Friday, November 7, 2008

Bust or No Bust in the Real Estate Market?

This seems to be a very popular subject indeed. Replies to my article below as well as comments on other boards keep kicking this question around. Most people say it’s a bust. Here is why I consider it a deflation, although the term itself is of secondary importance. What counts is the impact various factors have on both the players in the real estate market and the overall economy. Let me give you an example of one of those projects, in which I am involved as an adviser.

A friend of mine bought one hectare in Phnom Penh Thmey in April of 2007. It was the typical low-lying land along a higher-lying badly paved road, which was previously used as agricultural land, most likely a rice paddy. The difference in level was about 1 m. The reason he bought it was clearly for speculation, as the boom had been going on for a while now and he had profited well from a few previous deals. He paid $30/m2, which was still considered a good buy as most of the neighboring lots already went for around $50/m2.

First thing he needed to do was fill it up with dirt. He then built a low stone wall around it as a boundary. The land was then divided into 92 lots; the majority of them measured 4m x 15m, some twice that size, with some land set aside for villas. You also needed to allocate common land for streets, sidewalks, etc.

At that time, filling up one hectare cost about $5,000, so the total cost to him was around $310,000, including the low wall. The whole thing was a family affair; each of his adult children had chipped in to come up with this sizable amount. But one month later the price had already risen to $60/m2 and he had a lot of inquiries. Some people even came by with large wads of cash to buy on the spot. The market was this hot at the time. It really seemed like they were on the road to making a bundle. I had been watching the market and seen this incredible rise in prices, which to my critical mind was rather unhealthy. Much of the land was completely undeveloped - no power, no water, no access roads. But the local commune and Sangkat chiefs promised to bring in roads and power.

I advised my friend to sell immediately, forge the iron while it was still hot, so to speak. He was thinking about it and indeed sold off about 27 lots at $70/m2, but not because he thought this was a good price. He needed some money for different things, one of which was a big limousine. He said people didn’t believe the driver of a beat-up ’94 Camry was really the owner of the land. So the limousine was an investment in the business as well as a welcome status symbol. He no longer had a problem with the traffic police and fenced off streets were still open to him.

In October the price of land there had risen to $95/m2. I kept urging him to sell so he would have money to flip more land and in the end make more money than as if he waited for prices to rise.
But now he thought building the so-called Cambodian flats, basically row houses, would be the way to go. He could increase his overall profit by another quarter million. So he made plans for this but couldn’t carry them out for lack of capital. I did not want to get involved financially as I was by nature not a speculator but a trader or manufacturer by conviction.

Prices kept rising until they had finally reached $155/m2 in March 2008. In order to realize his plan he needed to build at least a model house so people could see the quality and then he could get down payments, which would be the base for his construction – a typical mode of financing and operation in the housing market (which he finally did, but not until August, a bit too late).

But slowly those price increases came to a stop on news of the real estate market collapse in the U. S. Although this did not directly affect the Cambodian economy, it made a few people with ties to overseas Khmer a little jittery so the white-hot state of the market became a red-hot state and finally only a glowing state in May. All admonitions to cash out were brushed aside in the hope of more rising prices after the election. He firmly believed it would go on and on and on.

A first disturbing sign was that prices dropped a little, e. g. $5/m2, then another $10/m2 in May and June. He still had buyers but didn’t budge. Then in July the market came to a complete halt, and prices started dropping even more, in our case, to $130, then to $120, and $110. It would still have been a nice profit of some $300,000. But in July everyone was waiting for the election to be over to see what was going to happen then, so no buyers. And that situation hasn’t changed since then until now – no or hardly any buyers. Finally the price for this property hovers around $100/m2, but determining a price is somewhat difficult if there is no action in a market. He is now holding on to his land waiting until the market picks up again. He is confident he can even sell it now at a discount and still make a profit, which probably is true. After a hype prices usually settle at a realistic level. His advantage is that some laterite roads were built so the site is not completely without access. Power is available nearby too. So some real value has been added.

This example is to illustrate my contention that it is not really a bust. I would like to point out that the signs for a slow-down started as early as March. This could be seen all over the place, not only at the site in question here. When things slow down gradually it is generally not a bust but a deflation. A bust is a free-fall.

But never mind the word. So far there is no word of anyone getting hurt in a way that they have lost real money, meaning cash. The big companies, e. g. the Koreans with multi-million-dollar projects, or the Canadia Bank have shown no signs of stopping their projects in progress. Of course, there is a credit squeeze; so many new projects have been put on hold.

But the majority of private speculators are just like my friend. The used their savings, possibly pooled them, or found partners to make those deals. Now they have been caught with their dreams of a nice profit unraveling, but it is not a nightmare yet, as they have no loans to pay back, and if they have some other means of making a living they can wait it out. And many of them, again like my friend, had gone through a number of previous deals that left them with enough money to live on for some time. One mustn’t forget that the cost of living, despite its 20%-plus inflation, is still only about one fifth of that in the U. S.

Like my friend said, ‘80% of the land in and around Phnom Penh is owned by rich people anyway. They have no problem holding on to it for some time.’

Westerners make a big mistake when they say it will get worse still. Again they forget there is virtually no mortgage market here. A recent article in the Phnom Penh Post stated that ANZ’s mortgage volume is about $5 million max, and they only loan 50% of the home value. That’s a negligible amount by any standard. So people losing their land or home won’t happen, apart from singular occurrences. Banks in Cambodia losing money on mortgage derivatives is not going to happen either. That concept is completely unknown in these parts. People losing their jobs and defaulting on their mortgages is an impossibility in Cambodia. People losing their jobs because of the real estate melt-down are the construction workers, service personnel, etc. Sorry, those people didn’t have the money to get into the game. Among others, these were all factors in the Western bust – not here.

So by and large, it’s a standstill, which will slowly re-gain some drive, perhaps not at the levels and hype as before, but surely there will be movement once the recession in the developed world is beginning to show signs of recovery.

As for myself, I didn’t speculate. I bought agricultural land, the cultivation of which still returns a slight profit, not as good as before because of the decline of commodity prices, but, like my Cambodian friends, my Khmer wife and I can wait for the market to recover. In fact, prices in my sector have been rising slightly already.

I also bought land to build a nice house on. Maybe it was a little too expensive, but then the location more than makes up for it – on a river bank about 500 m from the sea facing west. What more do I need?

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