When Will the Land and Building Bubble Burst?

Just recently another South Korean company unveiled plans to build another sky-scraper, and another satellite city both in Phnom Penh, and one in Sihanoukville, complete with shopping malls and full amenities - all with the benign approval from the Prime Minister himself, who has been known to boast with some pride that real estate prices are now even higher in Phnom Penh than in Hong Kong. Can Cambodia be compared to Hong Kong? After all, Hong Kong has been a vibrant economy for a long time with a lot of long-grown wealth dating back to the time of the Tai Pans, and land there is at a premium due to its geographical location and its overpopulation.

Cambodia has seen a surge in land prices and an unbelievable building boom over especially the last two years. Quite a few people became rich overnight and continued to fuel that craze. To pinpoint the origin and causes for this involves a little bit of guessing but with some insight into economics it seems like it all began with the development of the garment processing industry. Cambodia was identified as another cheap-labor country by Taiwanese and South Korean garment manufacturers, later complemented by Chinese companies. They flocked to Cambodia to build their garment factories and needed large tracts of land. At the beginning some of these factories were built right in Phnom Penh itself. Later they moved to the outskirts and nearby towns, such as Kompong Speu.

Initially, they mostly rented the land, which was then replaced by leaseholds concluded with the government or even private landowners. So far foreigners or foreign companies are not allowed to own land in Cambodia. Eventually, they circumvented this regulation by using Cambodian nationals as shareholders who would hold 51% of the shares. This way the company could buy and own land. By giving the Cambodian shareholders non-voting stock, foreigners owned the land de-facto. Why buy land in the first place and go to all this trouble? Land was still cheap. It could be bought for as little as $1 or $2 per sqm. Prices had only one way to go - up. Even if the factory wouldn’t survive, one could still fall back on the land.

Cash-strapped Cambodian landowners readily sold their land to these outside investors, got smart and bought another piece of land to sell. More and more people with a little money got involved in the speculative craze. (This also led to infamous land grabbing by powerful people.)

Anyway, this is most likely how the cycle started, and it is still going on to this day. Basically, it is the fundamental economic law of supply and demand. In a healthy economy the minute demand levels off prices start to stagnate and if there is an oversupply prices will start falling.

The problems start when speculators sell to other speculators exclusively, and not to end-users. This seems to be the case in Cambodia today. And this is not limited to just land. The building boom is just as affected by this ‘virus’. First it was only a few, but word spread quickly, and people came in droves from overseas, especially South Korea. Then Cambodians, including overseas Khmer, who had made money played the game with each other – buying and selling land at a pace never seen before in Cambodia. But condos and town houses are equally bought with the expectation of rising prices.

Another problem is that Cambodia is not a developed country with a healthy economy built on the foundations of a sound financial and fiscal structure. This speculation and building boom bypasses the general population altogether. Out of 15 million how many participate in this boom and how many benefit from it? There is no concrete data available but I would think perhaps between 50,000 and 100,000. After all, this is a country where more than 40% live on less than $2 a day. Wealth is concentrated in a few hands, and the majority of the wealthy people live in Phnom Penh and Seam Reap.

Cambodia is not the first, and won’t be the last, to go through such a real estate boom - and resultant bust. Europe has had it at various times, so has the U. S., and its next-door neighbor Thailand saw its real estate boom/bust in the late 90s. The latest bust in the U. S. is now having worldwide repercussions, which is the result of unparalleled real estate speculation fueled by easy money through sub-prime mortgage lending. All the signs point to a recession in the U. S. dragging down other markets with it. Just this week the European and Asian stock markets dropped by more than 7% in one day, more than at any time in 6 years, on the fear of a rippling effect on Asian economies. Experts say the axiom, ‘When the U. S. sneezes, Asia will catch cold.’ still applies.

It will reach Cambodia sooner rather than later. The U. S. is the primary market for its garments. In a recession U. S. companies will buy less. Money will be tighter and the psychological effect will have its impact on the real estate market in Cambodia as well. Europe won’t be able to make up for the losses since there is already talk of a leveling-off of their economies as well.

A look at the vast number of construction sites and at land that is being prepared for construction is more proof that the whole thing is completely out of balance.

Projects are under way, like Camko City, that in its sheer size and level of luxury seem to be built for another country. Camko City is not the only one. There is a multitude of others. Phnom Penh is practically one huge construction site. The above-mentioned Korean project is another case in point. It appears that Koreans do the majority of the construction, and the majority of the land speculation is now in the hands of Cambodians. A brief count of ongoing construction projects arrived at 50,000 units. Considering the sites being prepared, another 150,000 – 200,000 units are in various stages of planning or construction. This extends not only to the city itself but has reached the suburbs and outskirts as far away as 50 km from the center.

Land prices have reached exorbitant amounts, ranging from $100 per sqm in New Phnom Penh, a satellite city near the airport, to $8,000 per sqm in the center of Phnom Penh or along the riverside. Profits are equally exorbitant, or outright obscene. One sqm in New Phnom Penh, for example, a year ago cost about $30, now it is $120. Just the announcement of the building of a bridge across the Tonle Sap River 50 km from the city catapulted land prices in that area from $5 to $50, and now to more than $100 per sqm.

Town or row houses, so-called Cambodian flats, cost between $40,000 and $250,000 depending on location. (Some are also being built just like Western style town houses.) Single-family homes or villas can easily fetch a few million dollars. This boom seems to have left the realm of reality, it has reached what Alan Greenspan called ‘exuberant’ proportions. He had referred to the Internet bubble, but this phrase is easily applicable to this bubble in Cambodia.

A look at the simple and basic demographics of Phnom Penh underlines this assumption. There are about 1.5 million people living within city limits. 500,000 of those live at or below the poverty level, sometimes in simple cardboard or wooden shacks in slums. An average family has 4 members, that is, the remaining 1.0 million people constitute 250,000 households. Various estimates put the number of families with available cash of more than $100,000 at 50% (though I believe this number to be exaggerated), which would be 125,000. These would be able afford to buy one of those luxury condos or town houses. All of these more affluent families do own a town house, condo or other real estate property for their own use already. They would most likely buy these units to rent out or to re-sell.

Who and where are the buyers? Certainly it will not be the rural population, the 40% unemployed, or the slum dwellers. One segment is young people, the sons and daughters of those wealthy parents perhaps, that receive them as a wedding present. Another segment is the newly rich from all this speculation that put all their eggs in one basket and came out a winner and move upward in their housing needs; or others who made some money in a business venture.

Then you have the foreigners, a not insignificant factor. But will all these add up to a base to sustain that hyper-boom in construction? Even given that the city population will become more affluent in the coming years, this will be a somewhat slower process, most likely spanning a period of up to 20 years. So as a consequence, the surplus of construction can conservatively be estimated at 150,000 to 200,000 units after 2 to 3 years, if that boom continues unabated.

However, eventually, builders will find out, as others in different markets before them have, that supply outstrips demand. This will lead to a leveling-off of prices and finally, once the full scope of the problem has been recognized, to rapidly falling prices of both land and houses. It is a safe bet that this would happen in late 2008 or early 2009, most likely sooner if the fall-out from the impending recession makes itself felt in Cambodia in about 3 to 4 months. The real estate market will simply collapse. In parts of the U. S. one could find the exact same characteristics and symptoms. And sure enough, the bottom eventually fell out. There is no basis for a school of thought that this will not happen in Cambodia. There are no factors pointing to and showing that a poor country like Cambodia will be spared a crash caused by hyper-speculation such as the current one. When speculators sell to speculators a boom in that industry will lead to a bust as sure as night follows day. The question is not if but when.