Buildings go up and banks earn profits; it’s a simple fact of life in any reasonably functioning economy. Both the banking and the real estate industries would most probably prefer the public not see exactly how those two things go together. Some, such as Fadlo Choueiri, head of corporate finance and economic research at Credit Libanais, argue that the link is limited. “The way things differ between Lebanon and the region and the United States when we are talking about real estate development is that new real estate projects are not financed though banks,” he said.
Relative to other markets, this is partially true. Banque du Liban (BDL), Lebanon’s central bank, limits commercial bank financing available to real estate developers to a greater extent than other central banks, and property purchases are often equity financed. For incentivized Lebanese lira lending, only 60 percent of the value of the land may be loaned, according to Antoine Chamoun, general manager of Bank of Beirut Invest. Dollar lending is not capped, though Chamoun insists that 100 percent financing is never given.
However, what a developer may build on top of that land can be financed as much as the banks deem appropriate, based on cash flow analysis, which often includes a high dependence on off-plan sales. The truth is that the real estate sector is a big part of the Lebanese economy and is therefore a driving force behind the banking sector.
“It is not true that developers are not leveraged,” said Nassib Ghobril, head of economic research at Byblos Bank. “Some of them are using their money; some of them are using part of their money. They do have loans from banks. It doesn’t mean that they are overleveraged, but it doesn’t mean that they are leverage free.”
Since banks’ published balance sheets are not broken down far enough to find out, Executive set out to go beyond the rhetoric and find out the real extent of real estate lending — a difficult task when the financial power players are trying their best to ride out the wave of the real estate boom for as long as possible.
“There are banks who directly have real estate affiliates who are building and directing projects. So what do you expect them to say? Everything is rosy, everything is nice… you end up living in a fantasy land,” said Ghobril.
According to a sector breakdown of aggregate bank lending provided by BDL, when all relevant cogs of the real estate machine are combined, the total comes to about 36 percent of the banks’ private sector loan portfolio. This is a significant amount and a much higher portion than many bankers have said publicly in the past. And so with a significant amount of bank lending tied up in an industry that has proven to be a ticking time bomb in other parts of the world, it is essential to understand where Lebanon’s real estate market is going and how the banks could be affected.
Market Adjustment
In a market like Lebanon’s where lending to the private sector is relatively low, credit conscientiously provided can be a positive force for economic growth. But one man’s growth is another’s exposure, and the real estate market in Lebanon is not what it was a year ago. Prices have increased 250 percent since 2005 due to what Ghobril says is a combination of positive forces that is unlikely to ever come together again. Political stability, rampant speculation between 2007 and 2008, strong expat demand and market crashes elsewhere in the region have made for seemingly insatiable demand in the last three years. But “the pace of demand has slowed already and everybody is talking about it,” said Choueiri. Large luxury apartments have become so expensive that experts say developers will need to adjust their plans in order to stay on top of market trends.
“For developers who are looking to pursue their operations and their developments as if nothing has happened, this is a risky endeavor,” Choueiri added. After such astronomical price growth in only a few years, Lebanon is at a potentially precarious point and is less of a failsafe investment than it used to be.
“You no longer have this gap where the market here is undervalued and attractive compared to the rest of the region or the world,” said Ghobril. “In fact if you look at the actual indicators of the sector, the gross rental yield, the price to rent ratios, you see that valuation of apartments in Beirut have become higher than the rest of the region.”
According to The Economist, for a 120 square meter apartment gross rental yield has declined to reach about 4 percent, while the price to rent ratio — the number of years you need to rent an apartment to recover the cost you bought it at — for an apartment that size is currently 24 years, the highest in the region.
Further, Ghobril says that the indicators that do exist in Lebanon are insufficient and often misleading. For example, the number of construction permits issued is often used as an indicator of sector health, but the number of permits cancelled is not published.
He adds that Lebanon’s real estate market cannot be properly assessed without statistics such as the time it takes to sell an apartment, population growth and round trip costs for the person investing and divesting.
Fuel to the flames
In an effort to soak up excess local currency liquidity and spur lending, BDL lifted reserve requirements on loans for primary housing in June 2009 and has extended the incentive until June of 2011. This is where the two sectors become incontrovertibly tied. At first glance, the measure appears to be a success. Housing loans reached $3.1 billion at the end of March, increasing by $750 million since the introduction of the circular.
But there is growing disagreement as to whether the measure was a prudent one in the first place, though it has obviously achieved its objectives. The difference in opinion seems to be based on a preference for short or long-term thinking. The circular allowed banks to drop mortgage rates to new lows, with most hovering around 5 percent and some currently available below 4 percent for the first year. At rates this low, if inflation is factored in, the interest effectively disappears.
Bank of Beirut’s Chamoun says that the popularity of these loans is evidence of growing rather than fading demand.
“The number of demands [for loans] and loans granted since 2000 has been always increasing… that means demand is still going up,” said Chamoun.
But the availability of financing is one of the many factors pushing prices up. This is not a problem as long as the facility is still available and cheap mortgages abound. But if and when the facility ends, and banks are forced to raise their rates, Lebanon will be left with expensive mortgages and expensive property. And this is where the disagreement comes in.
Chamoun says that the good the facility has done for ordinary Lebanese citizens outweighs the future risk. “It’s better for me to be able to buy an apartment even with a higher price than not to have the possibility to buy any apartment,” he says. But Ghobril is more wary. As Chamoun admits, “prices are going by [the elevator] and our income is taking the stairs.” This, Ghobril says, is why after the circular expires in July 2011, it should not be extended.
So, we’re left with rising prices and an ever-growing dependence of banks on real estate market-dependent revenue. This is not to say that Lebanon is headed toward anything close to a Dubai-style bust. Only time will tell whether prices will retain their lofty position, as most believe. But this summer has shown that real estate in Lebanon, and especially Beirut, cannot keep climbing in value and sales forever. As gravity kicks in it is important to understand not only the forces at work in the real estate sector, but also how they can affect the keepers of our cash.
