GCC real estate market: Déjà vu or different this time?

Transactions momentum from 2019 interrupted in 2020; rental recovery in most segments to take longer

This report analyzes real estate fundamentals in the GCC in the back backdrop of the impact of Covid-19, current low oil prices and also compares the market with the Global Financial Crisis (GFC) of 2009. We analyze demand-supply drivers and examine trends in transactions, prices and rents that drive the outlook for real estate in the region.

— Editor

Report prepared by KAMCO

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Real estate sale transactions in the GCC rebounded in 2019, as total value transacted improved by 14.8% y-o-y to USD 95.1 Bn, from USD 82.8 Bn in 2018, according to our estimates. Saudi continued to contribute over 50% of the transacted value, while UAE added 20.4% to the region’s aggregate figure. However, the average value per transaction in the GCC fell by 4.1% y-o-y to around USD 155,680 in 2019 from around USD 162,330 in 2018. The number of transactions for 2019 jumped by almost 20% y-o-y to 610,747. These estimates exclude Abu Dhabi transactions as official data was only available for 2019 from Abu Dhabi Department of Municipalities and Transport. We believe the higher transactions in 2019, albeit at lower average value transacted were showing signs of a base bottoming out, following which we expected the market to enter the price stabilization stage, typically followed by the first leg of overall growth in both transactions and average value per transaction.

However, the impact of Covid-19 and related shutdowns affected various segments of the end user real estate demand, while oil price volatility further exacerbated the demand outlook for the sector. As a result, the combined transacted value in active markets Saudi Arabia and Dubai during the months of Mar-2020 & Apr-2020 fell by 47.3% y-o-y, while number of transactions dropped by 46% y-o-y over the same period. Post Covid-19 visibility crucial for onplan sales & price stability We noticed interesting price trends evolve in active real estate markets in the GCC. Average transacted values in Saudi Arabia and Dubai combined remained largely stable at around USD 290,000 for Mar-2020 & Apr2020, as we believe prices real estate remain sticky in the short-term. In Dubai, however we found that the contribution of off-plan transactions in Apr-20 jumped from 29%32% to over 52.5%.

The higher contribution of offplan sales in our view is ascribed to investors being more willing to look at primary market opportunities for real estate investments, while choosing to delay purchases of inmarket deals and being more price sensitive for such deals. Moreover, we believe a rebound of onplan transactions and higher visibility for overall future transactions would be needed for the sales market to revive itself and would be crucial for price stability in the sector. Rental recovery in most segments to take longer; new project timing key Fewer transactions and lower visibility for sales prices could potentially now lead to rental recovery taking longer in most segments of the market, and pushing rents at least one-step back from their respective pre-Covid-19 stages in the rental cycle. We expect the freehold industrial real estate sector to be the exception, where demand for quality spaces across specific warehouse types will remain strong, driving rental stability and in some cases even rental growth. Although there is no substantial overbuild in real estate segments like 2009, we expect the retail segment and commercial office spaces to be affected by structural shifts in demand, some with temporary effects, while others are likely more permanent and would alter incoming supply going forward.

A variety of direct and indirect government initiatives were announced to negate the impact of Covid19 on different sectors of the economy, including real estate. We believe GCC governments are monitoring and waiting to roll-out more policy action, depending upon the extent of support needed. The UAE witnessed prominent policy support both from governments, and real estate portfolio owners like Aldar, Al-Futtaim, Emaar Malls etc. via rent waivers including discounts in particular service charges. Some of the UAE government initiatives include:

• Higher LTV limits for Emirati and expat buyers, increase in the maximum exposure banks can have to the real estate sector from 20% to 30% provided banks hold additional capital, • Waiving off specific commercial and industrial fees (Abu Dhabi) • Rebate of 20% on rents for restaurants, tourism and entertainment tenants (Abu Dhabi) • Suspension of municipality fees for the aforementioned sectors for the remainder of 2020 (Abu Dhabi) • Reduction of 10% reduction on DEWA bills for the residential, commercial and industrial sectors alongside a 50% reduction in the deposit requirement for DEWA services (Dubai) • Renewal of commercial leases without the mandatory requirement to renew lease contracts (Dubai) • Reduction of municipality fees imposed on sales at hotels from 7% to 3.5% (Dubai).

Other initiatives from select GCC countries include rent reliefs from government and semigovernment entities leasing especially to retail and F&B sectors, voluntary rent reduction and waiver of utility payments from commercial property owners and residential landlords.

For the real estate sector, we expect the full impact of covid-19 on the demand side to be visible in the next 6-9 months, once the tenant and sales activity return to being fully operational. Moreover, despite the lead times required for projects to come into the market, we expect developers to delay and even reassess some of their project pipelines going forward. We expect leverage to be a consideration in this cycle as well similar to 2009, but it would remain largely specific to individual buyer and seller profiles. However, similar to past real estate cycles, we do expect to see opportunistic deals to emerge for investors, both in terms of yield hunting and capital appreciation.

