Opportunities in the Middle East

Source : Business Times - 26 Sep 2008

Amid economic gloom, Gulf property markets have shown surprising resilience, writes COLIN TAN

AMID the heightened uncertain global economic outlook and the doom and gloom afflicting many of the world’s real estate markets, the Middle East housing sector has been demonstrating surprising resilience especially given that the market has been enjoying at least four years of phenomenal price growth. Today, housing rents and prices in Dubai, Abu Dhabi and Doha - the three most popular markets to outside investors - have continued to climb even as they head south for most of the world’s major real estate markets.

However, recent emerging events - both internal and external - could signal that this comfortable situation may be about to change, albeit not in the immediate future.

For starters, interest from western foreign investors in Gulf property markets, especially in the high-end residential segment, has waned considerably. While some interest remains, there is less enthusiasm than before as British and US buyers re-focus on their home and other markets which they see as cheaper and more competitive. Now, less than a fifth of real estate purchases in Dubai were made by European or US investors.

At the same time, various measures to combat property price inflation, such as rental caps, trading restrictions and proposals for a capital gains tax have all combined to make Gulf property investment much less attractive.

The massive supply under construction over the past few years could also finally catch up with demand by the beginning of 2009 and overtake it by 2010. The problem is compounded by the fact that units completing in the coming years do not meet the actual needs of the different segments of the market. This will lead to oversupply in some market segments.

A Morgan Stanley report issued in late August caused a furore when it warned that the overheated Gulf markets are expected to experience a period of consolidation. It said real estate prices in Dubai have surged 79 per cent since the beginning of 2007. While the sector was unlikely to crash, it projected a series of price declines in 2009 brought about by an oversupply in the market. Property prices could then fall by about 10 per cent in 2010. This was followed by a Reuters poll which had Dubai real estate analysts suggesting that the correction in 2010 could be bigger at about 15 per cent.

Even Abu Dhabi’s Department of Planning and Economy got into the picture when it warned that prices could fall because of oversupply, speculation and an absence of proper regulation. It said the real estate sector has leapt by an average of 22 per cent over the past five years. Although it was expected to maintain high growth due to an economic upswing, a surge in population and tourism, high public spending and other factors, supply is rapidly gaining ground and could sharply depress prices in the medium and long term.

As properties in Dubai set the benchmark for the entire real estate sector in the Gulf region, it follows then that a price correction in Dubai will have a knock-on effect on the rest of the region leading to similar declines in Abu Dhabi and Doha and the rest of the Gulf region.

But how likely is this correction? We have had such similar market calls before but none of it had materialised. It is still early days and 2010 is still some way off but a no-show may well be played out again. One of the main reasons analysts get their calls wrong is that the Middle East markets are notoriously difficult to predict. This is due to the vast amount of petrodollars flowing into the region. As such the Middle-eastern markets operate to a different set of circumstances.

The Middle East provides 62 per cent of global oil reserves and 31 per cent of global production. The GCC alone was already generating a current account surplus of over 30 per cent of GDP in 2007, and that’s before oil topped US$100 per barrel.

Analysts suggest that the breakeven prices for oil producing countries is between US$25 and US$42 per barrel in the GCC countries. Government spending is generally based on the assumption of US$50 a barrel.

According to figures from IMF and HSBC, every US$1 increase in the oil price, sustained for one month, translates to an additional US$500 million of revenues for GCC producers. If one considers the difference between oil at US$60 a barrel, and at US$80 per barrel, it equates to a GCC economy US$200 billion bigger; a fiscal surplus US$100 billion bigger; and a current account surplus US$100 billion bigger. This means if the price of oil were to drop to US$50, the economy would continue to grow at a very healthy rate.

Consequently, governments have been able to pledge huge amounts for capital expenditure in the region. Broad estimates put the figures at US$500 million over the next two years, and US$2 trillion over the next ten. And it’s not just oil that is providing such a boost. Non-oil GDP is rising too as more of the GCC countries adopt a policy of diversification.

The rise of the non-oil sectors adds to an already strengthening economic position. National income growth averaged 19 per cent in the six GCC nations (Saudi Arabia, Kuwait, Qatar, the United Arab Emirates, Bahrain and Oman) in the four years to June 2007. Over the same period, GCC governments added US$500 billion to their net foreign assets despite huge spending on projects. Overall, the IMF forecast 5.9 per cent growth for the Middle East in 2009, and in some nations, notably Qatar and the UAE, analysts have double-digit expectations for near-term GDP growth.

Additionally, the Gulf is one of those rare parts of the world where the age dependency ratio is declining: it’s a young region, with its population entering a demographic sweet spot, and more and more people of a working age. The robust economic growth of both the oil and non-oil sectors have also lead to greater job creation and this has resulted in greater expatriate inflows into the region, thereby creating even more demand for real estate.

In the face of such robust economic growth and high spending on infrastructure, it is very difficult to see prices or rents declining.

Even the new proposals and measures to combat property price inflation across the region cited as reasons for lowering the attractiveness of Middle East property investments, are actually good for the market in the long term. They add confidence to the markets instead of detracting from it.

In the area of demand, departing western investors are easily replaced by local billionaires who are actually less fussy about their desired returns. A recent Boston Consulting Group report rate the UAE, Qatar and Kuwait among the world’s top five countries which enjoy the densest concentration of millionaire population in the world. It estimated the total GCC market has US$1.5 trillion in assets under management (AUM). The average AUM of a wealthy household was an estimated US1$ million - well above the global average of about US$400,000.

Before we forget, some of these wealthy GCC citizens have been reaping huge financial gains from their real estate investments over the past four years - not only on apartment purchases but gains on land in the early years of development. Many have come to build up very deep pockets.

It was always interesting to watch many seemingly dark vacant blocks of apartments light up over the weekend as many GCC nationals flock to their holiday homes be it in the UAE or Qatar. At the same time, many local owners have been known to be more than willing to keep their apartments vacant if they are unable to lease their apartments at the rents they want.

Finally, completed supply is very difficult to predict as they can drag on longer than in developed markets even before rising construction costs and inflation and bottlenecks have become a major problem these days resulting in even more delays.

Until the petrodollars stop flowing into region, it would be most unwise to bet on a market correction actually materialising.

The writer is associate director, Chesterton International