The Sri Lankan construction sector is showing signs of recovery, with opportunities emerging in real estate, mega projects, and regional markets. Housing demand remains high and increased foreign investment in tourism projects is driving growth.
Speaking to The Sunday Morning Business, Research Intelligence Unit (RIUNIT) Chief Executive Officer (CEO) and Founding Director Roshan Madawela discussed these shifting dynamics and the emerging opportunities for the construction sector in the region.
RIUNIT is a market intelligence and research company with over 21 years in Sri Lanka. Over the years, it has specialised in various sectors, including construction and real estate.
Following are excerpts:
What are the shifting dynamics of Sri Lanka’s construction sector?
The construction sector has historically been a key driver of the economy, especially in the post-conflict era starting in 2010. It peaked significantly in 2017, growing by 27% and accounting for 12.2% of the Gross Domestic Product (GDP), the highest in Sri Lanka’s post-independence history.
The growth boost began in 2010 with the return of tourism. At that time, many experts were amazed to see the hotel sector leading construction activity, surpassing housing, which is traditionally the main driver for the construction industry. However, during what could have been considered a rosy period for the sector, the country encountered a severe contraction in 2020.
This downturn was primarily due to lockdowns, the currency depreciation that followed, import restrictions, interest rate hikes, and a macroeconomic contraction. These factors led to the suspension of mega projects and the diversion of donor funds from construction to emergency welfare programmes. Consequently, the sector saw a 20.8% contraction in 2023. By this time, its contribution to GDP had shrunk from 12.2% in 2017 to 6.2% in 2023.
The contraction heavily impacted Small and Medium-sized Enterprises (SMEs), with issues such as delays, cancellations, and debt burdens hitting small contractors particularly hard. Many SMEs could not withstand these challenges and delinquency rates on loans increased to over 70% in 2023. While larger players fared better, SMEs struggled in what became a survival game.
However, the current situation of the construction sector shows signs of a comeback, particularly in 2024, where the sector experienced a revival in the first half of the year with over 14% growth.
This recovery coincides with the return of multilateral and bilateral funding and renewed demand for residential housing. On the supply side, the pricing of essential building supplies and construction materials remain more stagnant, with the strengthening of the Sri Lankan Rupee. Strengthening of the rupee for two consecutive years, low inflation, reduced interest rates, and increased remittances have created a favourable environment for growth, particularly benefiting large companies.
Additionally, the country has seen a slight return of foreign-funded projects. However, with a new administration, the extent of commitment to mega projects remains to be seen.
Private investments in sectors such as hotels, renewable energy, and mid-income housing are expected to contribute significantly to demand. High-rise construction is also poised for a return. Therefore, it is crucial to remain observant of the Government’s stance on these developments.
What was the progress of development projects in 2024?
In the second quarter of 2024, Government records show Sri Lanka had 224 large-scale development projects, including 53 new initiatives in water supply, electricity, and SMEs, along with over 100 foreign-funded projects through loans and grants.
While many projects previously experienced little to no physical progress, some are now being reactivated. This reactivation and the ripple effects of this contributed to the 14% growth witnessed in the construction sector in 2024.
Usually in Sri Lanka, the transport sector takes a significant share of Government mega project funding, particularly road projects. While new mega projects are unlikely due to funding constraints, we believe a certain extent of commitment is to be expected. It is hoped that the Government would complete funding projects such as expressways, flyovers, and marine drive extension that have been initiated.
It is understandable that these will not be embarked upon immediately. We are closely monitoring the progress of key projects like the Kandy Multimodal Transport Terminal Development Project, Getambe Flyover, and Port Access Elevated Highway to see which ones the Government will complete.
From the Urban Development Authority’s (UDA) perspective, it has signalled interest in Public-Private Partnerships (PPPs), which can be seen as a slightly less free-market approach to addressing the challenges of State-Owned Enterprises (SOEs). As the new Government doesn’t seem to lean towards privatising SOEs so far, given its position on the political spectrum, it is expected that PPPs will be a favoured approach for most of the reforms.
