Market Outlook and Emerging Trends
By Andrew Mallalieu, CPA MRICS on 21 Mar, 2012
Last year I opened the Pink Pages by speaking to uncertainty in the market. This year I thought I would provide you with “miscellaneous ramblings” of what we have seen in the market and what we are likely to see. While it is probably impossible to predict with complete certainty the direction of the Brabdos property market in every segment, I hope that from these perspectives you will have an indication of the direction that the market is likely to take. (Please do not skip to the conclusion as it may make no sense without following the progression in thought.)
Lets start with a statement I hear regularly – “There is an overstock of beachfront apartments”. Three years ago I would have agreed; it was not only what was built and what was under construction, but you also needed to add what was being offered from plan. Today when a statement like this is made I do not think that it is a fair reflection of the actual situation in the market. Lets start with actual supply from developers on the beach front – the total is 205. To that number we must add what is planned and could be completed in say the next three years (44) – giving a total supply of units for the next 3 years (249). We do not believe that it will be possible for a new, completed unit (not accounted for in the previous count) to be placed on the market within the next three years. Of the total units that will be available for purchase in Barbados over the next three years there is a concentration at perhaps three projects – Oceans Two, Saint Peter’s Bay and Port Ferdinand. (Take a look at the chart by our Knowledge Officer, Ramona Smart, which covers the market mix at the end of 2011.) So rather than making the generalised statement about the market being overstocked, I actually see a different picture. I think that there will be price appreciation created by a lack of appropriate supply in certain sub-sectors.
The Four Seasons Project
Please answer the following question: The Four Seasons project is? (a) Restarted (b) About to restart (c) Dead (d) Don’t know (e) Don’t care. Choose one answer only please. Since we cannot rely on the pronouncements from the developer in the media let’s apply some common sense. The Four Seasons project is a 100-room hotel with attached serviced villas (originally 35). The brand is the Four Seasons and the villas are to have the full gambit of the legendary Four Seasons service. The project has been halted now for three years for many reasons but the leading ones are: cost overruns; lack of shareholder equity and confidence; inability to raise debt to fill the place of equity needed; over-specified hotel (cost per room too high); complicated arrangements with the villa owners who expect a hotel delivered at the same time as their villa; and finally, a very complicated construction project involving a level of services that have not been completed on this scale before in Barbados. That is the short answer. Imagine what the long list looks like!
I believe that the Four Seasons project could have been and might yet be a success for Barbados. At the time that the villas were being sold, the highest price achieved for beachfront product (outside of Four Seasons) was around US$1,200 psf. The Four Seasons development achieved US$2,000 psf. They did not lack in sales, or high profile purchasers willing to put down large amounts of unsecured payments for a project that was to be three years in the making. This did not surprise me as the Four Seasons brand is very well aligned with the Barbados brand – it is exclusive and will offer unrivalled service at completion. This is exactly our niche market.
The original plan for the hotel projected that each room would cost in excess of US$1.0 million, calculated as the total hotel cost divided by the number of rooms to be built. The hotel profitability could not initially support this level of cost and therefore the business model showed that some of the profit from the villa development would be invested in the hotel such that the hotel would be profitable, as it did not have to carry the full burden of the building cost. When the villa development profits were eroded by the cost overruns etc. it became clear that the hotel could not be built without more debt or equity injected, and so started (or ended) the position that they are in today.
The Barbados Government, rightly so, chose to step in to assist the developer by providing an environment where the developer would be able to source the funding needed to get the project restarted, i.e. a loan guarantee. Somewhere along the way the developer has spun this loan guarantee into a bailout for the project by Government. They believe that Government should hold the debt and influence the NIS pension scheme to also loan money or take an equity position in the project. I do not see how that leap of faith is made, nor how it makes sense for anyone other than the developer and their consultants. This project is important to Barbados, but it is a private sector project, not a Government-funded development. Should Government become the driving force behind this project there will be significant conflicts created that could be detrimental to the very structure of our real estate development environment. Let’s not forget that the Government of Barbados has, at least once before, had a brutal experience as the owner of a hotel or hotels. At the time of writing this article it is still unclear what, if anything, the Government and the NIS have done vis a vis an investment in the project. Further, there have been reports from some media sources that a group of the original purchasers of the villas have filed suit in the High Court against the developer.
I genuinely hope that Government does focus on creating an environment such that the private sector is able to find conditions upon which they are willing to finance this project and see it to completion. I do also think that an investment in the Four Seasons Hotel would be wise for both the Government and the NIS. Beyond that into the villa development phase I think we will be on a sticky wicket.
