luxury, condo-

minium properties appeared in 2002 at the time of a ceasefire agreement between the Government of Sri Lanka and the rebels. The boom in demand caused prices to surge in this market segment and by 2006/07 values reached levels comparable to those in the developed world. However, as more and more developers entered this market and sought to cash-in, the return of conflict dealt a blow to demand and this segment was stifled from 2007-09 with many developers reporting losses.

Returning to peace in the island led this segment to receive an almost immediate dividend. To some extent there is an expat bubble element in the bullish double-digit growth that maybe sustained over the short term. In the long-term, more consistent growth is likely to prevail given the overall global economy dynamics. The government is also looking to encourage more foreign participation and has reduced the tax obligations of international buyers.

4500 4000 3500 3000 2500 2000 1500 1000 500 0

Th

m eE

pi

re M

on

ch ar On

e re th d Hy

20 kR e

e sid Sp

nc

ie

s ea Re sid

en

cie

s e sid

en

ar eP

at

d ho

Ba

rn

eR ac Pl s

ts rs en we To rtm e pa ac Pl eA d er i ea m m Lu os cie

l ya Ro

r Pa

2 Bedroom Square Foot Area

3 Bedroom AptSquare Foot Area

Source: Research Intelligence Unit (RIU)

Sri Lanka Real Estate Market Brief [ 5 ]

Sri Lankas Looming Construction Industry

Can you tell us a bit about the type of projects Sierra is involved with at the moment? We have just entered into a strategic business partnership with Browns and LOLC where all three parties will be active in the real estate market with Sierra handling all constriction related activities. Currently, we are developing a new and exciting leisure sector project in Kosgoda together with Browns. The Samudra beach Hotel is a state-of-the-art facility with a 150 room capacity and we have got all the necessary approvals from the central authorities. We are currently in the process of getting clearances from the local government authorities. This last stage can sometimes take too much time to complete. So do you feel quite bullish on the leisure sector? Yes, we are very positive in this regard and the current and future focus will be to develop top class hotels in various parts of the island. In this regard, we are looking at the top end of the market where tourists have a budget of $200 per night or higher. It will be good for the country to attract a better class of tourists who spend their money here. One example of such a project is the upcoming Tea Leaf that will be an excellent example of a boutique type eco-friendly experience. When we consider that 43,000 new hotel rooms are needed by 2016 in order to keep pace with the governments target to achieve 2.5 million inbound tourists by 2015, a massive effort is needed. In fact, this is a very achievable target and the leisure sector is currently the driving force of the construction industry, not the housing sector. If we fail to meet the demand then we will face a shortage that will in turn drive up the room rates. This will harm the tourism market. What is the future for the domestic tourists? Will they be able to afford the local rates in future? Domestic tourism is a very important aspect of the sector and it has to be accommodated. For some segments of the domestic market, flying to Thailand or Singapore will soon be more affordable than local five-star hotels. However, we have to understand that domestic tourism is our mainstay market and we need to ensure that they are well looked after. One aspect of this strategy should be to develop and upgrade the rest-houses that are scattered around the island in large numbers with some located in incredibly scenic and beautiful spots. These facilities should be renovated, perhaps under public private partnerships, in order to support the city-tocity tourism, like in India. From the construction sector perspective, what issues do you face? The construction sector in Sri Lanka is looking good at the moment and the outlook for the next decade is

An RIU Interview with Priyantha Perera, Group Director, Sierra Construction and Chairman of the Contractors Association of Sri Lanka discusses opportunities in the construction sector. very positive. We are currently looking at around eight percent growth rate that will likely increase over the coming years. However, there are some serious issues. Firstly, we are currently facing a shortage in human resources, particularly for the skilled and semi-skilled workers. This is partly due to the fact that many of our workers are currently doing jobs overseas. It is also a product of the fact that many school leavers come out with no technical skills in metal work, wood work, etc., that can contribute to this sector. We have taken some measures to address this but more efforts are needed. Another issue that we face is the rising cost of raw materials. One reason for this is the fact that most materials have to be imported. Another reason is connected to the fact that getting approvals for mining and quarrying takes a long time and is a difficult process. Consequently, the construction sector has to absorb this cost. We also feel that despite of the fact that we have the government that is largely supportive in terms of the policies that affect the construction sector, some individual officials in government departments can be too slow to do their jobs. Officials who drag their feet are responsible for slowing-down progress that ultimately has an economic cost.

