A spurt in housing developments is typically a sign of a growing economy but underneath all that might lay some anxiety of credit growth as developers offer financing to buyers at higher rates, an activity the central bank identifies as ‘shadow banking’

Earlier this year, real estate and investment firm CBRE Cambodia predicted that by the end of 2022, 300 new borey projects would enter the market with an additional 400 expected next year. While some are spearheaded by existing developers, a lot of them comprise new players in this category, either diversifying from another real estate segment or are new altogether in the industry.

The demand for borey housing or mixed residential landed properties, particularly low-to-medium cost units, has been phenomenal in the last few years.

Recent figures shared by CBRE bear testimony. For instance, some 39 projects were launched in the six months preceding April this year and between April and June, there were 10 new launches and seven completions. With the new launches, another 1,000 units are expected to augment the current supply.

By the second quarter of 2022, around 1,700 units were completed, representing 37 per cent of the total supply expected this year.

According to developer William Naramore, who has two borey projects in the capital’s Kambol district, it is to be expected.

He said Phnom Penh sees continuous population growth – some 100,000 people moving to the city every year.

“It is getting ever more congested and expensive to buy housing close to the city centre. Therefore, it is likely that suburbs around the fringes of the city will continue to grow for years to come,” said the owner and CEO of Borey Williams Co Ltd.

A strong impetus for sure, however the return on investment for borey projects is also a major stimulant for existing and new developers.

For the moment, overall residential house index dipped 2.9 per cent year-on-year in May 2022, as did the indice for Phnom Penh (down 2.8 per cent), data by the recently-launched Residential Property Price Index showed.

Developed by the National Bank of Cambodia (NBC) and the International Monetary Fund, the index tracks price fluctuations of new and existing residential units, and residential unit land prices, enabling NBC to monitor the sector, analyse the data, and formulate development policies, if needed, to reduce risks to maintain macroeconomic stability.

“Without a doubt, the returns are still quite healthy, especially if the projects are in less central locations where land prices are relatively low.

“Or maybe because the developer bought the development site quite a long time ago at extremely competitive prices. [Land] is usually the most expensive component of a real estate development, so the returns are still potentially very healthy,” said CBRE Cambodia managing director Lawrence Lennon.

That being said, Lennon opined that the returns would start compressing as the market becomes more competitive, thereby eroding the margin.

Developers might have to “eat” into that margin to discount on their projects, or that access to bank financing might have become more expensive.

“So, traditionally I would have expected returns to be about the 30 per cent mark but I expect that that would slowly start to decrease as the market gets more and more competitive as land prices increase, and the pressure of inflation and pricing competition rises,” he said.

Unregulated higher rates

Though the growth in borey development reflects an increase in income and savings by Cambodians, who are now able to purchase their own homes, it has possibly triggered concerns of credit growth in the real estate sector, both on the supply and demand side.

It was on this premise the NBC raised an alarm on its risks in 2018, concerns which reflected a period when the sector was undergoing a construction boom.

In its 2021 financial stability review, NBC pointed out that the real estate and construction sector has been “highly leveraged” over the last decade, and required a “closer look on potential risks” arising from it.

Credit to real estate and construction sector represented one-fifth of banks’ gross loans, and over one-third if personal mortgages are included, it said.

Given the significant growth in bank credit to the sectors, real estate-related exposure (which takes into account lending to both sectors, and mortgage) rose to 33 per cent last year from 22 per cent in 2016.

It is not clear if the exposure takes into account the credit growth taking place within the real estate sector where financing by real estate developers is provided to house buyers.

The sector is unregulated by the NBC but the Real Estate Business and Pawnshop Regulator (REBPR) instead. However, financing by developers, which are offered at higher interest rates – around 12 to 13 per cent – compared to bank loans at about seven per cent, are not regulated by REBPR either.

As borey projects multiply, concerns of credit risk have cropped up, compounded by a lack of insight into it. The NBC has previously called this activity “shadow banking”, and urged closer coordination from relevant authorities to ensure sustainable and inclusive growth of the sector.

At the same time, NBC has kept a close watch on the development in the construction and real estate sector and any potential impacts on the banking sector.

According to NBC economist Oudom Cheng, credit risks are there when financing options are loosened, particularly for those that do not require collateral and proper evaluation of the capacity to pay mortgage-loan installment.

