Real estate in a pandemic

By Madhusha Thavapalakumar

The prevailing pandemic has brought large changes across all sectors and Sri Lanka’s real estate market has been no exception. Like for many people out there, 2020 has so far been a big question mark in terms of financial stability for those engaged in the real estate industry. The pandemic and its unforeseen impacts – including frequent curfews, limited travel, job cuts, and wage reductions – have a profound negative impact on the country’s real estate market.

Sri Lanka’s real estate sector went through a dynamic development following the end of the civil war Sri Lanka endured for over three decades. The country’s real estate sector finally began booming as the urbanisation rate increased to 0.3% in the first five years following the war, after years of negative growth. Before Covid-19 struck, the urbanisation rate was expected to increase by 3-4% per annum, with Sri Lanka moving towards a diversified economy, according to KPMG Sri Lanka.

Therefore, The Sunday Morning Business this week is taking a look at Covid-19’s impact on Sri Lanka’s real estate market.

Working from home and reduced office spaces

“Work from home” is a concept which has been gaining popularity in many western countries for the last 20 years now, even though origins of this trend could be dated back to 1973 when the Organisation of Petroleum Exporting Countries’ (OPEC) oil crisis and gridlock brought the US to a standstill, just to save gasoline.

However, in Sri Lanka, only a handful of businesses permitted their employees to work from their homes before Covid-19. After the local outbreak of the pandemic and the subsequent lockdown, many Sri Lankan businesses, apart from essential services and manufacturing facilities, particularly those in the capital of the country and its suburbs, opted to work from home. Even after the lifting of the initial lockdown, most corporate companies remained working from home on a roster basis work schedule where employees have to physically report to work one or two working days a week and work from home the rest of the weekdays.

As a result, most corporate companies downsized their office spaces and, needless to say, have either given up or delayed decisions on real estate investment plans and expanding their office spaces as they are more focused on giving up rented out or leased spaces as a cost-cutting measure.

Overseas Realty (Ceylon) PLC Chief Executive Officer (CEO) Pravir Samarasinghe, in a report on the Covid-19 impact on Sri Lanka’s property and construction sector, compiled by PricewaterCoopers (PwC), stated that cash flow issues may force enterprises to move to lower-grade buildings or cheaper real estate.

“For example, you might see the firms may go from A-grade buildings in the business district to B-grade buildings or secondary business districts, or even to the periphery of Colombo,” Samarasinghe said.

In the recently released KPMG CEO Outlook, the results of a CEO survey of 315 global corporate CEOs points to a widespread desire to scale back on office space. Besides a widespread acceleration of digital investments, a majority 68% indicated that they plan to downsize their companies’ office space. Besides the cost reduction aspect, 72% of the CEOs saw benefits from remote working in terms of widening their talent pool and spending less time commuting.

According to a report on “Covid-19 Impact on Sri Lanka Real Estate”, compiled by KPMG in May 2020, the outbreak was expected to exert pressure on the office space market, and rental growth was expected to suffer in the short and medium term.

This forecast was made way before the second wave of the virus while Sri Lanka was celebrating being one of the few countries that “successfully” eliminated the Covid-19 community spread. Nevertheless, now that a second wave of the virus is hampering the country’s economy once again, the impact is expected to be beyond the medium term as companies, regardless of how big or small they are, have already become comfortable with working from home.

Facebook Founder Mark Zuckerberg, following the outbreak of the pandemic in the western world, stated that over the next five to 10 years, he could have 50% of his employees working remotely. Google CEO Sundar Pichai too is considering a hybrid work-from-home model in the long term, as employees prefer working from home over coming to office everyday. Similarly, many notable conglomerates in Colombo have opted for a hybrid work-from-home mode.

Regus, a multinational provider of serviced offices, business lounges, and conferencing facilities, in a recent report says that for property brokers, working from home could be seen as a threat to their bottomline, as their portfolio of large, single-site offerings become more and more outdated. 

Construction activities are on hold

The ongoing pandemic has worsened the construction sector’s financial struggles that date back to 2018. The struggles were created due to a large number of unpaid bills by the government to contractors. These issues were exacerbated by the constitutional crisis in late 2018 and the Easter Sunday incident last year which drove away foreign direct investments (FDIs), according to industry stakeholders.

A report done by JLL, a global real estate services firm in May 2020 titled “Covid-19 reshaping the Sri Lankan Real Estate Market Impact and Outlook” states that Sri Lanka’s construction activities have come to a grinding halt and delay completions of prime A-grade buildings that were anticipated in 2020 and 2021, thus leading to limitation in supply.

“In the short to medium term, there will be a notable reduction in fresh take up of spaces resulting in lower market absorption. The looming uncertainty will force occupiers to adopt conservative strategies in incurring capital expenditure. Anticipated chances for an increase in multinational companies’ footprint this year has also significantly shrunk with softer business sentiments across most industries globally,” the report added.

