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Caveat Emptor

December 16, 2016

When one of the richest men in Egypt warns of a real estate bubble, you really should take stock and have a think about it. This is especially true if we are talking about Samih Sawiris, a man who built much of his wealth from real estate in Egypt and is an insider to the industry with skin in the game. And he is not the only one who believes the writing is on the wall.

 

At a recent AmCham real estate conference, Samih warned, “The market is oversupplied and sustaining sales will be difficult in no small part due to the float of the EGP. Egyptians are now 30-40% poorer and their purchasing power dropped during the devaluation.”

 

A bubble is an economic cycle created by a surge in asset prices unwarranted by the fundamentals of the asset and driven by exuberant market behavior. What really worries me about this off-the-shelf definition of a bubble are the words “exuberant market behavior,” which echoes the warning of Alan Greenspan, in typical Fedspeak, of “irrational exuberance” in the run up to the global financial crisis of 2008.

 

In Mohamed El Erian’s excellent book The Only Game in Town, he summarizes the lead-up to the global financial crisis as a perfect storm in which the rise and fall of the housing market was debt-fueled by excessively complex and lax lending practices at a time when central banks mistakenly believed in self-regulation and failed to spot the dangers ahead.

 

In simple terms, during the heyday of the housing bubble in the US and most of Western Europe, real estate agents would often repeat the mantra of “safe as houses” to prospective buyers who were confident that the price of houses could only go up and up and up. These buyers were aggressively encouraged (if not induced) by predatory mortgage lenders who offered cheap credit with no questions asked. The frenzy and madness of this “irrational exuberance” is best captured in one of my favorite finance movies, The Big Short.

 

Let’s try and dissect whether the concerns about an Egyptian real estate bubble are warranted. CAPMAS’ 2012-13 household income and expenditure survey (the most up-to-date available) shows the richest 10% in Egypt are those who can afford to spend EGP around EGP 42,000 a year or more. Yet the price of a decent two-bedroom property in any of the new urban areas, such as 6th of October City or New Cairo, will cost a minimum of EGP 1.5 mn.

 

What this tells us is that clearly the majority of the supply of new housing is catered to the top 1% of Egyptians. The same story goes for any holiday homes in the North Coast or the Red Sea. There is no meaningful or cohesive government led policy that focuses on housing for the middle class or those with lower incomes. Despite recent improvements in regulation, access to mortgage lending for the less affluent is still very poor.

 

Yet, real estate developers announce a launch of a new project and within days, if not hours, all units are sold. They’re going like hotcakes ladies and gentlemen, so up until now there is clear demand for these properties. The typical story is for a family to buy a new home and move to one of the new urban development gated communities in order to upgrade their lifestyle. If they become more prosperous, they then start to buy more property as a form of saving and to secure the future housing needs of their children. If they become even more affluent and need to “diversify,” they start to invest in holiday homes in the North Coast and the Red Sea and, if things are going really well, they make the same investment for their kids and grandchildren.

 

But how long can this realistically last? Ten homes? Twenty? Can the rich still afford to maintain this demand after the devaluation?

 

Another question is whether these are actually sound investments or just speculation. The rental yields of the properties in the new urban developments are often much lower than their counterparts for the same price in the traditional affluent neighborhoods, such as Zamalek or Maadi. The yield on holiday homes are negligible compared to the cost and most people don’t rent their holiday homes anyway. Hence the ghost towns in the North Coast that are vacant for 10 months of the year.

 

As for capital appreciation, the secondary market has not been fully tested as most investments have unactualized as opposed to actualized returns, but what we can tell for now is that if someone would wish to sell their home in the secondary market they would have to compete with the ever increasing supply from the primary market offered by the real estate development companies. This goes to the heart of what Sameh Sawiris and others are warning about.

 

Another problem Egyptians have to contend with is a lack of optionality when it comes to their saving and investment decisions. Unless you are a sophisticated investor who can invest in other markets or higher risk investments, you really only have three options: either you put your money in certificates of deposit, real estate or the Egyptian stock market. This exaggerates the problem, because a lot of people who actively invest in the housing market as a form of saving may not have done so if more financial products where available to them (for example, investment grade corporate bonds).

 

Many people in the real estate sector believe the concerns of a real estate bubble are, to put it diplomatically, unfounded. Magued Sherif, the managing director of SODIC, recently argued that half of the population of Egypt are under the age of 25 and are victims of the housing gap. He added that despite the economic difficulties of the last few years, demand for real estate has been strong. 

 

Hesham Shoukri, chairperson and CFO of Rooya Group, agreed with Magued and added that real estate companies are catering for current and future demand. Some data supports this position; a report by Colliers International concludes that the residential supply in Egypt grows by 1% each year, while the population grows by more than 2%, demonstrating that demand outstrips supply. Finally, there is a valid argument that, unlike the US and Europe, very few people in Egypt buy property using debt, which means they are a lot less sensitive to changes in interest rates and the overall macroeconomic picture.

 

So is it a bubble or isn’t it? That’s one of the main problems with asset bubbles — you never really know until it pops. If there was consensus, the market would readjust and the danger would be averted. But, unfortunately, that’s not the way the world works.

 

What I would say is that there are clearly structural problems with the Egyptian housing market that will come to the fore sooner rather than later. These structural challenges and possible solutions are already known to us; a government led change in mindset in order to have a more inclusive housing policy, finding the missing middle and to focus on integrated communities, rationalizing pricing by introducing incentives to the private sector to cater for different segments of the market and deep reform in regulation to provide better access to mortgage financing, especially for those with lower incomes.

 

I would invite you to re-visit the excellent five-part series on the real estate sector published on Enterprise a few months ago.

 

Anybody who invests in anything with the confidence that prices can only go up and up and up will, inevitably, end up with a nasty surprise. Caveat Emptor.

 

This article was first published on Enterprise on Friday 16 December 2016

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