Residential rents will now take longer to stabilize

Prior to the impact of Covid-19, rents in the residential segment of the GCC real estate in markets were recovering in markets where: 1) supply additions were minimal 2) government initiatives for home ownership were being rolled out. However, affordability continued to remain a theme, as good quality affordable units continued to witness stabilizing rents. However, with the onset of Covid-19, and lower visibility for growth in household incomes, we expect affordability to remain the dominant theme in the residential market, and asking rents for new tenancy contracts to trend lower in the near term before bottoming out. In terms of upcoming supply, based on estimates from RE consultants around 135,350 residential units are expected to added to the GCC residential supply in 2020-21.

Rental performance since 2009 has been mixed, as few GCC markets have recovered from the lows of 2010, but most markets witnessed downward pressure in 2018 & 2019 from a combination of lower demand and incoming supply. This trend has driven rents in markets such as Dubai downwards toward rents of 2010. Average rents for high-to-luxury 2BR apartments are now just 1.8% (AED 110k/annum) higher than 2010 rents (AED 108k/annum), while the rents of more mid-end 2BR apartments are 5.6% higher (AED 87k/annum) than rents in 2010 (AED 83 k/annum) as per Asteco. The affordable 2BR apartments segment remains 7.2% higher (AED 59k/annum) as compared to 2010 (AED 55k/annum), a theme we expect to continue in the near term. Also, the average rents of 4BR villas contracted 4.8% from 2010 (AED 184k/annum) to 2019 (AED 175k/ annum), which further reaffirms the fact that residential demand remains skewed towards affordable units.

Sustainable yields hunting should keep investors interested

We believe yields are a function of macro, sector & property specific expectations of investors & the prevailing investment climate. Yields for more affordable apartments are usually higher than more premium apartments as the sales market is more active in the upper end of the market.

However, in Dubai, the yields spread between apartments in high-end areas and affordable areas compressed from 2015 to Apr-2020 by over 155bps, led by both and expansion of yields of high-end apartments (2020 avg: 6.2%) and contraction in the yields of affordable apartments (8.0%). In our view, this is largely ascribed to demand from yield hunting investors as against end user demand that usually prefers the top end of the market. Also, the cuts in benchmark interest rates has also led to a widening spread between yields and borrowing rates, which should be accretive for investors looking at capitalizing on income generating opportunities. Unlike 2009, we think more significant price declines could bring the yield discussion back into a compelling argument for investors looking at sustainable yields. Upcoming office space supply revisions plausible

We ran channel checks across consultants in the GCC for office space supply. As of end 2019, total supply of office space in the GCC (barring Oman) was around 25.72 Mn sq.m and upcoming supply was estimated at 2.42 Mn sq.m. Kuwait and Riyadh were the strongest office markets with natural vacancy rates of 2.9% and 6% respectively, while the vacancy rates in all other markets were in doubledigit percentages . In 2009, upcoming office space supply estimates were significantly higher and as a result of global financial crisis (GFC) employment growth in the non-oil sector grew at a slower pace, creating massive oversupply in commercial office spaces. The trend continued since the GFC of 2009, as most markets witnessed subdued business growth, that put pressure on rental rates across all quality office grades. However, GCC governments have currently announced various pro-business initiatives to incentivize businesses and employment that would have a positive impact on office space demand such as larger support for the SME sector, reduction of fees in certain markets, higher foreign ownership limits.

WFH & social distancing changes office space demand landscape

The onset of Covid-19 required employers to transition their workforce to work from home (WFH), a trend that is expected to continue in varying degrees depending on industry type, given the nature of the spread of the pandemic. The lower utilization rates of office spaces, with phased officebased attendance likely, combined with below full potential revenues for businesses could push tenants to negotiate office space rents with landlords. Moreover, given the ample supply – both existing and upcoming in most markets, this could push rents to spiral downwards. Planned projects including office components are also likely to be reassessed given the lower demand environment existing currently. An offsetting trend could be the higher space needed per employee on resumption of work, given social distancing standards employed by governments and corporates that could push the average office space occupied by employees in the GCC from 15 sq.m -16 sq.m higher. Nevertheless, we believe the key driver for growth in office space demand in the longer term for the GCC region will remain demand from growth in employment within the non-oil sector, with SME sector expected to play a key role. Regulations such as the UAE Central Bank mandating all banks to open bank accounts for SME customers within two days, provided all documentation and legal obligations are met will be accretive in the longer term for realizing higher office space demand.

Retail segment structural headwinds to continue

Retail real estate was the least affected segment on a relative basis in the GCC during the GFC, as consumer spending in the region continued unabated, footfalls increased, and mall space per capita in specific markets in the region was significantly lower than regional and global standards. The total supply of retail space in the GCC (barring Oman) as of 2019 came up to 15.3 Mn sqm based on data from various RE consultants. Even prior to Covid-19, the growth of online retailecommerce or etailing posed a major challenge to brick-and-mortar retail stores in terms of footfalls and their in-store sale conversion rates. Despite this increasing challenge, estimates of upcoming supply came showed a potential increase of over 25% with the addition of 3.9 Mn sq.m, while vacancy rates increased to double digits in most GCC markets. The oversupply concerns and selective consumer spending at physical stores also led some mall operators moved to charge tenants favorable leases, negotiable and rent-free periods and higher capex contributions towards fit-outs of retail spaces.

