A robust real estate sector, the foreign investment-driven condo segment has come under pressure, but it might be a well-deserved reprieve to correct itself

"An owner of a real estate asset will not often willingly describe their ownership position as distressed. Instead, a sign of this might be that they are willing to sell the asset at below what they purchased it for, have restructured their mortgage or stopped construction,” James Hodge, managing director of CBRE Cambodia shared in a brief interview last month.

These consequences, though subtle, have been apparent since mid last year, evident from the sector’s performance which echoed the intermittent Covid-19 upheavals.

One example was that 13 per cent out of 279 green net projects consisting of large multi-ownership of multi-let projects, tracked by the real estate and investment firm in the first quarter of this year, was found to be on hold, with over 60 per cent at core construction stage and about 20 per cent at topping-off stage.

This might be indicative of the developer’s struggle to finance the development, or simply that they have decided to wait for the market to turn around before pushing on with their sales or leasing efforts.

While defining the proportion and value of distressed assets is not possible as it depends upon the individual circumstances of the owner, Hodge stressed that a good indicator is in the form of non-performing loan (NPL) rate for mortgages.

As of January 31, 2021, NPL had fallen to 1.05 per cent, which was still slightly higher than a month back, but already “much lower” than its peak of 1.9 per cent in the middle of the year, Credit Bureau Cambodia

(CBC) data showed.

Accordingly, CBC said the share of mortgage loans had been relatively stable at 16 per cent of the total consumer credit outstanding balance portfolio.

Here, Hodge noted that the NPL indicator might have revealed a positive trend, as far as domestic investor solvency goes, but potential issues might not show up in this data because of the loan restructuring that took place last year, as well as the regular use of offshore financing for larger and foreign-owned projects.

Still, he assured, when compared with other forms of debt, mortgages still exhibited a low rate of NPL.

Like the other segments, the condominium market, which saw robust growth until last year, has come under pressure due to the pandemic, particularly with the collapse of international travel and tourism in Cambodia and supply chain disruption in the construction sector.

With up to 70 per cent ownership of condominiums by foreigners, the resulting drop in arrivals and sales saw downward price revisions for affordable, mid-range and high-end units in the last three quarters of 2020.

For instance, average sale prices for the high-end segment dipped under $3,000 per square metre (psm) towards the end of last year after years of recording rates of just below $3,600 psm.

The same with the mid-range segment, which sank below its $2,400 psm resistance threshold.

However, the average prices for the high-end and affordable segments have since regained 4.8 per cent and 3.5 per cent, respectively, in the first quarter this year, CBRE data showed.

In contrast, average selling pricing for the mid-range segment contracted 0.4 per cent in that period.

According to Anthony Galliano, CEO of Cambodian Investment Management Co Ltd, the transaction volume in the condominium market fell 15 to 20 per cent over the year whereas sales price contracted by 20 to 30 per cent. This does not include a fire sale of the assets which saw prices retreating further between 40 and 50 per cent.

“There is a short-term depression or recession in the market, and that has to also do with the [percentage] of foreign ownership,” said Galliano, who is also chief financial officer and a shareholder of DA&G Asset Management, a property management outfit.

Yield compression

Last year, seven out of 19 projects that were expected to be completed were deferred to 2021, CBRE data showed.

In that, some 10,825 units are expected to enter the market, seven per cent of which were delivered in the first quarter of 2021.

The total figure for this year includes an uptake from topped off projects last year.

With the entry of these units into a soft market, the industry will likely see a depression in pricing and further yield compression.

Although sale prices have picked up since the fourth quarter of 2020 for the high-end and affordable segments, it was not clear how long it would last when the sector has been under pressure.

“We will need to see some further adjustments in pricing in order to stabilise the yield,” Hodge contended during the firm’s Fearless Forecast presentation on the real estate sector for 2021 in February.

In the first quarter of this year, condominium rental rates recorded positive movements, with high-end and mid-range segments rising 1.3 per cent and 1.7 per cent, respectively.

