MIDDLE EAST - Rating agency Moody's today blamed oversupply and lack of property finance for an 18-month negative outlook for real estate markets in Gulf Cooperation Council  (GCC) states.

Although the rating applied mainly to commercial real estate, analyst Martin Kohlhase said the residential sector in some states would also be affected. In both cases, the outlook is likely to worsen "as vast supply meets slack demand". Dubai has seen a 50% decline in house prices and rental in recent months.

House prices and rents will both fall 10% in 2010, with no regional recovery forecast until 2012, according to the note. The exception will be Saudi Arabia, "one of the brighter spots", where a young population is supporting the residential market.

In the meantime, developers facing funding problems could be forced to sell assets or sign debt standstill agreements. "As long as the banking system is reeling with non-performing loans and high exposure to the real estate and construction industries on its loan books, markets for new projects are very unlikely to commence on a large scale," said the report. The pre-sale model, previously dominant, has now largely disappeared.

The agency has downgraded the ratings of issuers with real estate exposure over the past year because of a deteriorating operating environment. Dubai has deteriorated most, with the highest levels in the region of oversupply and customer defaults.

Investment in the region from overseas institutional investors is unlikely in the short-term due to mismatch between the actual single-digit returns seen in the markets versus the double-digit returns investors would require for taking on emerging market risk.

Differences between the single-digit actual returns and return expectations of above 10% to compensate for emerging market risk made the entry into the market of overseas institutional investors, including pension funds, unlikely in the short term.

That said, Kohlkase refused to rule out the possibility, saying prices would have to fall and economic recovery "would have to be more pronounced than is currently anticipated to restore the demand-supply balance and provide returns attractive to institutional investors".