RIU REAL ESTATE MARKET REPORT 2020: A change in fortunes expected

By, Roshan Madawela, CEO, Research Intelligence Unit (RIU)

Velocity of the luxury market apartment sales remained subdued due to the sluggish economic
conditions that prevailed for much of 2019. Additionally, three factors contrived to further stifle the
market. Firstly, the terror incident that shocked the world on Easter Sunday led to a complete loss of
confidence in the country and resulted in an immediate slump in tourism and all related segments of
the real estate industry. Secondly, uncertainty regarding the imposition of VAT on apartments turned
many potential investors away from the property market. Thirdly, the November Presidential elections
that further intensified the ‘wait and see’ sentiments in the market, added to the overall slowdown in
sales velocity.

Whilst the overall absorption levels for the majority of tier 1 luxury apartment projects that are
currently under construction had already topped 60 per cent, our quarterly sales data gathering in 2019
pointed to a significant tightening of market conditions. To revive the sales velocities, developers have
been offering more flexible payment schemes and attractive discounts.

Although some factors were beyond the control of policymakers, the authorities did little to help the
industry. Confusion reigned again for much of 2019 with regards to tax on property. The much discussed 15 percent VAT on condominiums that was finally imposed on 1 July and resulted in an 8 –
12 per cent increase in the prices of luxury and semi-luxury condominium units. However, the VAT was
only applicable for apartments valued over LKR25 million which represented a departure from the
original announcement that it would be applied to all inventory valued above LKR15 million. Following
the change in political leadership in November, the overall VAT rate in Sri Lanka was revised down to
8%. At the time of writing, VAT on apartments has been completely removed. The impact
of political change has already had a positive impact on business sentiments and our initial research
findings point to much-improved conditions in 2020. The RIU expects the real estate market to recover
and gather momentum in 2020.

Luxury apartment rental yields in Sri Lanka, which remain fairly attractive by regional standards, did not
change for most luxury apartment projects over the course of 2019. Rents in Colombo have
traditionally been relatively high, but the past few years have witnessed some levelling-off as the total
inventory of apartments has increased. This trend is expected to continue throughout 2020 and
beyond.

Turning to the retail sector, high-end mall space in Colombo began in 2019 at around 1.5mn sq.ft.
However, the opening of the Shangri-La mall, which was delayed by one quarter due to the terror
attacks, added a further 480,000 sq.ft to the total mall space in Colombo. Mall operators were also at
a loss for much of 2019 due primarily to the sudden slump in tourism following Easter Sunday. The
sector has continued to recover at a steady pace over Q3 and Q4 of 2019. In 2020, we expect to witness
further supply additions in the form of the Altair and Orian City malls.

With these and other pipelined mixed developments adding more retail space, the next few years will
further position Colombo 2 and 3 as the top premium retail hotspots of Sri Lanka. Whilst occupancy
levels of most of the retail malls decreased marginally in 2019, the RIU expects 2020 to see a turnaround in fortunes in this industry segment.

Grade A offices account for around 30 per cent of the total supply of grade A and B office space in
Colombo. Currently, the top end of the commercial office market totals around seven million sq.ft
(grade A and B) with grade A alone accounting for 1.9 million sq.ft. The World Trade Centre still remains
the largest commercial propertywith 625,000 sq.ft. as comparedwith the Shangri-La office towerwhich
added 530,000 sq.ft. The AOD (Academy of Design) and ready-wear commercial buildings also added
some 179,000 sq.ft. at the top end of the market in 2019.

At present, Colombo 1 and 2 stand out as locations with the largest supply of grade A office space with
supply totalling over 1mn sq.ft in 2020. Lease rates are converging towards US$2/sq.ft. The demand for
grade A office space continues to remain strong and robust. This was reflected by the very high
occupancy rates (above 90 per cent) during 2019 despite all the setbacks as described earlier.
Demand for high-end office space has traditionally lagged behind supply in Colombo. For the most
part, developers have opted to construct residential developments that yield more immediate returns
and consequently, the supply of commercial space, which is typically leased and not sold, has been
neglected. It’s also the case that many occupants of high-end commercial spaces are foreign corporates
(MNCs) with their earnings largely derived from US$, making current rental rates in Colombo very
attractive for them, especially amidst a perennially weakening LKR.

According to the RIU market data, demand for Grade A space will continue to be strong in 2020 and
beyond with occupancy remaining above 90%. In the next two years, a further one million sq.ft. of top
end space will be added to the market with the completion of seven new projects. The JKH Cinnamon
Life will be the largest of these, adding 264,100 sq.ft of space in Colombo 2.

The bare land market in Colombo city has been extremely sluggish in 2019 following 2-3 years of
euphoria in 2016-17/18. Consequently, bare lands have been a buyers’ market for the last 5-6 quarters
with some sellers preferring to hold rather than part with plots in Colombo. According to the data,
2019 was a year that witnessed the lowest levels of transactions in recent years. The RIU is of the view
that this market correction was inevitable, especially as the economy was growing at its slowest pace
for a decade. Early indications in 2020 point to renewed interest in the bare lands market in Colombo.
However, it will be several quarters before we see a significant incline in land prices.

It was reported in Q1 2019, that Colombo City hotels were facing challenges in maintaining healthy
occupancy rates that have been enjoyed in recent years. The main reason was the increased supply of
rooms within the Colombo city limits. However, following the Easter attack bombing incident, hotel
occupancy slumped to as low as 10%, leaving operators struggling for survival. The next two quarters
witnessed almost every hotel operator slashing their prices to attract local tourism. The strategy
appears to have contributed towards the survival of the industry and by Q4 2019, occupancy rates had
recovered to above 50% under normal pricing schemes. With total arrivals for 2019 recorded at 1.9
million as compared to 2.3 million in 2018, it has been a tough year for the City Hotels but the RIU
expects the industry to recover in 2020 and beyond. In particular, Colombo will continue to attract
more MICE Tourism (Meetings, Incentives, Conferences and Events), particularly from the Asia region.