By Shenal Fernando The Sri Lankan condominium market has been on a hot streak since the aftermath of the Covid-19 crisis as people were increasingly looking at non-traditional investment avenues such as condominiums in the backdrop of inflationary pressures and the relatively low levels of return earned on traditional investment avenues.  It is well accepted that the Sri Lankan condominium market possesses a significant long-term growth potential due to the rapidly increasing urbanisation of the country, its strategic location together with future possibilities arising out of the Port City, and the growing middle class which is demanding convenience and cost-effective housing. Therefore, there exists within Sri Lanka the fundamental characteristics required for the long-term growth of its condominium property market. Consequently, the hot streak observed in Sri Lanka’s condominium market in the immediate aftermath of the Covid-19 crisis wasn’t unexpected and this surge in demand for condominiums was supported by increased money supply and rising inflation levels. However, the foreign exchange liquidity crisis which has intensified greatly since of late has raised several poignant questions with regard to the near-term future of the country’s condominium property market. The general consensus among most industry insiders was that the near-term future of the local condominium market will be largely gloomy due to increased borrowing costs and constriction of demand due to increasing returns from traditional investment avenues following the recent interest rate hike and the likelihood that most ongoing and new condominium development projects will be abandoned by property developers until the current situation in the country improves.   Recent positive trends   Since the recovery following the initial economic crisis caused by the Covid-19 pandemic, the local condominium market had been on a red-hot streak until the escalation of the foreign exchange liquidity crisis in the country in early 2022. According to the Condominium Market Survey published by the Central Bank of Sri Lanka (CBSL) for the fourth quarter of 2021, the Condominium Property Volume Index, which gauges the relative strength of the industry based on sales, had increased by 49% YoY during Q4 2021 to 250 index points, representing a growth of around 48.4% Quarter-on-Quarter (QoQ) compared to Q3 2021. The CBSL had also observed that single condominium projects continued to remain the most preferred condominium category during Q4 2021 in terms of sales (73%). The CBSL further observed that while 77% of condominium-related transactions were priced below Rs. 25 million a year ago in Q4 2020, it had reduced to 49% in Q4 2021. This is reflective of the willingness of investors to purchase condominiums priced at higher levels, as well as the increase in prices of condominiums due to greater demand and increasing cost of construction material. Furthermore, in terms of the Housing Price Index of Lanka Property Web, the overall average selling prices of apartments in Sri Lanka had surged by over 36.08% YoY during Q1 2022 to Rs. 56.4 million from Rs. 41.5 million in Q1 2021. It was further revealed that the average price of a three-bedroom apartment in Colombo had increased by 27.3% YoY to Rs. 69.4 million during Q1 2022 from Rs. 49.9 million in Q1 2021. Moreover, following the 7 March decision by the CBSL to float the exchange rate, the Sri Lankan Rupee has depreciated by over 82%, and as of 5 April 2022 the selling rate of a US Dollar for Telegraphic Transfers (TT) was Rs. 370, and the buying rate of a US Dollar for TT was Rs. 350 as per the CBSL. Consequently, the condominium market is extremely attractive to non-resident locals, expats, and foreigners earning US Dollars and other foreign exchange. This was reflected by the 20.6% increase in foreign traffic to the Lanka Property Web website during Q1 2022 and particularly in the aftermath of the 7 March decision by the CBSL.    Demand for condominiums going forward   Speaking to The Sunday Morning Chamber of Construction Industry of Sri Lanka (CCI) President Ranjith Gunathilake pointed out that the recent decision by the Monetary Board headed by the CBSL Governor on 8 April 2022 to increase the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the CBSL by 700 basis points to 13.5% and 14.5% respectively, had resulted in a situation where the financing costs for potential investors in condominiums had increased drastically over the past four to five weeks. This is reflected by the fact that as of 29 April 2022 the Average Weighted Prime Lending Rate (AWPR) calculated by the CBSL based on the lending rates offered by commercial banks to their prime customers during a particular week, had increased drastically to 16.38%. In contrast, the AWPR published by the CBSL on 1 April 2022 stood at 9.58% and the AWPR published at the end of the final week of April 2021 stood at a mere 5.86%. The CCI President further argued that while theoretically, people had turned to real estate during periods of high inflation as a hedge against inflation, in the current situation following the CBSL