Egypt’s Real Estate Sector Poised to Benefit from Depreciating EGP

Thursday, 10th November 2016

For domestic investors facing the economic vagaries of the past few years and the hopeful but volatile immediate term, Egypt’s real estate sector remains a popular hedge against inflation and a sliding currency. The Central Bank of Egypt’s decision earlier this month to float the overvalued Egyptian pound should see property prices more or less track the pace of inflation. Devaluation should have a mostly positive outcome for developers on the whole, with investors in equities keeping an eye out for which companies are best positioned to mitigate increasing costs of building materials.

Developers bullish on real estate market amid devaluation

By and large, devaluation certainly doesn’t appear to be hurting developers. While we’re still in the midst of earnings season with a number of major players yet to release third quarter earnings this month, in the past week both Palm Hills Developments and Emaar Misr reported healthy results, with Palm Hills posting a 59% year-on-year increase in third quarter net profit after tax and minority interest, for a reporting period ending at a time when the parallel rate for the Egyptian pound was around 13 to the dollar versus the official rate of EGP 8.88.

In the second quarter of the year, covering the period in which the central bank devalued the official rate for the pound by 14% and in which the parallel rate for the US dollar had already reached EGP 11, Palm Hills recorded sales of EGP 1.2 bn, on par with the same period the previous year, and an EBITDA of EGP 142 mn, up 25% y-o-y. Meanwhile, Emaar Misr reported a third quarter net profit of EGP 372 mn, up about 68% y-o-y.

Over the third quarter for the sector as a whole, “average sales prices for both apartments and villas increased… exacerbated by increased demand from [domestic] speculators ahead of the expected currency devaluation in October,” noted real estate advisory JLL in their Q3 2016 Cairo Real Estate Market Overview, published last month before the flotation which ended up taking place in November.

“We still see the effect of the devaluation of the Egyptian pound as a positive function in increasing our sales figures,” said SODIC Managing Director Magued Sherif during the developer’s 2Q 2016 conference call in August, for a reporting period in which they recorded EGP 435 mn in revenue, up 44.5% y-o-y, with a net profit of EGP 97 mn, up 38% from the same period last year. “People still love real estate, they believe that real estate is a very good, safe way to store value against devaluation. So we are bullish about the market,” he added.

How might foreign investors respond to increasing costs of building materials facing developers?

“The market remains volatile but valuations of real estate companies have recently picked up on the flotation news,” said Jan P. Hasman, Sector Head of Real Estate Research at CI Capital. “Increasing costs of building materials are now the main concern of many investors, who fear an impact on future profit margins, especially in projects that have been already pre-sold in previous years and where space for increasing prices of the remaining inventory is limited. We favor companies with good execution discipline, limited legacy backlogs, low leverage and direct land ownership.”

Will contractors attempt to pass on some of the increased costs of inputs onto developers?

Hampered by import restrictions that saw dollars allocated to essential items such as medicine and baby formula, contractors had in recent months been forced to resort to an ever escalating black market rate to source dollars to buy imported inputs for building materials. Just last month, the government announced it was forming a committee to resolve issues facing contractors stemming from the currency crisis, including the possibility of compensation to affected contractors as being on the table.

“We expect that some contractors would attempt to renegotiate their existing contracts with developers due to increasing cost of materials,” said Hasman. “Some developers will inevitably need to bear some of this burden and attempt to reflect these increases in prices of their remaining inventory. Others could mitigate these pressures with heftier down payments for future construction works or awarding greater volumes to their contractors of choice.

“Companies with stronger cash flow discipline and no construction delays should fare better, in our view. Paradoxically, increasing material costs can sometimes trigger additional demand, with people rushing to buy their required units before developers begin repricing new product to compensate for increasing construction costs,” he added.

From the point of view of homebuyers, how will devaluation impact pricing and floorplans for different market segments?

With regard to already contracted sales, the possibility of developers restructuring or extending payment plans is not likely, said Hasman. “Overall, a seven year payment plan is becoming a market norm right now, with some developers offering a 0% down payment option on a six-year plan instead. For the time being, we do not expect the market to extend these plans further due to increased costs of funding, making speedy collections and execution a priority.

“It is more likely that average apartment sizes and land plots for stand-alone units begin shrinking again, in order to reduce the ticket size. We have already seen one developer stacking two villa-like dwellings on top of each other and making them accessible from different land levels on the opposite sides, in order to reduce land use and, thus, the unit price. We would not be surprised to see more of similar innovations in the coming months.”

As for the middle and upper-middle income segments, where “competition is becoming fierce as many large-scale projects and government-sponsored co-developments are now launching,” Hasman notes, “we initially expect that price growth in these segments could be capped next year. Price growth in the luxury segment is more likely as development land for such projects is increasingly scarce, capping immediate supply.”

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