After a decade-plus of going nowhere, the value of real estate and rental rates are rising so fast that Jakarta has been identified by PwC and the Urban Land Institute as the most promising property market in the region in 2013. Many forces are at work, some short term and others more long term and significant.

Policies and trends suggest a solid base has been established. There are some clouds on the horizon – inflation, speculation, leverage, hot money and macroeconomics, the usual worries in any fast-rising market – but analysts see these as manageable and expect the strength and steady growth to last. “The boom will continue for the next two years,” Anton Sitorus, the head of research at Jones Lang LaSalle Indonesia, told OBG.

STRONG NUMBERS: The trend so far is unmistakable. In the third quarter of 2012 office rents and sales prices were more than double their levels at the end of 2008, according to Jones Lang LaSalle, and the office vacancy rate was down to 4%, from more than 20% four years ago. In the Grade A segment the boom has been even more pronounced. The vacancy rate went from 30% in the first quarter of 2005 to 2% at the end of 2012. Absorption in the central business district hit a record 425,000 sq metres, up from 237,000 in 2010 and 100,000 in 2009; it was less than 50,000 a decade ago.

Condominium sales are also strong, doubling in 2011 over 2010, and numbers for the first half of 2012 indicate that sales for the year were up on 2011. Prices rose by 9% in the same period. In Colliers International’s second-quarter 2012 report, the price for unsold condominiums in the central business district was reported to be up 20% in one year. Industrial land has performed particularly strongly, with prices recovering rapidly in all areas, especially Bekasi, where the price per sq metre has almost tripled since 2008. The year-on-year rise was 85% in Karawang and 70% in Bekasi.

The situation is more modest in other segments. In retail, rent and capital values are up by around 10% from their 2009 nadir, and rents have only recently recovered their 2008 highs. There have been substantial rent increases, but these tend to be in luxury malls and in cases where tenants were given major discounts during the crisis. In the wider market, the increases have been smaller, and vacancies were at 5.4% in October 2012, up from 4.1% in the first quarter.

SUPPORTIVE CONDITIONS: Central to the rising property prices is the supportive economic environment. After GDP fell by 13.1% in 1998, it recovered gently, averaging 4.7% annual growth over the next decade. The pace then picked up, averaging 5.9% from 2007 to 2011. Initial numbers suggest that the 2012 GDP growth rate will be over 6%. Not only has the rate increased, it did so as most of the rest of the world was suffering. Growth dropped to 4.63% in 2008, reflecting the global financial crisis, but rebounded decisively. In a few short years, Indonesia transformed from a country whose recovery was in doubt to one that was resistant to shocks. This has resulted in renewed confidence from local and international investors which has fed through to property prices, both in real demand – resulting from prosperity, the desire for better housing and the need for commercial space – and in terms of people seeking to gain from the growth by buying property.

According to Bahana Securities, 25% of Indonesia’s population was middle class in 1998, when GDP per capita was $482. In 2003 these had risen to 37% and $1100, respectively, and in 2011 to 57% and $3391. Indonesia’s property market is particularly sensitive to moves in broad indicators, as the economy is largely domestically driven. Household consumption as a percentage of GDP has historically been around 60%. Demographics play a role in current demand. The vast majority of the population is under 18 years old, and by 2020 the proportion of very young will fall slightly and more people will enter the workplace.

BOUNCING BACK: Indonesia’s credit rating has returned to investment grade, having hit rock-bottom in 2001 when Standard & Poor’s gave the country a CCC sovereign rating. Interest rates continue to fall. The bank lending rate was 12.4% in 2011, dropping steadily since hitting 32.2% in 1998. Inflation is also now under control. From 82.4% in October 1998 it has fallen to 16% in 2006 and 4.4% at the end of 2012. These broad financial and economic improvements have resulted in more foreign direct investment (FDI) and domestic investment, lower mortgage rates, economic growth and increased consumer confidence, all of which has helped stabilise the property market and fuel its rise.

Foreign investment is particularly important to the property market, and growth in Indonesia is matched by the lack of growth elsewhere. Not only are the economies of the West continuing to struggle, but some markets in the East are starting to underperform. Trouble in the Chinese economy, a sense that property there may be overvalued and increasing tension between Japan and China have some investors questioning whether they should be exposed to that market, with Chinese investors also looking overseas. Other regional markets are also beginning to seem less appealing. The Kuala Lumpur office market has been flat or declining since 2008, and Singapore’s has failed to regain its 2008 highs. While Bangkok is showing signs of life, it too is below 2008 highs.

STILL THE INEXPENSIVE OPTION: Also essential to investor decisions is relative price, and in this respect Indonesia’s capital city is very attractive. Condominiums in Jakarta are still the cheapest among major cities in the region on a dollar-per-sq-metre basis, lower even than Bangkok, Manila and Kuala Lumpur, and approximately 20% of the price in Singapore. It is much the same for office rents. While it is more expensive than Manila and Bangkok, according to Jones Lang LaSalle, in the third quarter of 2012 rents in Jakarta were around 15% of those in Hong Kong, 20% of those in Tokyo and less than a quarter of those in Beijing.

The role of the authorities in the market is significant. The 2011-12 moratorium on new shopping malls, for example, caused available retail space to stagnate at around 4m sq metres of mall supply. Local regulations can also make it difficult to start projects outside the capital. However, the biggest issue is tax, with the total payable more than 40% in some cases. Value-added tax is 10%, the seller pays 5% transfer tax, the buyer pays 5% acquisition tax, a land deed execution fee is equal to 1% of the total value and a 20% luxury tax is payable on condominiums above 150 sq metres.

