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Property | Indonesia’s Commercial Property Sector in Temporary Slowdown

Indonesia's economic slowdown spells the end of a property market boom that had seen demand and prices rise sharply for several years running. Concerns about employment, inflation, high interest rates and a depreciating rupiah are weighing on consumer sentiment. While demand for residential real estate is buoyed by urbanisation – and possibly new rules that would allow foreigners to own high-end apartments – slower growth in household spending and business activity are taking their toll on the commercial segment. The backlog of projects currently in the construction or planning stage will see more offices, malls, restaurants and hotels enter the market over the coming years, threatening to keep prices, rents and occupancy rates suppressed for quite a while yet.

Indonesia’s Commercial Property Sector in Temporary Slowdown
The rupiah depreciation and rising inflation have increased capital costs for builders and borrowing rates for buyers. Steep hikes to minimum wages as well as prices for fuel and construction materials have driven up developers’ operating costs

Fears of a market bubble, meanwhile, seem premature given the long-term potential of Indonesia's emerging economy, the largest in Southeast Asia. Square metre prices in prime locations of Indonesia remain below those in many neighbouring countries. Furthermore, up and coming cities across the island nation offer lots of potential for property development in the long run.

Commercial property in Greater Jakarta

Market figures from Bank Indonesia (BI) show that the increase in real estate supply in Greater Jakarta (locally referred to as the Jabodetabek area) has slowed across all segments of commercial property from 2013 to 2015. The slowdown in new retail supply was particularly pronounced. The central bank tracks developments in a number of regions across the country for its quarterly commercial property report, which showed that supply for both leased and strata title property, by and large, made little headway as of the second quarter of 2015.

Year-on-Year Growth (%) of Leased Commercial Property Supply in Greater Jakarta

Source: BI Commercial Property Survey

Year-on-Year Growth (%) of Strata Title Commercial Property Supply in Greater Jakarta

Source: BI Commercial Property Survey

Offices: Despite the economic slowdown witnessed since 2012, office space in the capital has grown strongly over the past years, which has resulted in occupancy rates falling from 2013 to 2014 and further going into 2015. Little wonder then, that rental yields have come under pressure. In a report for the second quarter of 2015, real estate services firm Colliers International projected that some 500,000 square metres (sq m) of new office space would go on the market of Jakarta CBD each year in the 2015-2018 period, which would be more than in the preceding years. Annual growth in rents already slowed markedly from 2013 to 2014 and should slow further in 2015 given the less-than-buoyant business activity in Indonesia and the entire region. Dollar-denominated rents for grade A and premium buildings in the CBD actually decreased by 0.6% in 2014 after rising by 23.7% in 2013 (Colliers). With space becoming scarcer in the CBD and Jakarta's population continuing to grow, areas outside of the CBD (in Central, South and West Jakarta) will increasingly move to the centre of attention. As of early 2015, about half of the office projects outside of the CBD were only at the planning stage.

Retail: Unlike office space, retail space in Jakarta has not expanded much in recent years, not least because of a regional government moratorium that limits the construction of new shopping centres. The cumulative supply of retail space in Jakarta shopping centres amounted to 4.43 million sq m in 2014, and is projected to rise by merely 100,000 sq m in 2015-2016 (Colliers). The limited increase in supply has supported rents and occupancy rates in the retail segment. That said, retailers are still expanding in the capital region and beyond, and the market is still seeing new entrants, with Japan's AEON Mall one of the latest foreign retailers to join the fray. Interestingly, upmarket shopping centres generally enjoy high occupancy and rising rents, while middle to low-class ones experienced a moderate decline in occupancy (Colliers). Going forward, the retail sector benefits from a young and growing population and rising personal incomes. Resilient domestic demand should see the retail property segment weather the economic slowdown more easily than the office segment.

Hotels: Indonesia's hospitality industry is suffering from oversupply in key areas after a lot of new capacity went on the market in recent years, particular for the election year of 2014. Hotel owners faced a challenging market environment in the first half of 2015, with occupancy rates declining more than in neighbouring countries, as weak demand coincided with increased supply (See Indonesia's Hotel & Hospitality Industry has a Bright Future). Making matters worse for the industry, the government in late 2014 issued new rules that prevent civil servants from hosting government events or meetings in hotels unless absolutely necessary. While the rules have been relaxed since, they did noticeably hit occupancy rates at hotels around the country. In Jakarta, a quick improvement is not in sight as the capital is expected to add 6,251 rooms within three years (Colliers, 2nd Quarter of 2015 report) and boast a total of 46,627 hotel rooms by the end of 2015. Thanks to the increasing number of domestic travellers and foreign tourists, however, the industry should recover from its current trough in the medium term.

