Room for change: Huge demand underpins projected expansion

The real estate sector is a microcosm of Indonesia’s entire economy. The market features surging demand, good value in a regional context, a bright future, and bureaucratic bottlenecks that, if unaddressed, could create problems in the future. As is often the case, it is the demographics that loom largest, and in the real estate sector this means a massive need for low-cost housing, something the private sector has shown little appetite or ability to provide. That could change, however, as more and more Indonesians are considered a good risk for mortgage underwriters, which will add purchasing power for low-end housing units.

TRAJECTORY: The current trajectory is similar to that of other emerging markets: as central Jakarta builds up and out there are new hot spots forming, and the city’s future shape will be determined in part by how land is developed along transportation arteries. Investors have begun looking beyond the capital, as bedroom communities around it and other cities such as Surabaya, Medan or Balikpapan are seeing their first high-rise condos, modern shopping malls, big-box retailers and other hallmarks of advanced real estate development.

For the near and medium term, the outlook is positive, with double-digit growth expected in 2012. “The industry expects 20% to 22% growth,’’ said Nanda Widya, the president and director of Indonesian developer Metropolitan Land. “Aside from a growing economy and growing demography, banks are more willing to give loans and interest rates have decreased.’’ Indeed, financing is a major part of the forecast. Mortgage rates are at an historic low, having fallen beneath the 10% level, and that means a record number of Indonesians can afford to buy, instead of building their own homes cheaply. The trend has given rise to large-scale housing developments that are clustering around major Jakarta toll roads. “Intensified competition among banks has resulted in mortgage rates at their lowest in the history of the country. This combined with strong macro-economic fundamentals, stable interest rate and a growing per-capita income has led to a surge in demand for residential housing units.

So much so there is an undersupply of almost 8m across the entire country,” said Hiramsyah Thaib, the president director of Bakrieland, a local developer.

SIZE & SCOPE: Some of the common metrics used in real estate show consistently that Indonesia is undeveloped in a regional context. Leaders here typically benchmark themselves against neighbours such as Thailand, Singapore and Malaysia. Singapore’s property market accounts for about 35% of GDP, whereas in Indonesia it is closer to 5%. A developer building there can construct one unit for roughly the same cost as 10 in Indonesia. The mortgage-to-GDP ratio is about 32% in Singapore and slightly lower in Malaysia, but, again, closer to 5% in Indonesia.

For the country’s main developers, success will likely be determined by their land banks. Although land prices remain relatively cheap, they have seen high growth rates in the past decade. That is important because, particularly for residential projects, the millions of Indonesians who are responsible for the demand-driven economy are still price-sensitive. The cost differential of a condominium built on land bought today instead of five years ago would likely be large enough to wipe out a developer’s profit.

POSSIBLE REFORMS: Though in some ways a market of tight margins, two possible legal reforms could create opportunities. The more likely in the short term is a law that makes easier the process of eminent domain, or mandating the sale of privately owned land needed for public works. The law was expected to be passed by the end of 2011, and could create added expansion as those dislocated by projects, such as a toll road bisecting Java — home to more than half of Indonesians — look for new homes (see analysis).

The less likely but more impactful change would be a relaxing of the laws limiting foreign ownership, which is, as of now, highly restricted in the residential sector.

A partial loosening has been proposed, but allowing non-Indonesians into the market could create a major boom (see analysis). “The sector needs to be opened up to foreigners to attract investments. With foreigners allowed to buy properties, the prices will increase and investors will tap in,” said Widya.

DEMAND FUEL: The consumer-driven demand story has led to a market featuring developers oriented toward residential projects. Housing provides the bulk of revenue for them, with the bigger ones focusing on higher-margin products for the middle- and upper-class buyers. Smaller developers work the less-expensive market segments. Demand is highest for low-income housing, but because the profit margin is usually smaller, this corner of the market remains underserved.

Fuelling demand in nearly every sector is the sudden ease in getting financing. Mortgage rates are below 10% and more Indonesians have the ability to meet basic requirements for getting credit. As the mortgage market matures, inflation stabilises at a lower level and interest rates settle, there are likely to be more buyers coming. “With a growing middle class, historically low interest rates and one of the lowest mortgage-to-GDP ratios in the region, the country is well positioned to achieve sustainable growth in the real estate sector over the next few years,” said Harun Hajadi, the managing director of Ciputra, a large publicly traded developer.

