Middle East Real Estate Markets: Risks, Reforms & Investment

Overview of Global Property Markets

Over the last several years, the property markets of Egypt, Jordan, Kuwait, Qatar, Saudi Arabia, Syria, and the United Arab Emirates have followed the performance of global real estate trends, with prices in steady free fall following many years of appreciation. Due to the overall levels of speculation that had been taking place, many of these once-promising markets turned cold rather quickly. A striking example is Egypt, where prices fell 37% in 2009 as homebuyers canceled their down payments, which had a ripple effect on the commercial real estate market — this despite a shortage of 40,000 units per year in the lower end of the housing market. (Egyptian Property Plunges 2009) This conflict within these property markets reveals that tremendous opportunity can exist even alongside massive price implosions. To identify the best opportunities as well as the risks, this paper provides an overview of global property markets, their characteristics and challenges, portfolio diversification, transparency and efficiency, property investment vehicles, property companies (PCs), real estate investment trusts (REITs), mutual funds (MFs), the risks of investing in global property markets, emerging property markets in the Middle East, property market performance across the region, property company performance, the transparency of these emerging markets, and the Efficient Market Hypothesis. Together, these elements provide the greatest insights into the issues facing real estate markets in the Middle East.

Global property markets are facing a number of significant challenges as they go through a period of severe correction following a steady appreciation in real estate prices led by the United States. Prices in the U.S. increased steadily between 2000 and 2006, then declined by 33% between 2006 and 2009, following a massive bubble in the American housing market fueled by easy credit and speculative fever that caused home prices to rise by as much as 100% in some markets. (Mullins 2010) Because many of the mortgages were underwritten, bundled together, and sold to investors around the globe, the effects of the U.S. real estate market spread worldwide. Many investors found themselves holding mortgages that had lost their value due to the bursting of the price bubble, and this had a ripple effect on real estate prices internationally. Markets that had been appreciating in a fashion similar to the United States began to see serious price declines.

A notable example is Israel, where many people had experienced tremendous price appreciation in properties owned in North America and Europe. This allowed them to sell those properties and reinvest the proceeds into real estate in Israel, mirroring the housing appreciation seen in the United States. Once the U.S. bubble burst, Israel began to experience a similar decline. (Levin 2009) By contrast, Canada did not experience as severe a downturn. The pace of price increases had not been as extreme in Canada, a fact supported by a Cleveland Federal Reserve report that found housing prices rose twice as fast in America as in Canada. When the slowdown arrived, the decline in Canada was significantly more moderate. (MacGee 2009)

These examples illustrate how worldwide real estate markets follow a similar general trend while still displaying unique local characteristics. Egypt saw a sharp sell-off following a period of large increases, yet simultaneously faced a housing shortage of 40,000 units per year in the low-end market. Canada experienced slower appreciation during the boom and now faces slower declines. These situations highlight how real estate prices are shaped by local laws and regulations, interest rates, and investing traditions — markets that are interconnected yet independently unique.

Characteristics of the Global Property Markets

The global property market stands at a crossroads where globalization has interconnected markets, yet country-specific and regional factors continue to exert major influence. As the world became more globalized, a new way to market real estate emerged: the tranche. Investment bankers developed mechanisms to market mortgages to large institutional investors such as mutual funds, hedge funds, and insurance companies. (Lamb 2010) Different mortgages were bundled into a single group paying a stated interest rate, and as mortgage payments were made to the servicer, interest was paid to the owners of these tranches. As this practice became more common, the number of tranches grew dramatically. Coupled with globalization's improved access to foreign direct investment (FDI), investors around the world could purchase these kinds of investments, making the global property market more interconnected than at any previous point in recorded history.

Beyond tranches and globalization, the global property market remains decentralized. Depending upon the country, varying laws, regulations, demographics, and customs constantly affect these markets. This makes it harder for investors to export a successful real estate strategy from one market to another with the same degree of success. Real estate prices therefore vary widely according to these factors. (Lamb 2010) The combination of globalization and specific market conditions affects how much real estate prices fluctuate, as globalization fuels the speculative fever that invites large boom-and-bust cycles. Yet the severity of those moves depends on the factors specific to each market, causing some markets to experience large growth during expansions and severe downturns during economic distress.

Challenges in the Global Property Markets

The biggest challenges facing the global property markets are large amounts of oversupply and overbuilding. During the boom years, a variety of commercial real estate projects began — ranging from modest single-family homes to large commercial developments. While prices were climbing, many investors and developers assumed that property values would increase considerably within a few years. Fueled by greed, many engaged in financially imprudent real estate transactions, causing overbuilding in both commercial and residential sectors around the globe. Once demand began to decline, prices fell accordingly. Since so much money had been borrowed against higher real estate values, many individuals and corporations had trouble maintaining mortgage payments, causing foreclosures to rise dramatically in both sectors. A parallel example can be seen in Cambodia, where prices followed a similar uptrend until 2008, then declined by as much as 40% as the worldwide real estate market slowed. (Far East Property Markets Expected to Take Off into 2010, 2010)

The biggest ongoing challenge for these markets is therefore a severe overhang of supply resulting from large numbers of foreclosures and widespread overbuilding. These two factors will continue to depress prices well into the future, as the excess supply will take time to be absorbed. Once these issues are addressed, real estate prices can resume consistent appreciation.

Portfolio Diversification of Investment in Global Property Markets

Because global property markets are affected by both globalization and country- or region-specific factors, the risks will vary. The most notable risk variables are transparency and efficiency, since each country has different laws and regulations pertaining to its real estate market. To protect themselves against these risks, many investors seek to diversify their portfolios across different asset classes and across a variety of countries and regions. The idea is that if a risk materializes in a specific country or region, other areas of the portfolio will offset the severity of any decline. For example, an investor holding U.S. real estate might diversify into Canada to reduce exposure to U.S. risks, since Canada's tougher regulations cause prices to remain more stable by comparison. (MacGee 2009) Such a strategy can theoretically be applied across many different countries to reduce overall portfolio risk.