decision to hike policy rates, traditional investment avenues were once again offering investors an annual return exceeding the average capital gains of real estate, which stood at around 8-10% per annum. Gunathilake explained: “The CBSL has decided to increase the yield rates of the Treasury bills giving investors a 20-22% return within a short period. Such an amount is definitely greater than the appreciation of the value of real estate. So going forward people will prefer depositing their money rather than investing in real estate because the gains are long-term and not immediate and are highly illiquid.” This is reflected by the fact that the Weighted Average Yield (WAY) rate for the 91-day, 182-day, and 364-day Treasury bills had increased drastically to 23.48%, 23.85%, and 23.92% respectively at the 4 May 2022 Treasury bill auction. In comparison, the WAY rate at the 30 March 2022 Treasury bill auction for the 91-day, 182-day, and 364-day Treasury bills stood at a mere 12.92%, 12.25%, and 12.28% respectively.  However, Gunathilake did admit that while demand from locals may decrease going forward, there would be renewed interest in condominiums among non-resident locals, expats, and foreigners earning US Dollars and other foreign exchange, whose purchasing power had increased significantly following the over 82% devaluation of the Sri Lankan Rupee.   Anticipated under-supply of condominiums   According to Gunathilake, the price escalation observed in construction material due to the depreciation of the Sri Lankan Rupee and the shortages of such material as a result of the foreign exchange liquidity crisis had resulted in a drastic increase in construction costs during the past 12-18 months. This drastic increase in construction costs is reflected in the construction industry price indices published by the Construction Industry Development Authority (CIDA). Accordingly, as of April 2022, the weighted average price of cement has increased by over 140% since April 2021, in the face of the significant depreciation of the Sri Lankan Rupee and the forex shortage in the country which led to cement shortages and the rise of a black market for cement with exorbitant pricing. Furthermore, in the aftermath of the decision by the CBSL to float the exchange rate, cement companies have through several price hikes increased the price of a 50 kg cement bag to Rs. 2,750 from the Rs. 1,350 levels that were observed in early March. Similarly, according to the CIDA price indices as of April 2022, the prices of structural steel, PVC pipes, and asbestos ceiling sheets have increased by 167.6%, 112.6%, and 118.2% respectively since April 2021. “Due to the drastic escalation in construction material prices, today a condominium developer will have to incur double the costs of what he would have incurred some time back. So that means the overall sale price would have to increase by 100% at minimum. Condominium developers who have pre-sold a significant portion of their condominium units would struggle to recoup the new construction costs from the remainder. Therefore, I don’t think at this moment any condominium development will take place in Sri Lanka unless it’s a condominium development project close to completion, with over 70-80% of the construction process already completed,” stated Gunathilake. He further pointed out the statement by Finance Minister Ali Sabry to the Parliament on Wednesday (4) where Sabry had disclosed that currently, the liquid foreign currency reserves of the country were less than $ 50 million. Therefore, Gunathilake stated that he did not expect any real estate developers to commence any new condominium development projects even if they could factor in the increased cost of building materials due to the severe difficulties they would face in opening Letters of Credit (LCs).   Accordingly, he stated that the only stocks of condominium units available in the market for the next couple of years would be the stocks that already existed or were at near completion, and stated that there would be a significant demand for such units. Therefore, this under-supply of units in the condominium market would inevitably lead to it becoming a sellers’ market as early as three months from now. This, he stated, would allow developers and early buyers of such remaining condominium units to make a significant return on their investment. Gunathilake was of the view that the recovery of the condominium market would depend largely on the establishment of political and economic stability within the country. As he pointed out, a key selling factor of condominiums is the convenience they provide in terms of security and steady power supply. However, in the current economic situation due to recurrent diesel shortages, most condominiums do not have diesel to power their generators. Furthermore, he believed that people would be hesitant to move into such luxury housing in cities while the current instability within the country continues, and therefore he doesn’t expect the condominium market to recover for at least two to three years until the current volatile conditions in the country are stabilised.