With more borey projects, developers have to devise strategies to attract buyers to their projects. While there are many ways to do so, easy financing seems to be the most appealing choice to customers, Oudom said.

“These days, many borey projects are providing very attractive financing options and perhaps even less documentation requirements. For instance, customers are not required to produce any collateral and pay a big down payment.

“They just need to [show] proof that they are able to pay monthly installments on that mortgage. This is antithetical to mortgage-loan by banks which require both collateral and strict evaluation of payment capacity,” he added.

Oudom said looking back when loan-restructuring was conducted in the banking sector to ease the burden on borrowers, he said it was noting that the customers were those deemed to have gone through proper evaluation of their capacity to pay, and yet were affected by the pandemic.

“Needless to say for those who have chosen to pay mortgage installment directly to borey projects could have used their savings and strived to pay those installments to some extent,” he added.

With more borey projects, competition to attract customers would also increase, thus easy financing options are likely to prod people to grab the opportunity to either have a home of their own or invest.

“Obviously, existing vulnerabilities imprinted by the pandemic have not faded while new credit risk is probably trending upward,” Oudom said.

Installment plans

There are two types of developer licence. According to REBPR director-general Chou Vannak, a majority of the developing licences are Type 2, which allows developers to collect one per cent deposit from customers.

(Type 1 requires developers to complete their construction before they can sell their units).

Established last year under the Non-Banking Financial Services Authority of the Ministry of Economy and Finance (MEF), REBPR is tasked to monitor the sector’s activities, as well as the pawn broking industry.

Prior to the issuance of a licence, Prakas 089 (an update of Prakas 965) stipulates that developers must have a capital of $500,000, possess a housing development account and deposit two per cent of the project’s total construction cost with a commercial bank.

In addition, housing developers must have registered their business and drawn up a comprehensive business plan.

Depending on the scale and size of the project, developers are required to apply for a permit with the provincial or municipal department of economy and finance (below 30 villas or flats) or with the MEF itself (over 30 villas or flats).

Withdrawal of deposits is only allowed once the project has seen 70 per cent or more completion, and for phased projects, developers can draw the deposit to fund the next phase only when the existing phase is 50 per cent complete.

In 2021, REBPR’s had 57 developer licences on its record and 39 licences in the first seven months of 2022. Last year, total capital investment amounted to $1.34 billion, with the sum at $583.25 million between January and July this year.

To date, Vannak stated that no developer has been blacklisted for not meeting the requirements set by REBPR. “If they do not meet these requirements, then [we] would not issue [them] a license,” he said, while advising consumers to only shop from from licensed projects.

This is because there are “built-in mechanisms” in the application process as well as supervision to mitigate the risk.

“In the case of unresolved issues, REBPR will ask the court to intervene and issue a verdict as a last resort.”

Kheang Puthy, president of Cambodia Real Estate Association (CREA), finds that the two per cent safeguard is not adequate to “insure” an entire project because “if something goes wrong, it would be very difficult”. It should be increased to five per cent to contain the risk, he suggested.

An investor in several real estate projects in the country, Puthy said financing offered by developers is somewhat inevitable owing to the fact that house buyers are either unbanked or ineligible for bank loans.

“Actually, developers want their customers to go to the bank but the banks might not cover the entire purchase price,” Puthy said.

Accordingly, a Type 2 licence holder enables developers to offer financing for house buyers, which has become the “norm” for borey builders.

“Type 2 licence allows developers to sell and build their project at the same time. There is no limit on the maximum deposit a customer can put. For example, a developer can offer discounts to incentivise customers to fully pay for the property upfront or offer customers installment plans,” REBPR’s Vannak told The Post.

Currently, a majority of developers offer options to pay in full or via installment plans until construction is finished, as well as long-term installments, he said.

“Many developers have partnered with local banks to offer customers with access to mortgage loans,” he added.

Based on the breakdown for 2021, Vannak said 16 per cent of buyers made upfront payments, 46 per cent signed up for short-term installment plans during construction period, 21 per cent had installment plans with developers and 17 per cent applied for bank financing.

From January to July 2022, 18 per cent opted for upfront payments, short-term installment plan (33 per cent), long-term installment plan with developer (34 per cent) and bank financing (15 per cent).