BY TYPE: Apartments in high rises, owned as condominiums, at one time could only be found in the central business district (CBD) but this type of development is now common throughout the greater metropolitan area and increasingly in other cities. As of the second quarter of 2011 the total supply in the city was at about 82,000 units, with some 17,000 classified as low-income housing. Prices continue to rise, with the average in the CBD in the second quarter reaching Rp18.1m ($2172) per square metre, up 3.6% from the second quarter of 2010, according to Cushman & Wakefield data. Low-cost units sold for about Rp6m ($720) per square metre.

Only a minority of the units are lived in by their owners, however, making the condos more popular as an investment than a home at a ratio of about 60% to 40%.

Most speculation on condos occurs before the building phase. Developers typically reach out to past and preferred customers in an initial sale, and prices are expected to rise after secondary sales and the building’s eventual completion. Typically a unit is rented out for seven years to a decade before newer market supply becomes more attractive. But investors are not interested in just capital appreciation.

Rental yields are a factor, and developers have made that a part of their sales pitch. Banners for projects in the sales phase often reflect this, such as one in the CBD in the summer of 2011 promising an 11.9% yield. According to an industry study, Indonesia’s rental yields are the highest in the region, at an average of 11.38%. That compares with 8.98% in the Philippines, 8.76% in Malaysia, 6.43% in Thailand and 3.79% in Singapore.

“When people invest in condos they are typically getting the price appreciation in the building stages but also in the first few years,’’ said Anton Sitorus, the head of research for Jones Lang LaSalle Indonesia. “After seven to 10 years, a condo price stabilises.’’ A secondary market is small but developing, he said.

For most buyers, a condo unit is a store of value, a future residence for a son or daughter, and an investment. For the minority looking to live there, however, buying factors are different. These customers tend to select a tower with owners like them, to avoid the feel of an unoccupied building. They are also more sensitive to factors such as the upkeep and management of the building, and typically pay attention to the developer. Brand-conscious buyers often favour projects by Agung Podomoro, a developer known for well-tended condos and remembered for completing all of its projects during 1998 financial crisis.

HOUSING DEVELOPMENTS: Indonesians still prefer a house on land to a condo, no matter how the building is maintained or what resident profile it has. This is true even if it means a longer commute to a job in the city centre. Housing developments have sprung up all over Jakarta, and the ones in highest demand are situated close to the toll roads. Selling these housing developments is handled differently than condos, in order to attract owner occupants, and in this market a developer’s brand and reputation is even more important.

These developments typically have several hundred detached homes or row houses, often separated into several clusters which can be marketed in themes – extra greenery, proximity to a nearby office tower, a university or recreation facilities. Buyers typically see model units and floor plans and select one before the building stages. Typically a 20% downpayment is owed shortly after a purchase agreement, and developers use that money to finance building. Construction takes 12 to 18 months, and unlike the condo market, in which flipping during building is common, most developers restrict reselling until later, or perhaps allow just one ownership change. The idea is to avoid speculators and empty residences. “If you can’t create a development full of end-user owners, you aren’t going to be considered a good developer,’’ said Octavious Prakarsa, a construction sector analyst with Mandiri Securities. Developers are also obligated to build roads, schools, retail space and shop houses, and regulations require these spaces to account for at least 40% of the project.

SUPPLY PROBLEM: Most developers are not interested in building low-cost housing, even though it has the most demand – estimates vary but the deficit in affordable homes is pegged at about 7m units.

Developers are not interested because margins are lower – about 10%, against 20% or 30% on higher-end projects. That is not unique to Indonesia, but state subsidies and assistance plans have failed to provide incentives due to issues common in Indonesia. The state has several programmes to encourage private firms to build low-cost housing, including offers of cheap land, low-cost loans from state-run banks, speedy service at the permit stage, tax breaks and other incentives, but using them is difficult, usually because of public sector implementation problems. The discounted land may not materialise, or a developer’s state-issued building permits could be challenged by a local government. In the past, those units built were not reserved for low-cost buyers, but instead snapped up by investors looking to profit on a resale or for rental income. Additionally, some developers have had to retool some of their low-cost plans into middle-class developments due to the lack of emergence of promised incentives or in response to conditions dictating the need for adjustment.

To make up for the private sector’s non-response to the low-cost housing problem, small-scale developers have created projects on the city’s outskirts and state-owned builders have been enlisted.

OFFICE: The office segment currently looks like one of stagnant supply, and, therefore, rising prices. There are not expected to be any major new office towers in central Jakarta until 2013, but instead small bits of additional supply dribbling into the market. “It’s a good time for building owners,’’ said Jones Lang LaSalle’s Sitorus.