The loan-to-value (LTV) ratio is also a potential issue. In March 2012 Bank Indonesia said that from June 15 buyers would be limited to mortgages equal to 70% of the property’s value. Sharia institutions are also likely to be subject to LTV ratios. While the limit has been much discussed in the banking community, as it will slow loan growth, it may not be a problem in the property market, as many properties are bought without the involvement of banking institutions. People pay cash or in instalments as the property is being developed. While incomes are rising, many people, especially those who are self-employed, lack the paperwork needed to get a loan from a bank, such as collateral or a steady job.

FOREIGN OWNERSHIP: One issue that is currently being watched carefully is foreign ownership of land. Property rights are complicated and open to broad interpretation. They have been cobbled together from a number of influences, ranging from traditional law to Dutch colonial law. Under the 1945 constitution, very much a product of the anti-colonial mood of the times, all land ultimately is in the hands of the state to be used for the benefit of the people. Legal scholars say that Article 33/3 of the constitution stands in the way of foreign ownership, and this is strictly true, but the practical reality leaves some options open.

Hak guna bangunan, a building rights title, is open to corporations, including foreign-invested ones. It allows for the building and ownership of structures on land owned by another person, and lasts for 30 years, extendable for a further 20. The right can be transferred or sold. Also of interest is hak pakai, a 25-year land-use right available to foreign residents and foreign-owned domestic firms. It too can be extended, and some banks will offer mortgages on hak pakai titles. For some buyers, such as manufacturers, the laws as currently written and interpreted suit their purposes. For others, such as people wanting to invest in condominiums, they do not. One of the problems is a potential mismatch between titles. In the late 1990s the government passed a regulation that allows foreigner to buy apartments and offices if the underlying title is hak pakai, but in most cases condominiums are built using hak guna bangunan titles, as hak pakai titles are deemed less valuable and tend to generate less financing.

Reforms are in the works to improve the property rights of non-Indonesians. In a regulation promised in the spring of 2012 but apparently not yet executed, foreigners were to be allowed to obtain a building ownership certificate for an apartment, which would be valid for 60 years and extendable for a further 60. The regulation was to be restricted to Jakarta, Batam and Bali – though Balikpapan and Medan were also being considered – and would prohibit non-Indonesians from joining residents’ associations. In addition, a foreigner would only be able to own 40% of a single building and a floor price would be set of around $200 per sq metre. It would, however, make the market competitive with others in the region. “Foreign ownership is the most important point,” said Alwi Bagir Mulachela, the president director of property developer Selaras Mitra Sejati. “We want the regulations to change to allow foreigners to buy.” Bringing Indonesia into line with regional competitors could help the property market considerably, supporting prices and encouraging stability.

GREEN BUILDING: While the country is growing fast and becoming well known internationally, it is not clear whether it is experiencing quality growth. Only three buildings have so far received platinum level certification from the Green Building Council Indonesia (GBCI). A fourth, GKM Green Tower, is seeking certification. More buildings have also been certified by Singapore’s Green Building Council. However, the vast majority of buildings will not meet the GBCI’s standards. There is a sense that, while many companies talk about being environmentally friendly, few are sincere in their efforts. “The concept of green construction is still in early stages in Indonesia. The focus is now on persuading all industry stakeholders that this type of construction is not only environmentally friendly but also profitable in the long run,” Jendriko Silalahi, the president director of Artha Debang Development Group, told OBG. BUBBLE TROUBLE?: With prices having jumped so quickly, thoughts have turned to a possible bubble. Some see parallels with the time preceding the 1997 crisis: optimism, heavy foreign investment and predictions that prices will continue to rise. Especially worrying is the increased emphasis on capital gains rather than income. Aware of the danger, Bank Indonesia set the LTV ratio at 70%. Of particular concern is the number of condominium projects in the pipeline. At the end of 2011 the total was 106 and more than 44,000 units, and seven new projects were initiated in the first quarter of 2012. Analysts argue that the market is far from overpriced, however. Indonesia is still significantly cheaper than other markets in the region, the central bank’s LTV policy is seen as having stabilised the market and pure speculation is on the decline.

ECONOMIC CONCERNS: Larger questions about the market and the economy overhang. While inflation is low and people are becoming wealthier, there are questions about the affordability of housing, especially for the middle class, an important driver. Meanwhile, the traffic situation is so bad that it is endangering economic growth, a prime driver of property investment.

Politics may also play a role. The administration of the new governor of Jakarta, Joko Widodo, has emphasised balanced development and improving the lives of the poorer members of society. As the mayor of Surakarta he prevented several malls from being built, arguing that they would hurt small companies – a sign that his priorities may not always favour the builders.

OUTLOOK: The short to medium term for Indonesian real estate is more or less set. Prices will rise. All the essentials are in place: demand, economic growth, international attention and a low base. Still, risks abound, and issues need to be resolved. Attention must be paid to the government’s views on consumption, retail development, social equality, taxation and sustainability. Watch must be kept on end-user demand to ensure residential property is being put to good use, and the balance sheets of the banks must be carefully evaluated. While Bank Indonesia is calling for prudent lending, it is possible that bad property debts could be piling up at the developer level. Property rights must not be ignored, and everyone, foreigners and Indonesians alike, needs to make sure that they understand exactly how ownership is evolving. In short, as with any promising market worldwide, at the height of optimism care should be exercised and nothing should be taken for granted.