[ 6 ] Sri Lanka Real Estate Market Brief

What are your concerns regarding the wider real-estate market? In Sri Lanka, its hard for the middleincome segment to enter the property market. If you consider that a buyer needs around Rs.15 million in order to afford a decent house in Colombo, for most, this is beyond their budget. The reason why housing is costly is partly due to the high costs of construction, as I said earlier. The government needs to take steps in order to make housing more affordable like, for example, cutting taxes on essential material imports. The government can also extend more support to buyers from both the public and private sector to buy their own home. What opportunities do you see for those who can enter the market? Now, it is a good time for people to

get ready to start their projects. Mixed residential and tourism sector facilities will have a good demand in the medium term. Commercial and retail properties are also set to experience strong demand growth. How about the luxury apartment sector? Currently, we have too many apartments in Colombo where the market is over-supplied. Most people who buy these apartments do so for renting out and very few actually live there. If we take Colombo 06 for example, we find that since the dawn of peace, people who originated from the north have now returned to Jaffna and surrounding areas. This has resulted in a slackening of demand for high-end properties that were

previously experiencing strong demand from locals and expats. Finally, turning to you, what keeps you motivated and how do you see your future in the industry? I started out as a businessman over thirty years back in various areas including agriculture and manufacturing. However, in the early eighties, I entered the construction sector and started Sierra. I excelled in this sector due to my all round knowledge in design and engineering as well as construction. The construction sector is the biggest business in the world. It employs workers at all levels. Currently I am the Chairman of the Contractors Association of Sri Lanka.

Residential Lands in the suburbs

Trends in Residential prices and interest rates The story of land prices in the suburbs has been one of almost continual appreciation over the past two decades according to available data. The factors exerting upward pressure on prices include rising demand for housing, currently estimated at around 90,000 units per annum, increases in per capita GDP , increases in migrant worker remittances and the financial health of local corporations. Fluctuations in interest rates have direct short-term impacts where the relationship is traditionally a negative correlation. Available data (Central Bank / Valuations Department) also indicate that the rise in residential land prices in the suburbs has been much sharper than it has been in the city areas, be it from a much lower base. This is likely to be a reflection of the fact that unlike some CMC areas that may have reached their peak in terms of development potential, given existing regulations on constructions and building restrictions, the suburban areas are still significantly below their development potential. The second factor is
400 350 300 250 200 150 100 50 0 0 10 20 25

2000

2001

Dec 2009

Jun 2010

1998

1999

2002

2003

2006

2004

2005

2007

2008

Per cent

15

socio-economic and demographic. Given the affordability power of the middle-income buyers who mainly consist of newly-weds and civil servants, which accounts for the larger share of the property market, CMC areas are a non-starter for most middle-income buyers tighter budget constraints. However, the contrast in prices increases between the CMC areas and the suburbs is less pronounced for industrial lands. We can also note a sharp dip in the overall price levels in 2007 which is likely to be a consequence of high interest rates at the time, the return of conflict to the island which was then followed by the global financial crisis that had a direct and negative impact on foreign remittances. However, 2009 was a turning point with the ending of the conflict and with the domestic economy largely on-track, RIU notes a stable growth rate of around 4.5 percent at present time. The rate has the potential to increase further up to around 7 percent, given a favour.5 able interest rate and stability in the Middle East.

Index

Colombo District Yield om 3 month Treasury Bill Weighted Average Prime Lending Rate

Source: Central Bank of Sri Lanka/Valuation Department/ Research Intelligence Unit (RIU)

Trends in residential land prices and foreign remittances

20 15 10 5 0 -5 -10 10 5 0 25 20 15

Index

Dec 2009

2001

Land Price Growth - Colombo District Growth in Private Remittances

Source: Central Bank of Sri Lanka/Valuation Department/ Research Intelligence Unit (RIU)

Jun 2010

2000

1998

1999

2002

2007

2005

2003

2004

2006

2008

Per cent

Sri Lanka Real Estate Market Brief [ 7 ]

www.lk.kpmg.com

Contact us
Reyaz Mihular Partner Head of Advisory KPMG in Sri Lanka T:+94 (11) 5426400 E: reyazmihular@kpmg.com Roshan Madawela Director Research Intelligence Unit T: +94 722741305 E: roshan@riunit.com

Shiluka Goonewardene Principal Financial & Real Estate Advisory KPMG in Sri Lanka T: +94 (11) 5426403 E: sgoonewardene@kpmg.com M.F. Jifry Manager - Real Estate Advisor KPMG in Sri Lanka T:+94 (11) 5426423 M: +94 727356544 E: mohamedjiffry@kpmg.com

Divya Hundlani Anaylst Research Intelligence Unit T: +94 (11) 4369616-8 E: divya@riunit.com

Mohamed Hilal Niyas Manager - Publications Research Intelligence Unit T: +94 (11) 4369616-8 E: hillal@riunit.com

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. 2012 KPMG Ford, Rhodes, Thornton & Co., a Sri Lankan Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved. Printed in Sri Lanka. Publication date: January 2012.