Let’s turn to a positive trend. The returns on the investment in Barbados beachfront properties for rental in the holiday market have improved over the last several years. Hayden Hutton provides an analysis on this in a later article in The Pink Pages and I encourage you to read his analysis (also available via this BLOG - click here). I would like to look at one of the possible reasons for the improvement in the Barbados villa rental returns. Quite simply the villas offer better value than the traditional hotel room for the holidaymaker. I believe that our hotel plant (in general) has become outdated, over priced, and mismatched to the market that we serve. By exception we have some excellent hotels with modern rooms and the owners have regularly updated their offerings – but these are the exception. In the last ten years we have seen nearly 500 apartments and villas added to the stock that offer over 1,500 rooms. Most of these have been built to a higher specification than that which the hotels offer. Since the units are owned individually and the owners enjoy their use personally as well, they are generally kept at a high standard. The other factor that has hurt the high-end hotels is the Barbados Tourism Authority’s focus on driving volume to the lower and mid market hotel stock through its marketing campaigns. Up to recently there has been little focus on the importance of the villa market and little help given to the higher end hotels. The new leadership of the BTA seems to have brought new focus on the villa market.
The bottom line is that we can truly boast today that an investment in a beachfront villa in Barbados offers at least three areas of financial benefit – the appreciation in value, the return from rentals and the value of owner occupancy.
Local Land Development
I hear stories weekly of land developers seeking change of use permission for more tracts of land. However, the sale of serviced lots has slowed dramatically in the last 24 months and we predict that sales will slow even further in the next 12 months. We believe that the current supply of lots exceeds the demand and there will be little appreciation in land prices over the next 2 to 3 years. In real dollars the holding costs and the effect of inflation may well exceed any appreciation in value. The bottom line here is that while making an investment in a serviced but vacant land lot has always been a major avenue for private savings, that model is being challenged today by the excess supply.
No comments on the local land development market would be complete without mention of the ever-increasing costs of development. I submit that all of the increases in land prices over the last 3 years can be attributed to the increased cost of development. The profitability of the developers has actually decreased and in some cases been eroded completely. These costs include the holding period for change of use; the costs of the physical infrastructure (road, utilities, drainage); the systemic delays in getting the Certificate of Completion from the Government department allowing the completion of the sales; the finance costs and the selling costs. Land development today is a risky business and the returns are substantially less than they were in the past.
Buyer Funded Model
The last area I would like to offer some comments has perhaps been my favourite subject over the last year – the buyer funded model. Some people are tired of hearing me on this but it is important to reinforce the reality. Fundamentally if you fancy yourself a developer then you must make sure that you have the financing (equity or debt) to complete your project without relying on sales proceeds. The developer model that became prevalent in the 2000’s was one where the purchaser would pay in advance of the construction costs and these payments would substantially fund the development. With purchasers defaulting, cost overruns, and lack of sales, developers who did not have the capacity to inject capital or raise debt have found themselves with failed projects. While this has not happened often in Barbados it is the reality around the world and astute buyers today will not accept this model.
The positive affect that this change has brought about is a more cautious nature of developers to first analyse the market for the product that is in demand. When these developers move ahead with a project they do so having taken an informed decision to risk their own capital; they take a view of the market and they proceed. These developers rely on professional advice or conduct their own detailed market assessments. Two good examples of projects like this that have recently been making waves in the market are Coverley and Valley View. We believe that developments that follow this model will attract buyers more readily than others.
My Predictions - 2012
As always I will end my contribution with my predictions for the Barbados property market for the next year. I may not always be right but you can check out my record by reading past copies of The Red Book. Here is what my crystal ball is saying, and it is no longer clouded with uncertainty or biased by hope; it is instead based on emerging trends. I would like to add a special note here which is not directly related to real estate but has a significant impact on our market, and that is that I believe that the world economy is likely to see a further boost once the US economic recovery is confirmed and the uncertainty of the US election year politics are behind us in November.
(1) The high-end market (completed homes and apartments) will see price appreciation of 7% this year and beachfront will be higher.
(2) Local land prices will remain at 2011 levels and absorption periods will lengthen further.
(3) Beachfront apartment stock will be reduced by some 20%.
(4) The holiday rentals market will continue to offer superior returns as a result of high quality stock. Apartments and villas offering rental returns will lead the market recovery.
I hope that my miscellaneous ramblings this year will give you some sense of the definite direction that has developed in the Barbados real estate market.
The Red Book 2012 - The Pink Pages - Page 99 - see our entire e-book here.