“Rents are going to go up significantly.’’ The CBD had about 4.12m sq metres of office space in the second quarter of 2011, with rents averaging between Rp140,000 ($16.80) per sq metre per month and Rp150,000 ($18), according to data from international consultancies. The focal point is Thamrin Square, which is ringed by malls and luxury hotels, and continues along major thoroughfares such as Jalan Jenderal Sudirman and Jalan HR Rasuna Said. The occupancy rate in the CBD increased by 0.5%, to 89.4%, in the third quarter of 2011, with around 448,000 sq metres of space remaining vacant, according to the third-quarter report from Cushman & Wakefield.

Outside the CBD, things are different. There is more building activity and more take-up of new office space; however supply seems likely to outstrip demand in the next two to three years. Alongside the CBD, a second premium location has emerged in southern Jakarta.

This second area of dense office space has in the past been a cheaper alternative but prices are for the most part on par with downtown now, or at a discount of no more than 10% or 20%. The area is home to most of the multi-national energy companies working in Indonesia, and also offers proximity to some of the suburbs preferred by white-collar workers. In total, 1.5m sq m of office space is available outside the city for an average of about Rp108,000 ($12.96) per sq m per month.

INDUSTRIAL: Take-up in 2010 in the Jakarta area surged by 150%, providing another example of how global interest in Indonesia has soared since the financial crisis. Land prices on industrial estates has ticked upward along with the increased demand, rising to an average just above Rp500,000 ($60) per sq metre for the year, according to Jones Lang LaSalle data. Rent per square metre for factories in the capital was generally Rp50, 000-60,000 ($6-7.20) in 2010, and between Rp30,000 ($3.60) and Rp40,000 ($4.80) outside the city.

The year’s rising prices and demand are a departure from what had been a decade of sluggish growth after the 1997-98 Asian Financial Crisis. In addition to market forces, another demand driver for industrial land will be a government regulation that will force all factories and other manufacturing facilities to be located on professionally managed industrial estates by 2015. Developers report increased inquiries about industrial estate, most of which is outside the city. A number of smaller towns within 100 km of Jakarta are developing as industrial clusters. Tanggerang is closest to Soekarno-Hatta International Airport, whereas Bekasi, Cikarang, Karawang, Cikampek, Bogor, Serang and Cilegon have toll-road access and good facilities.

The activity here is often tailored to Indonesia’s consumer-driven growth narrative. Inquiries are coming mostly from carmakers, pharmaceuticals and fast-moving consumer goods. Developers have in the past decade been more focused on residential and office projects, but the surge in industrial demand that began in 2010 has them re-evaluating that concentration and calculating new forecasts for this segment.

RETAIL: International names are beginning to pile in, fuelling what was an already healthy retail sector, and growth is likely to continue as modern malls, hypermarkets and big-box retailers spread from Jakarta to Javanese bedroom communities and other quickly growing cities. The growth of retail is likely to follow the patterns in the industrial segment, as the factories and workforces create the need for services located nearby.

Mall rents in Jakarta averaged about Rp602,500 ($72.30) per sq ft per year in second-quarter 2011, according to data from Cushman & Wakefield, up 1% over second-quarter 2010. The price ranged from about Rp506,000 ($60.72) in secondary locations to Rp834,000 ($100) in preferred spots such as the CBD.

Retail space in Indonesia can be leased or purchased on a strata-title basis, in which a development is divided into common space and individual lots, which can then be purchased. The model works often for malls in which individual stores have a uniform size, shape and features – like an indoor market with rows of identical stalls. By June 2011 Jakarta’s total retail supply reached 3.5m square metres. About two-thirds of stock was leasable and the balance in strata-title developments.

OUTLOOK: Demand appears to be set to rise for the near and medium term, meaning developers are likely to be successful. Particularly in the office segment of the market rents are expected to rise in 2012, as no major new supply is expected. With an increase in foreign interest, the downtown condo market is also an attractive one. Foreign businesses are a common customer for condos built with the rental market in mind, and despite about 1500 units sitting empty in the second quarter of 2011, according to Cushman & Wakefield research, rental rates experienced a small increase in the period, up 3% to Rp155,000 ($18.60) on average. The most gains appear to be made outside of Jakarta’s core. Industrial growth on the perimeter is a leading indicator of the recent spikes in residential and retail demand. Similar market conditions can be found in commercially important cities such as Surabaya, a major port, and Balikpapan, where growth is being driven by the oil and gas industry on Borneo. While new supply in several real estate market segments in the coming years may temper growth, stagnation of further development and price contraction are unlikely.