Industrial estates: The economic slowdown obviously impacts demand for industrial real estate. Investors, particularly foreign direct investors, remain wary about the country's near-term prospects, curbing their interest in land for factories or warehouses. Industrial land sales in and around Jakarta dropped from more than 1,200 hectares in 2011 to less than 500 ha in 2014 and were “generally sluggish” as of 2Q15 (Colliers). As a result, the increase in land prices slowed significantly in 2012 and prices have been generally stagnant in the first half of 2015 when compared to 2014. In the longer run, developers are banking on an economic recovery to support prices, especially in view of the government's push to substitute imports with domestically-made goods and nurture downstream processing industries in the natural resources and agriculture sectors.

Other commercial property: The prospects in other segments of the commercial property business depend on the respective market they serve. Hospital and other medical real estate benefit from solid demand growth on the back of rising health spending and government-sponsored universal healthcare. The healthcare market is seeing rapid growth throughout Southeast Asia, but nowhere in the region has expenditure increased faster than in Indonesia (See Health Insurance in Indonesia: Public Coverage No Threat to Private Sector). As for properties for leisure and sporting purposes, weaker consumer confidence will be felt in this segment just as everywhere else. A young population, expanding middle class, increasing health awareness and the spread of urban lifestyles, however, look set to lift demand for such properties in the future.

Developers under pressure temporarily

Indonesia's property boom of late was spurred by low financing costs for both developers and buyers, as restrained inflation from late 2009 to early 2013 allowed the central bank to maintain low interest rates. Since then, however, the rupiah depreciation and rising inflation have increased capital costs for builders and borrowing rates for buyers. Furthermore, steep hikes to minimum wages as well as prices for fuel and construction materials have driven up developers’ operating costs over the past years (though cement prices have come down again more recently, as the rapid expansion in production capacity outpaced demand growth).

To overcome the current slowdown, developers may need to alter their project portfolio. Diversifying to residential properties could help them ride out temporary weakness in commercial property, particularly offices and industrial estates.

Secondary cities hold immense potential

Uncertainty about the global economic situation is hurting investment sentiment in Indonesia, as well as other emerging economies, and just how long this phase will last is anyone's guess. In the meantime, the government of Indonesia is trying to assure investors of its ability to implement reforms to improve the domestic business environment, though critics say the pace is too slow (See Indonesia’s New Economic Package: A Disappointing Start to Deregulation). Indonesia's economic fundamentals remain strong, which bodes well for the commercial property market in the long term.

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Nevertheless, developers should find attractive growth prospects in provincial capitals across the country. The office segment in the East Java capital of Surabaya, is looking a lot stronger than over-supplied Jakarta. Occupancy rates for office space in the city jumped from 86.9% in 2014 to 90.5% in the first half of 2015 (Colliers). Somewhat inappropriately termed “secondary cities”, regional urban centres will be first when it comes to development potential going forward (See Indonesia's Economic Potential: A Look Beyond Java). The national infrastructure drive is improving connectivity across the archipelago, which should support development of cities that property investors and developers formerly neglected, favouring instead the low-hanging fruit in Jakarta and Bali. This may be about to change.

Global Business Guide Indonesia - 2015

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Indonesia Property Snapshot - Real Estate

Contribution to GDP: 2.79% (Q3 2015)
Mortgage to GDP Ratio: 3.5% (2015)
Housing Backlog: 15 million (estimated 2016)
Average Condominium Price: 48,100,000 IDR/sqm (CBD, Jakarta, Q3 2015)
Average Retail Space Rental Price: 500,00 IDR/sqm/month (CBD, Jakarta, Q1 2016), 545,968 IDR IDR/sqm/month (Jakarta, 2016)
Average Office Space Rental Price: 401,010 IDR/sqm/month (CBD, Jakarta, Q1 2016)
Average Industrial Land Price : $221.51 USD/sqm (Bekasi, Q1 2016), $144.16 USD/sqm (Tangerang, Q1 2016)
Relevant Law: Government Regulation No. 41 of 1996 on Housing or Residential Ownership for Foreign Citizens Based in Indonesia allows foreigners to own leaseholds of up to 70 years subject to renewals at 25, 20 and 25 year intervals.