Economic Update

Published 31 Oct 2017

The high-end segment of Sri Lanka’s residential real estate sector looks to be heading towards a period of consolidation and flat returns on the back of a sharp increase in supply.

Estimates suggest up to 5000 luxury homes will make their way onto the local market between now and 2020, with supply peaking next year when 2800 units are scheduled for completion. The influx of available properties is expected to test market demand, with speculation rising that developers may be forced to lower prices in the short to medium term to maintain sales activity and revenue flows. 

Planned measures to curb lending to the sector may well put prices under added pressure. However, foreign interest in the country’s luxury housing projects has the potential to increase.  

Capital gains tax set for April 1 launch

A decision to introduce capital gains tax (CGT) on real estate next year may well have a knock-on effect across the upper end of Sri Lanka’s property market. The tax is scheduled for implementation on April 1, 2018.

Under the provisions of the newly ratified Inland Revenue Act, which was approved by Parliament on September 7, a 10% levy will be applied to capital gains generated from the sale of housing or other property over a 10-year period. The new law also stipulates that all CGT payments must be settled within one month of the finalisation of the asset sale.

Speculation is rising that the tax could deter investors looking for a quick turnover of assets. However, the CGT is unlikely to weaken demand for buyers looking for a home or longer-term investment.   

Concerns rising of possible credit crunch

Analysts have also questioned whether measures proposed by the government aimed at protecting the financial services industry could curb real estate sales in the near term.

With property speculation across the upper end of the sector having driven up bank lending, any cooling in the market is likely to help ease concerns in this area.

At the end of August ratings agency Moody’s lowered its outlook for Sri Lanka’s banks from stable to negative, citing poor asset quality and weaker profitability in the real estate sector. The agency said it expected the ratio of non-performing loans to rise following a period of significant loan growth.

Moody’s noted that bank lending for housing and construction was one of the main contributors to loan growth in recent years, accounting for approximately one-quarter of the 23.8% increase recorded in 2016.   

In mid-August the government informed the IMF that it planned to implement a series of measures aimed at reining in high levels of credit exposure in the financial sector. Lending for real estate and construction would be a particular focus, it said.

Mangala Samaraweera, the finance and mass media minister, and Indrajit Coomaraswamy, governor of the central bank, confirmed Sri Lanka’s commitment to tightening the levels of credit that were being made available to the property market in a letter they sent to the IMF. Written in June, the letter formed part of the groundwork for latest review of Sri Lanka’s $1.5bn extended fund facility with the IMF.

“To strengthen our financial system, we intend to undertake several measures: deploy, as needed, macro-prudential tools such as a sector-specific limit on the loan-to-value ratio including in the construction and real estate sectors,” the letter stated. 

Foreign demand expected to bolster sales

An imposed limit on the level of loans to total property value will inevitably put a squeeze on sales. However, some analysts expect lower demand in the domestic market to be offset by higher levels of interest from foreign investors.

Lower prices would also benefit domestic buyers who are in a position to purchase property without the need to borrow. A cap on lending, meanwhile, could see purchasers extend their reach outside of Sri Lanka’s central locations in a bid to acquire affordable housing. Residential developments further away from Colombo and other large cities are expected to offer good returns in the coming years, as growing urbanisation drives demand.