The property markets in the Middle East are unlikely to see an influx of institutional capital in the near future, says Craig Plumb
The recent announcement of a $1bn (€798m) real estate fund to be established by the Investment Corporation of Dubai (ICD) and Brookfield Asset Management represents a major boost in sentiment for the Middle East real estate market, which has largely been shunned by institutional investors.
While the volume of capital flowing into global real estate markets has continued to increase in recent years, with Jones Lang LaSalle (JLL) expecting this to exceed $400bn in 2012, the level of investment in completed commercial real estate in the Middle East remains extremely small. Just $200m of direct investment in completed commercial real estate has been recorded across the entire MENA region in the first quarter of 2012, representing just 0.7% of total global real estate investment during the three-month period.
Dubai has been the most active investment market in the region recently, but even here there have been just a handful of transactions by institutional investors, with most sales between private investors. The most active sectors have been land sales, development projects and residential buildings, with few sales of completed commercial assets. However, JLL has recently advised the seller in the largest ‘arm's-length' transaction in Dubai this year, the sale of Building 6 in the Dubai International Financial centre (DIFC) to Legatum, a Dubai-based investment company, for approximately $60m. There were a number of under-bidders in this transaction, showing the current strength of interest in securely leased completed prime commercial assets.
This deal is somewhat unusual, with more of the transactions in Dubai occurring between related parties. One deal occurred earlier in 2012 with local bank Emirates NBD swapping its debt into equity by acquiring two landmark assets in the DIFC (Limestone House and Index Tower) from Union Properties. This cannot, however, be described as an arm's-length transaction as it involved two Dubai government-controlled entities.
The limited level of sales activity in the Dubai market. The major reason has been the lack of suitable investment-grade property in the market at sufficiently attractive prices. As the market is relatively immature, it remains dominated by development projects, with few completed and securely leased assets available. The short-term lease structure and the ability of most owners to sit tight and not reduce prices in line with current market conditions have further restricted the volume of real estate transactions, as has the limited availability of funding for real estate investment.
Another indication of the relative immaturity of the local real estate market is the lack of indirect investment vehicles, with investors having few choices between direct purchase and shares in a limited number of listed real estate developers. While two new real estate investment trusts (REITs) have been announced over the past year (Emirates REIT and NBAD), the concept has not yet proved attractive in the Middle East. Part of the reason for this is the absence of real estate taxation, which deprives these trusts of some of their attraction in other regions. Another reason is the requirement for these trusts to purchase suitable investment-grade real estate on the right terms. The most successful structure for REITs in the Middle East is likely to be those that are ‘sponsored' by developers or owners holding onto an existing pool of attractive assets. To date, none of the major developers in the region have proposed such vehicles but this may well be a feature of the market over the next few years.
Market conditions have been another factor restricting sales activity in recent years. With values down from their 2008 peaks and many cities experiencing excess supply, the opportunities for short-term capital gain have been limited and many investors have chosen to invest outside the region. The Arab Spring of 2011 hase boosted sales activity in the residential sector in markets such as Dubai, but have not had a notable influence on sales activity in the commercial market.
While there has been interest from overseas institutional investors attracted by the prospect of distressed pricing, these groups have been largely frustrated by the lack of suitable available product and their inability to complete with locally based investors with different risk expectations. As a result, Middle Eastern markets have been characterised by ‘backyard' investment activity from local family groups or private companies in recent years.
Given the lack of opportunities in their home markets, the Middle East's largest institutional investors (sovereign wealth funds) have shown continued interest in acquiring assets outside of the region. The most popular destination for Middle Eastern investors over the past few years has been central London with that trend typified by another notable sale in late 2011 - the W Hotel in London's Leicester Square - to a Qatari investor for around $315m.
Government-related entities from the United Arab Emirates and Qatar have purchased a number of landmark properties in London in recent years, including the former American Embassy in Mayfair and the Harrods department store in Knightsbridge. In addition, Qatari Diar is developing the Shard Office building at London Bridge and the Chelsea Barracks redevelopment. Although Middle Eastern investors have shown an increased interest in overseas markets outside of London, with recent purchases in Asia, South America and Eastern Europe in 2011, their major focus remains the more established and mature markets.
The extent to which the ICD/Brookfield fund represents a turning point that will trigger more institutional investment in the Dubai market will depend largely upon the availability of suitable investment-grade assets at attractive prices. While activity levels could well increase, most of the activity in 2012 is likely to continue to come from local private investors rather than overseas institutions, as the region continues to be a net exporter of real estate capital.
Craig Plumb is head of research for Middle East and North Africa at Jones Lang LaSalle