The affordable segment posted the highest growth at 3.5 per cent quarter-on-quarter, highlighting a shift in focus towards the domestic market, CBRE data showed.

However, CBRE noted that there was a long way to go to make up the decreases in rental rates that were recorded over 2020.

“In comparison, the high-end rental rates at the end of the first quarter of 2021 were down 9.4 per cent year-on-year on average while mid-range rents were down 12 per cent year-on-year,” it stated.

In his February presentation, Hodge had mentioned that the mid-range segment had been bumpy, and that things could change when a new project is completed, given that it “still isn’t a quite deep enough segment”.

“We really need to get a clear trend of where things are going to go but yields are in the right kind of range for what we would expect,” he said then.

While he maintained this view in present time, he found that it was unlikely to be a significant compression as prices are now more closely correlated to rent due to the switch in focus from developers towards local buyers.

This brings the issue of rent and prices into the picture where the real estate sector remains bullish over the absorption rate for condominiums despite lower returns in the pandemic.

Here, mid-range developers were more flexible over how they market the project compared to high-end developers who were more reluctant to adjust their sale prices.

“When rents come down, prices also adjust, this is the function partly in the secondary market. It is also a function of the mid-range segment. When they are thinking about pricing, they are trying to encourage that sale more closely,” Hodge said.

Yet, competition in the mid-range segment, which is expected, will cause developers and owners to act in a “slightly different way” as opposed to the high-end segment where there is less competition.

That being said, Hodge felt that absorption rates in condo units and how many are sold is likely to narrow, as people are not yet able to travel to Phnom Penh.

“Travel had a big impact. [However] we think the absorption rate [for mid-range] should increase this year because of the changes to lending options as well as developers’ approach to sales.

“Therefore, we are more bullish on their promotion and offers, and the same really for the affordable segment,” Hodge said.

`Gambling on returns’

That being said, he does not dismiss the concern related to guaranteed rental returns (GRR) which condominium developers offer to investors, typically foreigners, to entice sales.

“There is obviously a lot of pressure at the moment on developers, who have been offering GRR back in the really strong market days of 2018 and 2019,” he said.

Back then, developers offered six to eight per cent per annum return on prices which could create problems on their cashflow now.

It is not natural for developers to hold large amounts of cash in their bank accounts in order to pay back GRR, he said, adding that even if they built it into their sales price, they are usually spending that money on their next project.

“So, they are gambling on being able to make an appropriate rental return from tenants, and that is more challenging now,” he said.

Ordinarily, this would involve a contract between the buyer and seller, and if the latter is not able to meet their obligations, there are various processes to go through including pursuing a breach of contract claims, or filing for insolvency, if all else fails.

While this circles back to the question of distressed projects and possible examples of failed obligations in the “not too distant future”, Hodge opined that many developers would have priced the cost of the GRR outgoings into the purchase price of units and could rely on retained savings to keep up with payments.

Echoing him, industry expert, Thomas O’Sullivan, CEO of Realestate.com.kh said although Covid19 affected the profit margins of developers, “by and large they would be able to deliver on the GRR promise, provided they carefully manage their cash and cashflow”.

Noting that demand for rental apartments remained, developers who sold on GRR and were hoping to profit on monthly rents or breakeven, might run at a loss.

“For example, an apartment that was renting for $1,200 a month in 2019, might be leased out for $900 a month today. Even in the current market, if a developer is desperate, they would be able to lease out units. At the end of the day, it is all based on price,” O’Sullivan said via email.

He estimated that some 90 per cent of developers who sold units on GRR in the last 18 months would be feeling the effects until international flights return and the market opens up again.

“However, I don’t believe that any developers that recently handed over or will soon hand over [units] have defaulted on paying buyers the GRR.

“Some developers even give the buyer a discount, equal to that of the GRR. So in theory, the buyer gets it all upfront in this case,” he said.

Eating into profit margin

But as the effects of the pandemic move up a notch in Cambodia, struggling developers might face more challenges as the longer the projects linger around, the costly they become with interest rates racking up on their construction loans.

