The non-delivery spectre that stalks GCC real estate

23 February 2007

The GCC has been in uncharted territory since Iraq's quick defeat in March 2003 primed the pump that doubled the region's economy in the intervening four years. Practically every expectation about investment, spending and trade has been exceeded. Even the crash by more than 60 per cent in the Saudi share index that began on 25 February last year has been absorbed with little obvious macro-economic ill-effect. From an economic perspective, doing business in the GCC has been like walking on the moon. The usual laws don't apply.

The problem with trailblazing is that there are no maps showing where the pitfalls lie. Prudent adventurers take care with every fresh step. Prudence, however, is missing in some GCC market sectors despite signs that there's trouble ahead.

The fall in oil prices by more than $20 a barrel since the summer and lower demand for Opec oil will produce later this year negative headline growth figures, though the non-oil economy continues to grow. Higher interest rates imported through the GCC dollar currency peg will discourage consumption and investment.

Cost increases are stripping the gloss off impressive company top-line figures. There's uncertainty about GCC foreign exchange trends now that full currency union in 2010 is off. And Washington's anti-Iran rhetoric is doing a better job frightening its Middle East friends than deterring Tehran.

Ignoring signs that the region is heading for choppier waters, some investors are behaving as if the boom will never end. Overcapacity is being built in practically every sector apart from the pool of skilled national labour.

The stock market crash has effectively blocked one of the most important sources of corporate finance. Borrowers can turn to loans, bonds and private placements instead.

Savers have fewer options. GCC real estate still offers retail investors the possibility of a high double-digit yield. A recent deal generated an annualised return on capital of more than 10,000 per cent. For the speculator, the temptations are irresistible: in Dubai, you can buy and sell a property in not much more than two weeks. This is efficient, but it will facilitate instability when the Gulf property market finally turns.

The first warnings of a real estate slump were issued more than three years ago. But surveys showed that the number of residential properties coming to the market then was small compared with demand. This is no longer the case. In 2007/08, tens of thousands of new homes will be released to investors and final users. The secondary market will increase several times.

Speaking at the MEED Ras al-Khaimah conference in February, CB Richard Ellis Middle East managing director Nicholas Maclean warned the slump could be big and that it might happen in 2009. The real estate majority, however, remain publicly confident that the good times will continue to roll. Their argument is that developers can control the timing of the release of properties. There is plenty of liquidity with nowhere else to go and the non-oil economy will remain buoyant.

They have a point. But the trigger for a crash will not be higher interest rates, rising costs or excess supply, though they will give it momentum once the slump starts. The biggest issue facing the Gulf real estate market is the impact on confidence of the inability to deliver projects on time to the end user: people who buy a home to live in rather than to make a quick profit.

The record for some prestige GCC projects has been poor, with prospective owners experiencing delays of more than a year. Many buyers who have put down a big deposit for a loan with high borrowing rates and a straight-line repayment schedule cannot afford to pay rent while they wait for their homes to be finished. And once the impression spreads that GCC developments are persistently late, foreign investors will find other places to buy. If these trends occur simultaneously

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