Growth of e-tailing & Covid-19 impact to reduce footfalls in near term

Along with e-tailing continuing to attract an increasing share of retail sales in the GCC, the onset of Covid-19 exacerbated business activity in brick-and-mortar retail stores. The immediate impact was the shutdown of mall spaces and retail outlets which brought physical store sales to standstill, affected retailers cashflows, who in turn approached mall operators for rent waivers. Hypermarkets that operated at lower capacities and those that largely ran delivery of grocery retail were the few active tenants in mall space retail in the region. As a result, several mall owners in the region supported retailers who were affected by offering rent waivers, taking a hit on their gross revenues. Recent take up of retail space in the region included a higher proportion of F&B and entertainment tenants with hospitality linked mall space becoming popular. The shutdown due to the pandemic meant that all these mall space clientele barring F&B were forced to observe a complete standstill in their normal business activities. F&B and luxury & fashion retail who were hit hard due to the current crisis emanating from the pandemic are trying to recoup their lost ground on achieving sales via setting up online apps, collaborating with multi-brand online platforms and liaising with last-mile delivery players, who are operating at full capacity across the region.

The demand side environment for retail real estate looks particularly challenging going forward, as the resumption of mall space activity for customers is unlikely to go back to full potential until GCC governments see the effects of Covid-19 receding for good. Like witnessed in the UAE, mall operators are likely to operate with time-limits for mall visitors and apply social distancing regulations along with a cap on maximum per store footfall at any given point. This should translate into lower realized sales for retailers and could potentially lead to further negotiations on reduction of rents. Moreover, sales via ecommerce in the GCC region for large retailers only constitute low single digits percentages and some prominent retailers have ramped up their online channels to witness a 3x-4x increase in their online sales during this period up upgrading their overall digital presence. This in our view could also lead to some retailers deferring new store openings as well. We believe the current headwinds in the retail sector, like a drop in consumer spending, lower brick-andmortar footfalls and sales conversions could put significant downward pressure on retail rents going forward.

Industrial - Warehouses remain the bright spot

We expect industrial warehouses to be the strongest segment in the GCC real estate, with structural and cyclical trends favoring demand for spaces tailored towards unique storage needs. Although consumption, trade and supply chain reconfiguration remain the core drivers of industrial warehouse demand, the other more recent source of demand growth constitute: 1) Expansion by 3PL logistics and e-commerce companies 2) Newer F&B models such as cloud kitchen operator, while vertical farming also contributed to incremental demand. Industrial rents across the GCC vary widely across countries and within individual countries and range as wide as USD 2.7/sq.m/annum to 25/ sq.m/ annum according to various real estate consultants. The large differential in rents is due to type of storage spaces which range from open yards, dry, ambient, temperature controlled and chiller warehouses and demandsupply trends disparity between different markets in the GCC.

Prime GCC industrial real estate yields compelling

Apart from the growth of 3PL logistics, ecommerce volumes and newer concepts in F&B, industrial warehouses are witnessing significant additional demand for storage units from governments’ increasing focus for their strategic reserves of food, medicines and essential supplies, with the onset of Covid-19. Moreover, rising inventory for other sectors during this time are also a source of demand for warehouses across storage types.

Prime GCC industrials warehouse yields in the GCC remain strong and above global averages with sustainable yield averages of 8%-9% possible for investors looking at prime assets, making them our preferred segment for GCC real estate exposure.

GCC real estate equities – remain selective

Real estate equities plunged along with broader markets on fears of the spread of Covid-19 and the impact of lower oil prices on the GCC economy. The Refinitiv GCC Real Estate Total Return Index closed 23.6% lower YTD at the end of Apr-2020 while the MSCI GCC index which was down 22.6% over the same period.

However, the Refinitiv GCC Real Estate Total Return Index remains 50% higher than its Mar-09 and Mar-11 lows. Real estate stocks in Dubai were the worst performers with declines of over 30% at the end of Apr-2020 YTD, while Saudi Arabian real estate companies (11.5%) and Saudi Arabian REITs (-12.6%) fell the least over the same time frame.

The performance of real estate equities will remain linked with economic activity, and the near-term outlook for the sector would depend on the extent of time GCC economies would take to recover completely from the impact of Covid-19, and be able to resume full potential economic business activity that supports demand across the various real estate segments. There were a host of measures by GCC governments that were aimed at directly or indirectly supporting real estate demand, like the UAE increasing the maximum exposure banks can have to the real estate sector from 20% to 30%, with banks being required to hold additional capital if they surpass the 20% exposure threshold. We expect the market to favor equities and REITs which are more exposed to prime industrial warehouses and residential, over ones that exposure to the retail segment and commercial office segment. We also believe that real estate developers with strong placement capacity would continue to outperform from their off-plan and on-plan sales.