In 2012 and the first half of 2013 Indonesia’s property sector expanded rapidly, reflected by robust profit growth of Indonesian property developers (of the 45 property listed companies on the Indonesia Stock Exchange in 2012, 26 posted net profit growth exceeded 50 percent) and, obviously, Indonesian property prices rose accordingly (generally prices of residential property grew nearly 30 percent per year between 2011 and 2013). It is worth taking a look into why the country’s property sector was ‘hot’ in this period.

Read more: (Updated) Analysis of Indonesia's Residential Property Sector

Firstly, this strong growth came on the back of Indonesia’s robust economic expansion. Although GDP growth in 2012 (+6.2 percent) was below the post-Asian Financial Crisis growth peak in 2011 (+6.5 percent), most analysts expected that Indonesia’s economic growth would accelerate again after 2013; a view that would later prove to be highly inaccurate. With GDP growth at +6 percentage point (year-on-year) levels, Indonesia’s per capita GDP and purchasing power were rising accordingly, implying that more and more Indonesians could afford property. Strong middle class consumer spending made the residential business segment (houses, apartments and condominiums) the largest contributor to Indonesia's property growth, accounting for about 60 percent of the total property sector.

Secondly, Indonesia’s demographic composition supports economic growth, including the property sector. Indonesia has a large population (approx. 250 million people in 2015) that is becoming wealthier, reflected by the country’s rapidly expanding middle class segment. Each year several million of Indonesians are added to this segment. Moreover, the country contains a young population with around 50 percent of the population being below the age of 30, implying that many Indonesians are expected to buy their first property in the near-middle term. Furthermore, in line with the global trend, Indonesia has also been experiencing the process of (rapid) urbanization. Currently, over half of Indonesia's total population resides in urban areas. Several years ago, the United Nations (UN) stated that by 2050 two-thirds of Indonesia’s population is expected to live in urban areas. This means that there are many more houses, apartments and condominiums to be built in Indonesia’s urban regions to meet future demand (while, in fact, Indonesia is already being plagued by a backlog of 13.5 million property units and therefore President Joko Widodo launched the “One Million Houses Program” in April 2015). This situation also implies that due to limited land availability in urban areas, prices will tend to increase rapidly, while developers need to focus more and more on the development of vertical property such as apartments and condominiums.

Thirdly, Indonesia's property market rose sharply on the back of the central bank's low interest rate environment. Between February 2012 and mid-2013, Indonesia's central bank (Bank Indonesia) kept its benchmark interest rate (BI rate) at 5.75 percent, a historically low policy rate for Southeast Asia’s largest economy. Indonesian commercial banks saw their mortgage loans rise substantially. By May 2013, about 46 percent of banks' total credit was allocated to consumers’ mortgage loans.

Strong Growth Suddenly Dropped

In the second half of 2013, Bank Indonesia became increasingly concerned about a property bubble developing as the general economy was slowing but the property sector had surged sky-high in the first half of 2013 (prudent fiscal management has been a characteristic of Indonesian authorities in the post-Asian Financial Crisis period). The lender of last resort said it had detected speculative buying and therefore implemented a tighter monetary regime. Although it was unlikely that a bubble was to burst (given that domestic demand for property remains huge and most purchases are done by end-users, while property prices - despite having risen rapidly - come from a low base), speculative buying was indeed growing. Usually a property developer in Indonesia sells most of the units of a new project (for example an apartment building) before construction starts. It was increasingly common for Indonesian investors to purchase several units and sell them (gaining good profit) before the building was constructed. Sometimes a unit would switch from owner several times before construction was finished, each time becoming more expensive.

In the second half of 2013, Bank Indonesia tightened its policy. It raised the minimum down payment (DP) requirement for property purchases and curbed mortgages for second home ownership (to prevent an excessive build-up of housing debt). Banks were also barred from providing loans for the purchase of properties that were still under construction (for second time, or more, home buyers). The higher DP requirement (or lower loan-to-value ratio) applied to properties measuring over 70 square metres, hence aiming specifically at the middle-upper end of the market.

