LONDON, 5 July 2004 — Real estate is a very attractive investment asset class in the GCC states. Judging by the spate of real estate developments, funds, and the emergence currently of housing finance and securitization, the sector is experiencing a boom that is making many investors and consumers jittery.
Is the Gulf market merely a real estate bubble nurtured by an artificial market, waiting to burst at the sign of any serious worsening of political instability or a dramatic fall in the price of oil and its inevitable knock-on effect on the other sectors of the economy?
Most Gulf bankers agree that a correction in the real estate market is due, but they differ on the size of the correction — 5 percent; 10 percent; or 20 percent.
In Kuwait for instance, the market is already on a downward trend. Margins, according to one banker, are low — up to 2 percent. The market is flush with liquidity as Kuwaitis are repatriating more of their funds home. The municipality has also increased the size of rentable areas of developments. Land values have appreciated sharply from 20 Kuwaiti dinars per square foot only a couple of years ago to over 52 Kuwaiti dinars per square foot at present.
Subsequently, yields from real estate developments, subject to the area and type of development, have declined from 12 percent to 6 percent in general. The areas allocated for commercial or residential real estate development is very limited because most of the land belongs to the government and are oil production areas.
The internal dynamics of the Gulf real estate market also lends itself to a dichotomy, which at best can be perceived as both reformist and confusing. Yes, foreign ownership of property is now tolerated. But under such protectionist conditions that make a mockery of any espoused conviction to a truly free market economy.
In Dubai, for instance, foreigners can buy freehold properties only in certain designated so-called property free zone areas, which are limited in numbers and are usually aimed at the higher end of the market. Otherwise they can rent or buy on short lease-holds.
Bahrain, the UAE, Qatar, and Kuwait are in the throes of a classic real estate boom — both in terms of prestigious commercial property projects such as Bahrain Financial Harbor; the Amwaj Island Resort in Bahrain; the Dubai International Financial Center; Dubailand Theme Park as part of the Arabian Legends Resort Complex; and so on.
But, by far the biggest market is Saudi Arabia, especially the environs of Riyadh, which is seeing an unprecedented number of real estate developments. The Saudi capital, according to various studies, is earmarked for significant economic development over the next decade or so.
The size of the real estate sector in the Kingdom, according to one Saudi asset manager, is in excess of SR1 trillion and is second only to the oil and gas sector.
However, not all Gulf investors are keen to put their eggs in one basket. As such real estate funds, promoted by Gulf banks, are also targeting deal flows and developments such as multifamily and assisted living in the US, UK and Europe. First Islamic Investment Bank in Bahrain, for instance, has a US real estate portfolio of over $1.2 billion. Gulf Finance House in Bahrain too has Gulf Atlantic Real Estate Funds in the UK and in France, and is in the process of closing its first Spanish real estate fund, the $50 million Al Andalus Fund. Dubai Islamic Bank similarly has just launched a 179 million Euro Al-Islami French Property Fund.
All the above funds have one feature in common. They are all Islamic real estate funds. And the demand for such funds and products seems insatiable. The Dallah Albaraka Group (DBG) recently closed subscription to its SR140 million Al Shurook Real Estate Fund two weeks after the launch because demand was so high. DBG in the last few years has launched and closed several such funds including Durrat Al-Aroos; Al-Madinah Al-Munawarrah; Al-Riyadh; and Al-Omran.
Last week’s Islamic Real Estate Finance (IREF 2004) conference in London organized by Islamic Conference Group, stressed the dramatic growth of the market and the challenges relating to new markets; product innovation; entry and exit strategies; outperformance; benchmarking; indexing; valuation; retail housing finance; Sukuk (bonds and certificates) and securitization; and Shariah compliance.
The City of London was pitching strongly to get a bigger slice of this market. The Lord Mayor, Alderman Robert Finch, who inaugurated the conference, stressed that “real estate is a cornerstone of many Islamic asset management strategies. The development of more liquid instruments to deepen this market is a new and crucial initiative.”
Others berate the Islamic sector for its moral ambivalence in the real estate sector. They point to the fact that, save perhaps Malaysia and Kuwait, most of the Islamic real estate developments are concentrated at the high net worth end of the market. They rue the lack of key worker and low cost housing developments. They point to the pockets of poverty and lack of proper housing in all the Gulf states. This at a time of supposedly huge liquidity in the market.
Perhaps the most revealing thing that came out of the conference is the huge gap in the enabling factors such as legal infrastructure, tax issues, and the use of special purpose vehicles under certain jurisdictions.
Issuing an asset-backed Sukuk (Islamic bond or certificate) under Saudi law, for instance, is not feasible. As Trevor Norman of Volaw Trust & Corporate Services Limited in Jersey explains, “Sukuk are not recognized under Saudi corporate law as a valid instrument to be issued by a Saudi registered company.”
By Saudi law, the owner of the asset (either real estate, vehicles, plant etc), has to be a Saudi national, hence the establishment of a Saudi SPC (special purpose company), which in turn also had to be owned by Saudi nationals. For the Jersey SPV (special purpose vehicle) to retain economic control of the assets (as per the requirement of the Islamic investors) a complex trustee and agency solution had to be found which satisfied both Saudi law, Jersey law and the requirements of both the issuer of the Sukuk and the investors therein.
In fact, this was the structure used for a recent Sukuk, Caravan 1 which involved Saudi private sector transport assets. The issues raised equally apply in general to real estate assets in the Kingdom. “This transaction,” added Trevor Norman, really brought home the differences between the Civil Law and Common Law jurisdictions, and the one problem we didn’t solve was the uncertainty over enforcement of Saudi laws.”
Islamic finance, stressed one banker, operates in an environment of “negative consent” in some of the Gulf states, where it is tolerated but not proactively supported through the regulatory, supervisory, and legal infrastructure.
This dichotomy is not only confined to the Islamic finance sector, but also in the economy in general.