Although the payment plans are with the developers, Vannak stressed that “installment plans are not loans by developers”, adding that NBC would have a better assessment of the housing sector’s credit risk level.

Neither NBC nor MEF could be reached for comment.

Why offer loans?

According to CREA’s Puthy, developers want their projects to sell well, reiterating that some customers might not have bank accounts. To reduce the risk of them seeking informal loans, developers offer in-house loans instead. As such, Puthy said there should be more effort to raise financial literacy among Cambodians.

In any case, he said, the ratio of developers offering loans has reduced to 40 per cent compared to 50 per cent previously. “It is about 60:40 now, with bank loans being the larger loan provider. It is better and more secure to go to the bank because housing loans are big.”

Meanwhile, developer Naramore said a majority of their customers seek home loan financing to purchase a home. “We require between 20 and 30 per cent down payment, and they can finance the remainder through one of our partner lenders. We offer in-house options for financing only in a very short-term model of up to 24 months,” he said.

Conversely, a lot of the “big players” offer in-house financing option, which “may or may not” be done with a financial institution under a brand, such as “New World MFI or Chip Mong Bank”.

“Many developers have bank relationships where they can borrow against their developments at a moderate rate from local banks, and extend credit to customers at a higher interest rate.

“This lowers the barriers to home ownership for customers by offering easy access to credit through the developer without the need for customers to apply for a home loan with the bank,” said Naramore.

He shared that for developers that have a workable model to offer in-house financing, it provides “much more” control to the developer, additional revenue from interests, and at low risk.

Banks that provide home loans to customers end up “carrying home loans on properties all over the place”.

If a customer defaults, they are stuck with a property that they have to “force sell”, which may result in a loss.

“This is why banks are so fearful of making bad loans, and have been traditionally very conservative in their lending. This results in making it very difficult for many customers to obtain home loan financing through a traditional lender.

“In contrast, if a developer extends credit to a customer and the customer defaults, the developer takes back the house, makes necessary repairs, and then resells the home at current market rates, typically higher than the price originally sold,” he said.

While he believed there are many customers that might have defaulted on their mortgage with developers, he conceded not having any data on it.

Anthony Galliano, CEO of Cambodian Investment Management Co Ltd, observed that Cambodians are progressively becoming more savvy and sophisticated.

However, there is still a large segment of the market that is focussed on “attaining the product they want, without due consideration to the cost, especially in relation to financing”.

He felt that borrowers may be more interested in the affordability of a monthly payment to attain the asset, rather than the interest paid, and the terms and conditions, including the interest paid over longer rather than shorter period of time, and rate comparability.

“If a property buyer fails to obtain a loan from a bank, which will be at a market rate and payment terms, then that borrower is certainly a higher credit risk and will be at the mercy of worse terms and more punitive measures in the event of default,” he said.

‘Everybody loses’

Moving on, Galliano pointed out that there is no secret that larger developers which offered financing have a connection to banks, whether through some form of ownership within their own group, a partnership, or a borrowing relationship.

It is “certainly common”, he said, for developers to take deposits and either require instalments over time or milestone payments.

“Personally, I don’t like to purchase any property unless it is already built, and the property has evidenced its quality, sustainability, and is operating without fault,” he opined.

While the development of brand new properties generally lure buyers, they are priced higher, are branded as paradise occupancies, and are promoted “incessantly” through the developer and agents.

“[Yet], the risk of delayed completion, potential bankruptcy of a developer, and unknown quality at completion is unavoidable,” he said.

Echoing Galliano, developer Naramore shared that many new developers may have substantial experience, but the opposite was “likely true too”.

“I know of several developments that launched, didn’t sell well, and then ceased operations having never finished their projects.

Everybody loses in those scenario … the customer, the developer, the investor, the banks, the government [loss of tax revenue], landowners in the area [potential loss of land value] and even the reputation of the area,” he said.

In addition, many of the new property developers are using a “me too” brand strategy which typically does not resonate with customers. This type of strategy can result in many players offering a non-differentiated product which competes on price only, driving down margins and lowering overall value to the customer.

With developers trying to compete predominantly on cost, they may be tempted to use sub-standard materials, skimp on quality control due to staffing costs, and try to avoid paying taxes or obtaining permits and registration.

“Many Cambodians are realising, sometimes the hard way, that many times you get what you pay for,” he said.