Indonesia has become an attractive market for other ASEAN countries due to stable economic growth supported by the increasing size of the middle-class.

In particular, Indonesia'€™s property sector has very positive long-term prospects.

The important factor is the population of young people in Indonesia, which stands at 50 percent of the total population, or 250 million persons.

This population of young Indonesians means there will be many potential first-time home buyers in the coming years.

There will also likely be an increase in demand for commercial properties such as shopping centers and office buildings.

Thus, foreign developers will be attracted and competition will stiffen in the property market.

Heading towards the launch of the ASEAN Economic Community (AEC) in 2015, the Indonesian Real Estate Developers Association (REI) is encouraging developers to improve competitiveness by strengthening funding.

Funding is a crucial factor in the success of any property project.

Insufficient funds can lead to delayed project completion and a failure to achieve company targets.

Moreover, insufficient funding endangers the development plans or expansion plans of a company.

Until recently, most developers only used conventional financing from internal funds or the banking sector.

A Bank Indonesia (BI) survey undertaken in the second quarter of 2014 (Q2-2014) showed that internal funds, at 62.4 percent, were the primary source of funding among most developer respondents. This extends a trend seen between 2011 and 2012, when internal funding accounted for 56.8 percent and 53.6 percent, respectively.

The second-largest financing resource was bank loans, which stood at 27.1 percent. This figure decreased from 28.2 percent in 2011 to 32 percent in 2012.

We had expected that BI'€™s regulation regarding the prohibition of indent housing sale would lead to increase in bank loans.

But on the contrary, real estate financing from banks is currently decreasing while internal financing is currently increasing.

Bank lending to the property sector is still growing despite the fact that its growth began to slow down in line with the rising trend of interest rates.

As of June 2014, working capital loans in the property sector reached Rp 36.2 trillion (US$3.05 billion), a growth of 14 percent year-on-year (yoy).

This figure represented a slowdown compared to 34 percent yoy growth in 2011 and 38 percent yoy growth in 2012.

This drop-off was also in line with the deceleration in the growth of total loans, from 24.6 percent yoy in 2011 and 23.1 percent yoy in 2012 to 17.2 percent yoy in June 2014.

Local developers are now facing competition from foreign developers that have distinct advantages such as large assets and equity, a strong business network, capital with a low-interest financial base and more sophisticated investment models.

The largest domestically listed developer'€™s assets and equity '€” which stand at US$1.9 million and $1.1 million, respectively '€” are still far behind Keppel Land, a Singapore-based developer whose assets and equity amount to $10.9 million and $5.9 million, respectively.

Other financing options can be used by developers from the capital market.

Currently, only big developers can be registered in the capital market.

Based on data from the Indonesia Stock Exchange, 54 property developers are listed as public companies. Aside from the stock issuance, developers can also take advantage of other capital-market instruments, such as debt securities (bonds) made available through a public offering scheme.

The Indonesia Stock Exchange listed 38 property companies that have made public offerings of bonds.

Another capital-market product that can be used by developers to finance their projects is real estate investment trusts (REITs).

REITs are an investment instrument that appear in the form of securities and can be purchased by investors from the company that publishes property REITs.

REITs securities are similar to stock certificates that show ownership of a particular company, but its placements are in property projects rather than company assets.

A tax regulation related to the transaction of REITs was established in 2007 and REITs were first launched in Indonesia in 2012.

However, demand from investors for REITs is still low.

REIT financing in Indonesia is still hampered by several factors.

The first factor is the low efficiency of both the banking system and the capital market in Indonesia, which can be seen in the high cost of funds or bank funding costs.

One of the ways of bringing down the costs would be to improve the tax mechanism.

A number of countries such as Singapore, Thailand and the Philippines have applied excellence REITs through a special treatment that is free from income tax. But Indonesia imposes a layered tax system that inhibits the use of REITs.

The issuers of REITs are subject to taxes, both when buying property or selling REITs to investors.

Currently, the Collective Investment Contracts (CIC) needed to buy REITs products impose a 10 percent value-added tax (VAT) and fees for every acquisition of land and buildings (BPHTB) of 5 percent.

On top of that, the rental tax of 5 percent must also be paid.

In the meantime, developers are subject to an income tax (PPh) of 5 percent.

The high cost of taxes that investors must pay has resulted in low interest in REITs transactions.

The second factor is the lack of disclosure of corporate information, particularly among property companies. The current disclosure system is still difficult to apply since many companies in Indonesia began as family businesses such that there is no urgency felt to audit their company.

Another factor is the number of daily workers in property projects.

Up to 90 percent of construction workers in Indonesia are seasonal workers who receive their salary on a day-to-day basis.

This condition reduces the concentration of the workers, creating concerns that ongoing property projects will not be completed on time.

Through the improvement of the financing side, local developers can compete with foreign developers. Therefore, there is a need for active communication between the government and businesses to create real solutions to improve developers'€™ financial capabilities and attract investors in the property sector.

One way of doing this would be to simplify the technical regulations and tax incentives for capital-market instruments such as REITs.

The writer is an industry analyst at Bank Mandiri

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