Furthermore, FDIs and local investments into the construction sector have been very low or negligible compared to the previous years. Making struggles worse, the Government too has suspended most of its large and medium-scale construction projects due to financing issues.

Given the current circumstances, the demand for condominiums has slowed down with a probability that they recover over the medium-long term as the economy recovers, according to Samarasinghe on the PwC report. He added that on the supply side, it is likely there will be less investment for condominium apartment projects due to the current inventory of apartments in the next few years.

He stated that normally a household’s capacity to borrow may be five times of the household’s annual income and there can be incentives given by the Government, especially for the first-time homeowner by way of concessionary interest rates. He also suggested that the Government can also provide the land at a concessionary rate, making apartments more affordable.

However, there are some encouraging signs on the construction space. Speaking to The Sunday Morning Business about Havelock City in late October, Samarasinghe explained that none of their plans for the project has since changed, with the company proceeding with the Urban Development Authority (UDA)-approved design.

“Sri Lanka’s current Covid-19 status will not impact us since 95% of our staff are living on the project site itself. We have 600 contractors staying on site and they do not move around, and we do not plan on hiring any new people.”

Havelock City was bolstered by a financing arrangement with DFCC Bank a few days prior to these comments, and the project’s commercial complex, Mireka Tower, is set to finish construction on 31 July 2021 and officially open to the public by September the same year.

Furthermore, Capitol TwinPeaks, the Rs. 25 billion flagship mixed development project by Sanken Group’s Capitol Developers and Sanken Construction, located on the Beira lakefront in Colombo 2, has begun the installation of their 50th-level sky bridge.

Following the announcement in early 2019 for plans to set the record for South Asia’s highest sky bridge, the project, which is set for completion and handover by end-June 2021, began the installation of the sky bridge on 29 October 2020, despite the second Covid-19 lockdown that continued to affect many of Sri Lanka’s industries.

Tenants and landlords

The Covid-19 pandemic and the resulting economic downturn have disproportionately affected renter households, particularly those that rely on wages from at-risk jobs. The pandemic hit at a time when nearly half of all renters were cost-burdened, paying more than 30% of their income for housing, according to a study done by Harvard University.

Meanwhile, according to the JLL report, landlords are not implementing rental discounts as of late on prime A-grade buildings; however, they’re expecting to offer flexibility over contract negotiations. Existing tenants are using this opportunity to renegotiate contracts and are requesting for a rent-free period. Landlords exposed to short-term lease structures will be the most vulnerable to the prevailing situation.

The report adds that flexible office space operators (co-working and serviced offices) in particular may be at risk if members decide to cut short-term contracts. The anticipated increase in vacancy will potentially force landlords to offer elevated concession packages to close transactions with tenants in order to expedite discussions.

Lull in residential market

Samarasinghe, in the PwC report, says that the recovery of the residential housing market will be supported by trends in urbanisation, increasing land prices, income levels and a proportion of high net worth individuals, and ownership of multiple investment assets impacting the demand for condominium apartments over the medium to long term.

Meanwhile, Maga Engineering (Pvt.) Ltd. Director of Finance and Planning Mega Kularatne, in the same report, stated the year would be challenging with the competition from foreign contractors, especially in residential real estate, and inconsistent government policies.

The residential sector of the country was gradually gaining pace with a significant number of new enquiries and launched towards the end of 2019, following softened demand post Easter Sunday attacks in April last year. However, with a downturn in global economic conditions caused by the spread of Covid-19, inquiries and walk-ins were declining again since late February this year, as per the report of JLL.

“Uncertainties worsened following the imposition of lockdown, with few potential buyers already deciding to hold back on buying decisions. Concerns are highly increasing on costs, cash flows, and delays in launches among developers and construction companies. There will be notable delays in launches and handovers due to halting of construction activities. Some developers are already offering discounted rates to expedite transactions soon as the curfews are lifted as a measure to reinforce cash flows,” the JLL added.

The residential sector is a resilient market and the capital’s condominium market has remained resilient throughout various economic conditions. From an investor perspective, apartment investments in Colombo benefit from stable cash flows, regardless of market conditions. The JLL forecast that was done way before the second wave in the short to medium term expects to soften demand due to diminished consumer confidence as well as reduced mobility and liquidity.

Meanwhile, the KPMG report notes that closing deals relating to the sale and renting apartments and houses will be on hold for a period of time due to the difficulty in arranging sales visits and inspections of properties. Furthermore, despite the actual domestic demand for housing units with the growing population, and reducing household size and housing gap in the market, the overall economic situation could make home buyers anxious and postpone purchasing decisions.

“Any transactions during the short term will fetch distressed prices. Residential apartment sales were seeing renewed interest since January 2020, following a lull in the market in 2019. The residential apartment market has seen a lack of continuous demand, due to both concerns on the economic and political front and also inconsistent policies in the sector during the past few years,” KPMG noted.

