A Classic Casey Real Estate Spec

Interviewed by Louis James, Editor, International Speculator)

L: Doug, last time we spoke, you mentioned a real estate opportunity you're checking out in Egypt that you said not one in a million people would think of. Sounds like a classic Casey contrarian deal. Care to tell us about it?

Doug: Sure. Let's start with the basics. Cairo is the ninth largest city in the world, with 19.6 million people, as of last year's head count. Due to years of typically idiotic centralized government planning, the city is totally inadequate to the needs of its population.  I've seen credible estimates that housing shortages could run anywhere from five to eleven percent.

Cairo is a strange city. It's gigantic and chaotic, and basically a dump. On the other hand, the Nile is beautiful, and the old city along its shores has lots of Belle Époque buildings that were constructed before Nasser turned the country into a socialist hellhole. These are buildings with thick interior walls, high ceilings, and nice woodwork. But they've become totally run down – even worse than their equivalents in New York, before it was forced to make changes. Don't forget that Cairo was home to one of the world's hottest stock markets for a while in the early '50s. When King Farouk was still around, the place was quite a decadent party capital.

And Egypt isn't going to disappear; it's the oldest civilization on earth.

Anyway, Cairo has a good supply of fine old buildings, generally great weather (believe it or not), an improving business climate, and a central location for business in the Middle East. It adds up to an interesting speculation because the prices are so cheap. And I'll typically buy anything almost anywhere if the price is right…

L: Then I bet one in a million Cairo residents have thought about the situation.

Doug: Well, there must be more than 20 who have… I was speaking globally. Anyway, because of a stagnant economy and government controls, individuals rarely move within in the city. Stats say that only about 10% of residents have changed their residence in the past five years, with marriage being one of the main reasons it happens at all. About 140,000 couples are married every year, but only 30% are even able to move out of their parent's homes, due to finances and short supply.

L: Ah, a picture emerges… But why haven't enterprising individuals stepped up to meet the need? Bad government planning doesn't stop people from turning deserts into subdivisions in other places.

Doug: Positively stupid (in the technical sense of the term) rent-control policies had kept new projects to a minimum. But with the Internet, jet travel, and the world media, the new generation of Egyptians now know what's out there – they see a higher standard of living, and they want it.

The rent-control laws go back to the 1940s, with barely any increase allowed for seven decades – just one percent per year. That's not just less than inflation, but way less than official inflation figures, which have frequently exceeded 15% per year.

A 1996 law began to undo the process of rent control, which had been a hereditary entitlement, like a property right. Previously, rent-controlled apartments would be passed on from generation to generation. After 1996, only one additional generation can acquire the rent-control status, with the inheritor needing to have been living in the apartment at the time of the previous tenant's death. These circumstances are hard to prove, of course, and there's a lot of corruption in the process. So progress returning the apartments to the free market has been glacial – only 10–15% of rent-controlled apartments have been privatized.

Because of this persistent stupidity, rent-controlled apartments are valued at deeply discounted prices. Rent-controlled apartments in places like New York City are valued significantly less than market rates, but Cairo's rent-controlled apartments rent for about five percent of the market rent for similar units.

L: That must create huge distortions in the market.

Doug: Yes. As you might expect, there are many unintended consequences. One is a large number of empty apartments in the midst of Cairo's housing shortage. The rent is so low that some people find it worth paying, even if they've moved away years ago. There are estimates that 25-30% of rent-controlled apartments have no residents. Many have tenants who've moved abroad – 5% of Egypt's GDP comes from remittances. But they don't want to rent to anyone else because of possible legal complications.

Another result of rent control has been the devastation of many buildings. Building owners have no incentive to repair buildings, and maybe not that much cash to do it with, when the tenants pay so far below market prices. In some buildings, neighborhood associations have tried to do some maintenance and perform some urgent repairs, but as you can imagine, the damage rent control has inflicted on these buildings is huge.

L: Okay, so how do you turn these lemons into lemonade?

Doug: I'll get to that, but first, you have to understand that Egypt is changing, and Cairo with it. Egypt experimented with despotic socialism, like many other countries in the 20th century, and has recently been emerging from that long, dark night. It is in a way not unlike some of the former Soviet republics you like so much, Louis, since the fall of the Berlin Wall.

Cairo's suburbs are expanding rapidly into new cities. Development of high-demand, Class-A office space has shifted to these suburbs, away from the already dense downtown. 

These developments are creating a newer, decentralized Cairo. No specific area stands out as the new center. Instead, real estate development companies are competing to create new centers and residential areas. But my guess is that most people who can afford it will prefer to live in classy old buildings near the river – if they're available.

L: Sounds pretty dynamic.

Doug: It is, but not without growing pains; some of the new developments have been quite successful, others have been flops. Some 80% of the city's businesses are still operated from residential units in downtown Cairo, and there is still a large demand for housing in the city center, next to the major places of employment.

L: And you would really invest in Cairo real estate? The last time you wrote about Egypt in the International Speculator, you weren't too positive. And you once advised one of my Eastern European students not to invest in Egypt.

Doug: That's true, but the liberalization of banking laws has begun turning things around, and has been a big push behind these developments I'm telling you about. Before, people bought homes with cash, like in Argentina and other places. You could pay for property with multiple payments, but you couldn't move in until the final payment was made. Mortgages were virtually nonexistent until only a few years ago. The number of mortgages is increasing steadily, but financing is still limited. The major development companies often finance deals themselves, originally offering financing over four to eight years, but now some have even moved to 17-year financing at rates of 13–14%.

This change is a result of the new banking laws, and I sense a real estate and banking boom on the horizon. The demand is there, and more financing may be as well; under the old laws, Egyptian banks held huge reserves – 57%.

Now, I favor strong banks with high levels of demand deposits on reserve. But we're not talking about my ideal banking system, we're talking about what's happening in Egypt. If this money is unleashed in the form of loans, housing prices would almost have to go up.

L: So, how does one play this market?

Doug: There are three public companies responsible for the majority of the suburban developments: SODIC (CA.OCDI), Palm Hills Development (CA.PHDC), and TMG Holdings (CA. TMGH). All three companies took a big hit in 2008, but they've been recovering since the market turned clearly upward again in April of 2009.

But I think an even more interesting opportunity is an idea being spearheaded by my friend Marshall Stocker, of Emergent Property Advisors. Marshall's outfit is one of the first companies attempting to privatize rent-controlled buildings in downtown Cairo.

You see, it's possible to pay tenants to move out and give up their rent-controlled "rights", and then renovate some grand old buildings in prime locations, but with 70 years of abuse. Pretty much the same drill as worked in New York a couple generations ago. The current landlords don't have the capital to do it, but Emergent Property Advisors does. The plan is to market the renovated apartments toward high-net-worth professionals from the upper-middle class.

L: What if some holdout curmudgeon doesn't want to leave?

Doug: He doesn't have to. The profit assumptions assume only a portion of the tenants decide to sell.