Bricks and mortar investing has lost steam after a paradoxical run over the last decade. Real assets of which property is the most accessible for the average investor, has long been considered a good hedge against inflation and uncertainty. The argument put forward by proponents rests on the power of property law in using free title holdings as collateral for financing. Infrequent valuations give investors the emotional comfort that all is well. The lure of investing in property is as much psychological as it is financial. The perceived safety of property saw an extraordinary bubble build up from 2001 through to 2007, especially in the Colombo district.
 While not leveraged through debt financing, the story had its usual cast of speculators and hot money. At the heart of the bubble fuelled property mania were the Ponzi schemes run by the cohort of “finance” companies lead by the now defunct Golden Key Group. At the height of the property bubble in 2005 a unit perch of land in Piliyandala, on the outskirts of the city of Colombo, was selling for Rs 1 million, which would have yielded all of 3% in rent for the most luxurious house. A forward multiple of 33.3 (meaning it would take approximately 33 years to pay back your investment!) As of June 2011, properties marked at Rs. 400,000 (per perch) were struggling to clear, a drop of 60% in six years. Clearly something was amiss in 2005 for those who cared to look. The story at the time, which plays a crucial role in all investment bubbles was that with inflation out of control, the only asset rising as fast if not faster was property. Spruikers (one who promotes his own cause) were at work day and night showing gullible investors how fast prices were rising. Their claims were further substantiated by rising rents in pockets of Colombo.
The reality was something very different. First, the UNP when elected into office decided to give an amnesty for all black money to enter the formal economy. Most of this ended up being recycled to property, given the legal protection accorded to property rights. Second, the much touted CFA lead to a population exodus from the Northern and Eastern provinces primarily to northern Colombo and Colombo 6, doubling rents within months. Finally, the tsunami disaster brought in a beauty parade of “technical” advisers to supplement NGO’s, the country’s largest growth industry. All explanatory factors, bar NGOs, were one-off events and property had not entered a new phase. Unfortunately many investors decided to join the party once prices had already risen to unsustainable levels in 2005.
The gradual fall lead to a cascade with the collapse of Golden Key and parts of the Ceylinco Group with fire sales(quick disposal at any price) becoming the norm from 2008. While markets are showing some stability now, in keeping with the obsession towards property and the history of all economic bubbles it has moved away from Colombo to the Southern Province (Hambantota in particular) and more dangerously the Jaffna district. Median prices in Hambantota have shot up a cumulative 250% between 2005 and June 2011, based on the median of advertised and settlement prices of private sales, as recorded by the Provincial Council. Given the high incidence of tax avoidance when recording transaction prices, I’ve adjusted them upwards by a conservative 25%.
That fails in comparison to the goings on in Jaffna, where land prices are up by a whopping 300% in the last two years, based on the above measures. The narrative for the southern sojourn is built on hope and concentrated development activity, neither of which are credible justifications for the current elevated prices. While gated communities with all amenities may drive Diaspora interest in Jaffna, they aren’t suckers to overpay.
The Diaspora may well continue to invest on behalf of relatives, but the difficulty with Jaffna is determining the true value of property as the dynamics of the early 1980’s may not be a good proxy. Settling political uncertainties along with accelerated demilitarisation coupled with large scale interest from Tamil Nadu makes current valuation appear cheap. If on the other hand, any of these variables prolong or don’t materialise, valuations appear over the top.
Interestingly, rents (the real income source from any property investment) have gone sideways for well over a decade as increased supply has constantly put downward pressure. A large outbound migration of workers has also lead to an increase in supply of properties putting pressure on rents. With more over-valued apartments coming on the market, the rent situation is only set to get worse.
Thus total returns from the asset class looks depressing. A drop in apartment prices of between 20-40% appears reasonable. Land prices in the Colombo district are bifurcated with outer-ring suburbs showing promise of growth and those within the city and its immediate vicinity likely to fall before stabilising. Price stability will depend on total tourist arrivals, with one million medium-stay visitors being an important landmark. If the average person, on a median wage cannot afford the average house, it can be safely assumed that the property market is over-valued.
This is very much the case across most of Sri Lanka at the moment, thus prospective returns from property look anaemic. That doesn’t mean that a manic rise in prices driven by a toxic combination of free money and speculative excess cannot be ruled out. Buying an expensive asset in the hope of it becoming “insanely” expensive is not investing, but speculation on steroids.
(Kajanga is an Investment Specialist, based in Sydney Australia. You can write to him at kajangak@gmail.com) |
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