Hospitality sector took biggest hit

Tourism is one of the top three revenue earning sources of Sri Lanka. The industry has gone through massive developments over the past decade and the real estate industry of the country has been leveraging on this development. Huge hotels were seen being built across the country to cater to the targeted annual tourist arrivals. Nevertheless, amidst the prevailing situation, hospitality properties across the country are now making very little or no business.

According to the tourism industry report for the first quarter of last year, compiled by the Sri Lanka Tourism Development Authority (SLTDA), the total number of SLTDA-registered accommodation establishments was 2,403, while the number of classified tourist hotels was 147, among which 23 were five-star hotels. The presence of small and medium-scale enterprises was strong with guest houses, homestays, and bungalows, recording the highest number of registered establishments with 969, 476, and 412, respectively. The total room inventory was 38,908 and classified tourist hotels had the highest inventory of 13,544 rooms.

At the onset of the pandemic, the hospitality industry in Sri Lanka was still recovering from the effects of the Easter attacks last year. There was a significant decline in tourist arrivals in 2019 in comparison to the year 2018. However, the sector recorded a softened growth towards the end of 2019 as a direct impact of travel restrictions around the world due to the spread of Covid-19.

Occupancy levels were hovering at below 50% even before the start of the lockdown, according to JLL. In February 2020, Colombo’s hospitality market suffered an 8.1% drop in occupancy in comparison to the previous year, mainly due to a dramatic drop in Chinese tourists as Covid-19 was spreading in several parts of China. The effect was greater in the leisure markets of Sri Lanka’s south-west coast which recorded a 21.7% decline in occupancy levels as compared to February 2019.

These figures dropped to zero level in April with the closure of the Bandaranaike International Airport (BIA) for tourists in March, and also due to the seven-week-long local lockdown that effectively kept locals from going on trips and vacations. Following the lifting of the lockdown, contributed by local tourists, hotel occupancy rates across the country were slowly improving and reached 20%. Disrupting the slower growth, the second wave raised its head in early October, crippling local tourism too. With curfews being imposed in several cities across the country, local tourism is yet to pick up.

KPMG noted that travel restrictions, event cancelations, reduced personal and business travel, etc. will impact short-term occupancy levels and low demand will bring pressure to reduce average room rates, thereby creating a significant impact on profitability.

“The recovery of the sector is likely to be well into 2021, assuming the pandemic does not see a resurgence. Over the past couple of years, Sri Lanka has seen a sharp rise in the supply of leisure-related real estate. The supply has outpaced tourism demand, and the informal leisure sector such as home stays and serviced apartments have also been creating pressure on room rates in the formal sector,” KPMG added.

Retail sector slowdown

Driven by rising income levels among the masses, the Colombo retail sector was witnessing a slow but steady metamorphosis. However, domestic retail spending suffered a temporary decline, especially in the non-essential and leisure services, since the nationwide lockdown triggered by the outbreak of the virus and prevailing import restrictions.

As the transmission of the virus fell into the Sinhala and Tamil New Year season and then again into Diwali in November, and then possibly Christmas in December, JLL expects a full-year financial impact on retailers, especially in the non-essential category, leading retailers to actively seek temporary rent reliefs from landlords. Additionally, retailers who were planning on expansions or refurbishments are also likely to hold back on their decisions, if liquidity and capital constraints arise.

Meanwhile, Sri Lankan e-commerce sites and online retailers have gained significant traction during the pandemic. Being permitted to operate under curfews, retailers with the requisite wherewithal to fulfil online orders and provide doorstep delivery are emerging as the key beneficiaries in the current distressed business environment.

As a result of all this, along with the drop in tourism and reduction in domestic retail spending on non-essential goods, as KPMG noted, retail stores and malls are financially suffering. It added that domestic buying may be affected as a result of reluctance or inability to visit such retail and mall spaces due to health concerns.

Furthermore, many restaurants are also running mostly empty, with limited operations only through delivery. Certain retailers are facing higher cash flow risks due to high operating costs and cash being tied up in the stock build-up for the Sinhala and Tamil New Year season.

Measures to safeguard the real estate market

As per the report that has been referred to write this article, more fundamental reforms in policies will have to be devised at the national level in order to attract foreign investment into the real estate market, despite the prevailing situation.

Common spaces of highly dense vertical buildings and gated housing developments will pose a high risk of virus transmission. Therefore, additional attention must be given to drawing up plans and protocols for present and future scenarios in order to mitigate such risk. As the crisis is likely to permanently change real estate, industry stakeholders need to reposition themselves as soon as possible to ensure they are prepared for new trends such as reduced office working, the rise of the digital economy, and a decline in business travel.

For commercial real estate property owners, assessing a tenant’s financial position and identifying those who are most likely to survive and prosper will be key in selecting where to invest in and create a strategy for moving forward. Furthermore, real estate companies must consider old and new funding options to shore up cash in the short term.