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Wednesday, 27 April 2022

How are Egypt’s real estate developers being impacted by recent inflation and the devaluation?

How are Egypt’s real estate developers being impacted by inflation and the recent devaluation of the EGP? Egypt’s infrastructure players are being squeezed by rising raw and building material prices, higher borrowing costs, and the Central Bank of Egypt’s (CBE) 21 March decision to let the EGP slide against the USD, we reported recently. Today, we talk to some of the country’s leading real estate developers to understand how the sector is being impacted. They tell us they’re taking a hit from the significant price hikes, but that players with projects at a more advanced stage — and those that have amassed land and inventory — are relatively well placed to absorb increases and recoup losses over the course of multi-year project cycles.

Many key materials have seen costs soar since war broke out in Ukraine: Within the last two months, key building supplies and materials have seen cost increases of anything from 15-40%, MNHD CEO Abdallah Sallam tells Enterprise. Steel rebar — which accounts for almost 10% of a developer’s construction budget — has jumped to an estimated EGP 20-22k per ton, from EGP 14-15k, ORA Developers CEO Haitham Mohamed tells us. Cement has doubled in price to EGP 1.5-1.6k per ton, from EGP 800. Aluminum has almost tripled to over EGP 120k per ton, from EGP 43k, and steel rebar has increased to EGP 20k per ton, says O West CEO Tarek Kamel.

This inflation is both a local and global phenomenon: When we look at cost increases, steel prices can be used as a benchmark because they impact everything, RedCon Construction Vice Chairman Tarek El Gamal tells Enterprise. Steel price increases in Europe are within the same range as what we’re seeing in Egypt, he adds.

But with the recent EGP devaluation, Egyptian developers are facing an extra hit: The EGP has slid around 17% against the USD since last month’s devaluation, says Kamel. And though many real estate construction materials are sourced locally, all have some level of FX exposure. For example, cement — for which there are several local manufacturers — is significantly exposed to global energy prices, with soaring coal prices alone accounting for some 50% of the increase in cement prices, industry players told us previously.

FX rate changes, supply shortages and general panic have all played a role in driving inflation, says Kamel. The war in Ukraine brings fundamental supply shortages, with Russia and Ukraine being key suppliers of raw materials used in steel production, says El Gamal. Not all materials are in equally short supply, but shortages are being seen everywhere, says Sallam. The war caused a chain reaction that hit multiple areas — tourism, wheat, Egypt’s ability to import goods — in a very short period, before the additional shock of the devaluation. “If it was just one factor, rather than this whole combination, it could have been a bit easier to hedge or digest without the dramatic effects in the market,” he adds.

Uncertainty about supply chain creates its own vicious cycle: A big chunk of the price increase in raw materials is driven by uncertainty, says Kamel. After the war ends, there will likely be a backlog of demand, and no one knows how quickly factories will recover and begin supplying goods again, he adds. And this is all very normal given that the market is facing devaluation and inflation so soon after facing covid, notes Mohamed. “You still have excess demand and low supply. But this will stabilize in a couple of years,” he predicts.

So are these increased costs hitting margins? While answers vary, the overall consensus is “yes”: “If we don’t do anything, cost increases will definitely impact our margins,” says Sallam. “But we’re trying to take some measures [to reduce the impact].” RedCon is already feeling the hit to its margins, says El Gamal. “We’re revisiting our studies to see how to face this kind of spike in costs and absorb it in different ways,” he adds.

Meanwhile, contractors are don’t have clarity on where raw materials prices are heading, making it difficult for them to commit to pricing during what most in the industry hope is simply a messy transition period.

But developers also note that factors like the status of projects will affect the size of the hit — so the impact on individual firms varies greatly: “In my specific case, for O West, the impact isn’t big — and the main reason for this is that we’ve already awarded the biggest chunk of our units to contractors, so development and construction are already happening,” says Kamel. “But this might vary from one developer to another, based on project status. High sales with little awarding and contracting is high-risk, while awarding and contracting in parallel with selling is almost no risk,” he adds.

This is closely linked to the developer’s financial capability, Kamel continues. A developer with shaky finances has to keep selling, to collect money and then award to contractors, whereas developers with solid financials can sell and award simultaneously, to an extent, he notes.

Companies that have amassed land and inventory — which are typically larger players — are often in a better position to absorb extra costs and recoup losses, several sources note. Projects that already have their infrastructure in place are at an advantage compared to ones that don’t, notes Kamel. A project that’s been there for a few years has probably sourced a lot of its material already, and has plenty in stock, he adds.

This is crucial, because land in particular is poised to get a whole lot more expensive: Land normally appreciates by 10% annually, but developers buying new land will definitely find it substantially affected by inflation, notes Mohamed.

But ultimately, developers need to look at average costs over several years to assess how their margins could be impacted: Adopting a medium to long-term view, Mohamed believes that cost increases will be absorbed so that, on average, margins won’t be affected over a period of several years. But possible caps on price hikes could limit how much developers could increase prices within a single year, he notes. “I’m expecting to take a hit in 2022, but we can overcome this in 2023 and 2024 because prices will increase more than normal. So margins will go back to normal,” he says.

This kind of hedging is a fundamental part of the industry, El Gamal notes. “The nature of our industry is that it takes years to build our products, so we’re always looking at averages,” he says.

Keep an eye out for part two, wherein we look at what steps real estate developers are taking to mitigate the short-term fallout from raw material cost increases and the devaluation, and whether project deliverability is being impacted.

Your top infrastructure stories for the week:

  • Egypt signs major agreements to produce green energy in the SCZone: Egypt signed agreements with French energy giant EDF Renewables and Emirati energy firms AMEA Power and Masdar to build plants producing green forms of energy including hydrogen and ammonia
  • US conglomerate Honeywell wants to invest USD 200 mn in petrochemicals and the production of green aricraft fuels in Egypt, saying our location could see us become a pivotal center linking Europe to the Middle East in green fuel projects.
  • Egypt is mulling establishing a local fleet of bulk carrier ships and auxiliary units to transport Egyptian exports and imports, according to a statement by the Transport Ministry.
  • Mokattam Corniche will get a new look: State-owned El Nasr Housing has signed an agreement with engineering firm Scope International for the EGP 32 bn development of Mokattam Corniche, according to a cabinet statement.

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