Another important change involved the country’s interest rate environment. After having touched the historic low of 5.75 percent from February 2012, Bank Indonesia gradually, yet aggressively, raised its BI rate between June 2013 and November 2013 to 7.50 percent. This tighter regime was implemented in order to combat high inflation (which occurred after the Indonesian government increased prices of subsidized fuels), to combat the country’s wide current account deficit, and to tackle the uncertain international climate (due to the tighter US monetary policy large capital outflows from Indonesia emerged causing a sharply depreciating rupiah rate from mid-2013).

Thirdly, Indonesia’s political year (Indonesia organized legislative and presidential elections in 2014) caused severe political (hence economic) uncertainties. Ahead of these elections, Indonesian developers tended to postpone new projects (the postponement of property projects was also the result of lower mortgage disbursement and higher BI rate).

Together these factors managed to cool down Indonesia’s property market. For example, Bank Indonesia's Residential Property Price Index declined by 6.3 percent in 2014, down from an annual growth rate of 11.5 percent one year earlier (moreover the country’s inflation rose 8.4 percent in 2014, thus outpacing growth of the property price index). The biggest decline of property growth was felt in the Greater Jakarta region. This is also the consequence of Jakarta’s property market (as well as several other large cities on Java such as Surabaya and Bandung) having started to become somewhat saturated due to heavy property development in recent years. Other islands, such as Sumatra, Sulawesi and Kalimantan, are now said to be potentially large markets for (urban) property development as these are currently still underdeveloped.

A Bank Indonesia survey shows that residential property sales in Q1-2015 experienced a significant dip in growth at a quarter-to-quarter (q/q) comparison. The sales turn-out for the first quarter of 2015 recorded growth of 26.6 percent compared to 40.1 percent in the fourth quarter of 2014. Meanwhile, the rate of bank mortgage disbursements for houses and apartments in Q1-2015 rose by a mere 0.12 percent (q/q) over the previous quarter.

Trying to Boost the Property Sector

Indonesia’s economic growth slowed to a six-year low in the first quarter of 2015 and therefore authorities are eager to implement measures to boost economic growth. As the central bank has limited to none room to cut the BI rate (due to high inflation, the wide current account deficit and heavy external pressures), it raised the LTV ratio for home mortgage loans per June 2015, thereby reducing the obligatory minimum DP for first home buyers. The maximum LTV ratio for the purchase of a first home was raised to 80 percent (from 70 percent previously), while for second home purchases the maximum LTV ratio was raised to 70 percent (from 60 percent previously). Lastly, for third homes the new ratio is 60 percent (from 50 percent previously). This applies to properties above 70 square meters utilizing conventional financing.

Indonesia’s property players very much welcomed the new LTV ratios as it may bring back more life into the country’s property sector. However, it will require some time to feel the impact of lower DP requirements. Moreover, given the continuation of slowing economic growth Indonesian consumers have become more cautious in terms of spending.

Secondly, the Indonesian government announced it will allow foreigners to own luxurious apartments with a minimum value of IDR 5 billion (approx. USD $384,615), meaning it needs to revise Government Regulation No. 41/1996 on Housing for Foreigners Residing in Indonesia which bans foreign ownership of all Indonesian property. Currently, foreigners can only obtain property under the so-called ‘right of use’ category (no the ‘right of ownership’) for a maximum period of 25 years (but is renewable for an additional 20 years). It is expected that foreigners continue to fall under the ‘right of use’ category after the revision but with an open-ended duration as well as the right to be inherited by foreigners’ heirs.

Although there are currently relatively few developers that focus on the construction of luxurious apartments, several analysts claim that the move could boost growth in the domestic property sector by 20 percent. If so, then it will also imply a multiplier effect on the economy as other industries closely related to property - such as cement, ceramics as well as the construction work force - will grow accordingly.

Future Outlook Indonesia's Residential Property Sector

Indeed interest rates are expected to remain high for the middle term and a quick rebound regarding Indonesian GDP growth seems unlikely, but for the middle and longer term Indonesia’s property sector is promising. One reason being that property prices in Indonesia are still among the cheapest in the Southeast Asian region. Moreover, high demand for property will persist as Indonesia’s population is large and young (meaning many more first home buyers are still to come), while urbanization and higher living standards contribute to property demand. However, focus has (and will) shift to other regions than the Greater Jakarta area, Surabaya and Bandung.

This column was written by R.M.A van der Schaar, Managing Director of Indonesia Investments. For questions or further information you can reach him here