No doubt a “common occurrence” in any downturn, Hodge claimed, developers will find it difficult to dispose of their units while landlords spend a long time to secure prospective tenants.

“Both are likely to face a situation where they have to give away more in order to achieve a successful deal. This could be in the form of a rental, price discount, or other incentives.

“Alternatively, they can look at offering more services and points of difference to compel the tenant or buyer to do the deal,” he said.

However, all this puts pressure on the project’s cash flow, and so, developers would have to be very careful with their outgoings, prioritising those elements that work for them, aiming to maximise returns and hoping they do not have to seek additional funding in order to complete the project.

Separately, O’Sullivan opined that increasing cost of land, raw material and labour could eat into the profit margin of developers here, some of whom enjoyed nearly 60 per cent in the past, assuming sales price does

not increase with fixed costs.

“But is this such a bad thing? There are not many countries where developers have enjoyed 40 to 60 per cent profit margin,” he said.

`Getting rid of property’

In any case, industry experts speak of changes that are already happening in the condominium scene as developers pivot their sales to the domestic market to stem losses.

For instance, the removal of GRR scheme and fixture and furnishing, which would bring down the prices for locals, O’Sullivan said.

“The shift to the local buyers’ market worked very well throughout 2020 ... all in all, this is a great thing as it meant that developers were filling their local sales quota and condos were now of less risk of being uninhabited,” he added.

These are plans that are “wellthought-out” by seasoned developers as opposed to the first-time developers who were at risk of being “caught out” for riding the real estate “gold rush” in Cambodia.

Meanwhile, Hodge said the pivot towards the domestic market was apparent in the mid-range market where prices have been adjusted to take account of the increased competition in the sector.

Ongoing or further disruption could see further exacerbation of trends witnessed last year, in that developers might look to reducing prices or offer more incentives to spur bookings.

However, putting Covid-19 aside, O’Sullivan is of the view, based on his analysis, that Cambodia is not at risk of oversupply.

As the economy rebounds, Phnom Penh would ramp up in terms of urbanisation and multinational businesses as investors and tourists return to the Kingdom.

“While there might be a slight price adjustment in the rental market due to many developments completing in the next few years, I do not think it is a major risk.

“We are experiencing some shortterm hurt due to Covid-19 but it is not a long-term problem,” he said.

Similarly, Hodge finds that the pandemic’s impact on rents and prices would make for better value for money for overseas buyers and incoming expat tenants, which could help drive the market in the future.

Likewise, CIM’s Galliano believes that the present situation might provide opportunities to buy properties from foreign investors who are not seeing a return on their investment.

“Holding on to an inventory without a GRR scheme will cost you money because you are paying maintenance fees and are not getting any return on it. It is a horrible thing especially when the market is going south.

“I see an opportunity in that area where foreigners who can’t come here would want to get rid of them, willing to take a hit rather than continue to hold on to something that is not giving them returns,” he said to a question posed to him by O’Sullivan in a recent webinar by Realestate.com.kh.

More breathing room

Looking at the whole picture, what the pandemic did to the real sector was give it a new impetus to reconsider methods to realise value from what it does.

While the sector has cooled down, landlords and developers are still keen to do deals as ever, Hodge said, adding that “they just have to find other ways to get those deals done”.

Asked if the pandemic saved Cambodian from a property bubble, he explained that the Cambodian market was already going through a typical market cycle prior to the pandemic.

“And, if we look at price and rent trends in the last few years, we can hardly say there was a bubble [as] indicators in most sectors hadn’t moved a great deal in recent years, excluding land and borey sectors,” he said.

Although there were no “big” upward adjustments in rents and prices, there was a rising wave of development, which acted to compound the effects of reduced demand seen as a result of the pandemic.

Essentially, the pandemic and downward adjustment in the market mean that there would be fewer new launches for a while.

“This will give the market some breathing room to absorb incoming supply before more space is added again,” Hodge said.