The UDA has also mentioned projects such as the Colombo Fort Heritage Project, particularly focusing on refurbishing certain old buildings. Additionally, the authority plans to build 50,000 housing units. With a housing shortage always present in the country at any given time, these initiatives could pave the way for exciting new developments.
While the UDA has outlined major projects in the pipeline, their progress will largely depend on securing funding. Entities such as the Asian Development Bank (ADB) are likely to step forward, while Foreign Direct Investments (FDIs) are expected from countries such as Singapore, Japan, and Canada, among others, for various initiatives in these areas.
What are the emerging opportunities in the region?
Construction and real estate are closely intertwined sectors, as many construction companies have transitioned into real estate development due to their skill sets. This trend is quite prominent in the domestic market.
The real estate sector typically accounts for a significant portion of construction activity, with determinants in the Sri Lankan context including complex demands driven by long-term trends such as urbanisation, population growth, and societal changes. Short-term factors influencing the sector include interest rates, remittances, disposable income, construction costs, and exchange rates, among others.
Following the war, hotels and apartments emerged as leading contributors, with commercial property following due to its slower rate of return. Commercial projects which require leasing often see revenue materialise over six to seven years. Within Sri Lanka, geographic hotspots for work and housing are concentrated along the west coast, while transport and other infrastructure projects are more evenly distributed.
Demand and supply for utilities depend on several factors, but housing consistently shows a shortage of units, making real estate a primary driver of construction. In recent years, high-rise residential buildings have seen significant growth. Although this trend paused temporarily, a medium-term resurgence is expected.
In the short term, residential high-rises are likely to lead the market, with commercial and retail projects following later. Real estate is expected to be one of the top three drivers of construction in the short to medium term.
Opportunities in the construction sector extend beyond housing to include mega projects, transport infrastructure, and high-rise residential and commercial buildings. Foreign investment interest has also increased, particularly in tourism-related projects such as hotels and resorts, as the macroeconomic environment becomes more conducive to growth.
Additionally, construction exports, including non-metallic minerals, engineering products, and waste metals present notable opportunities. Companies with backward linkages in construction and access to natural resources may explore viable export markets. Australia’s construction exports reached nearly $ 800 million at their peak.
In addition to exports, there will also be opportunities in the region, with many Sri Lankan construction companies expanded regionally, particularly into Bangladesh and the Maldives, where demand has been strong.
Despite internal crises in these regions, the overall construction demand has remained and larger players have leveraged these opportunities effectively. This regional expansion represents a significant opportunity for the construction industry across short-, medium-, and long-term periods.
What is the growth rate forecast for the construction sector?
I would say the construction sector is looking at a growth between 5-7% in the medium term, driven by factors such as resumption of mega projects, real estate developments, and hotel constructions.
We expect manufacturing to contribute significantly as well, with new factories and warehouses being established as part of anticipated economic growth. Manufacturing is critical for Sri Lanka’s economic independence, reducing sole reliance on revenue channels such as remittances and tourism, which tend to be somewhat volatile in relation to shifting political and economic dynamics in the country.
Many economists and commentators advocate for greater Government emphasis on manufacturing, which would in turn benefit the construction industry.
What are the risks associated with the construction sector?
According to Government data, typical risks include delays in third-party approvals, poor performance by subcontractors and consultants, land acquisition challenges, and procurement delays.
Exchange rate risks remain a concern as well, but have stabilised recently due to improved political conditions, inflation control, and interest rate management. These favourable macroeconomic trends have supported a growth rate of approximately 5% in the industry, with potential for further expansion to 6% or 7%.
In terms of supply, mid-income residential demand remains consistently high. While commercial construction faced challenges during lockdowns, including increased vacancy rates and reduced absorption, these trends are reversing.
Several large-scale commercial projects have entered the market in recent years. Semi-luxury apartments, by contrast, exhibit high occupancy and low vacancy rates, indicating stronger absorption capacity. Therefore, high-rise residential projects are expected to drive initial construction activity, with the commercial market following suit as recovery continues.