MENA Real Estate: A Positive Outlook, Despite Current Challenges

Key takeaway – In a challenging global and regional context, the MENA real estate sector is showing resilience and holds strong prospects.

While the global economy is characterized by weak fundamentals, below-potential growth and low inflation, the regional outlook is hampered by political instability and declining oil prices. Yet, the MENA real estate sector, despite a short-term outlook clouded by risks, is expected to perform well in the long run – supported by favourable demographics, rising per capita income and an improving mortgage market – and remain an attractive destination for investors.

In the Middle East and North Africa region (MENA), growth is expected to remain flat at 2.2 percent in 2015 and in 2016. Sluggish growth prospects are due to: a) prolonged political instability and ongoing conflicts in Syria, Iraq, Libya and Yemen; b) declining oil prices, which have reduced revenues and growth in oil exporting countries; and c) a chronically slow pace of reforms, which persistently hinder investment.

However, the growth potential of MENA’s real estate sector remains strong. Across a surface of over 15 million km2, demand is supported by favourable demographics, rising per capita income and an improving mortgage market. MENA hosts about 6 percent of the world’s population, about the same as the European Union (EU). Most countries are experiencing rapid population growth – due to fertility rates substantially higher than in other economies with similar real per-capita income. About half the population lives in cities, and is under the age of 15. Despite high dependency rates, the more than 100 million citizens aged between 15 and 29 are likely to support future demand. Over 2009-14, per capita income grew at about 4 percent per annum and the labour force has grown faster than total population.

MENA countries can be grouped in two broad categories: a) those with an already established real estate sector, where abundant supply already anticipates future growth – such as Saudi Arabia, Qatar and UAE; and b) those with a wide supply gap such as Kuwait, Jordan, Algeria, Iraq, Egypt and Libya

In Algeria, prices are rising and rental yields are expected to remain stable. In the residential segment, prices are still 30-50 percent below their 2007-peak, but are rising as a consequence of: 1) a housing shortage, estimated at about 1.2 million units; and 2) severe supply-constraints due to land scarcity – as ownership is concentrated in the hands of the government. In 2014, the price-to-income ratio in Algiers rose to 26.1 times the average income, making housing unaffordable for most citizens and potentially creating the conditions for future social unrest. As a result, the government committed to build 1.6 million ‘social housing units’ between 2015 and 2019. Going forward, demand is likely to be driven by rapid population growth (currently rising at ~2% annually), increasing urbanization (at ~74% in 2014) and a relatively high GDP per capita (USD 5,536 in 2014). In the office segment, increasing supplies are likely to keep rents stable. Despite a significant increase in supply, market diversification (the development of a better quality, modern stock of office buildings) and improving demand will maintain rental yields at their current levels (~3.0%). Key risk are political instability and the sharp decline in oil (~50% over the last 12 months) and natural gas (~35% over the last 12 months) prices, which might strain government’s resources and reduce its commitment to affordable housing.Source: Author’s elaboration, 2015.

Egypt: in Cairo, prices are expected to rise in the residential and retail segments, while the office segment is stagnant. In the residential segment, prices are rising. In 2014, the sale prices of apartments and villas surged, by about 15 and 25 percent respectively – pushed by a stabilizing political environment and an improving economic outlook (in 2014 the Egyptian economy grew by 2.1%). In the near term, prices and rents are expected to further strengthen, as supply is not expected to grow significantly, mostly due to completions delay. Relative to income, house prices in Cairo are: a) more costly than in Western Europe; b) twice more expensive than in most Gulf countries; and c) four times those of the US. In the retail segment, an improving sentiment is pushing up rentals. In 2014, improving demand – especially from the Food & Beverage (F&B) sector – led to a fall in vacancy rates to 19 percent, from 25 percent in 2013. Although rentals remained stable in 2014 (at approx. USD 1.2K per sqm), increasing demand from new brands coupled with delay in completion of new projects will support rental prices, despite the about 50 percent increase in stock expected in 2015. In a sluggish office segment, the outlook remains bleak. In 2014, tepid demand led to office market lethargy, with vacancy rates rising to 35 percent, from 22 percent in 2013; as a result, rental prices remained flat. In 2015, an expected additional supply of 52,000m2, when added to the 904,000m2 of existing supply, is expected to put downward pressure on rental prices. Key risks are a volatile security situation and delays in the implementation of structural reforms.

In Jordan, prices are expected to rise in the residential segment and remain stable in the office segment. In the residential segment, undersupply is likely to drive rentals and prices. The ongoing turmoil in neighbouring countries and a relatively high population growth (2.3% during 2009-14) are driving residential demand. The demand of about 90,000 extra units created by Syrian refuges – when added to the average annual needs of Jordanians (32,000) – has substantially inflated prices, now 100-to-300 percent higher than during the pre-crisis period. The situation is further aggravated by limited land availability in Amman. In the office segment, a minor over-supply will keep prices stable. Because of a slight oversupply of office space, especially in the for-sale market, prices are expected to remain steady, or even gently decline. Key risk are the ongoing tension between the Muslim Brotherhood and the government, negative spillovers from the conflict in Syria and an increase in land prices as a consequence of regulations restricting residential units higher than five storeys.

Kuwait suffers from undersupply in the residential and retail segments, while office space is oversupplied. In the residential segment, a chronic undersupply has driven rentals for years, also helped by a rising population – led by an influx of expats (2.7 million, expected to grow at 2.9% during 2014-19). An increasing demand for investment properties is adding pressure to the market. The positive spread between return on investment – measured by capitalization rates – and borrowing rates indicates room for moderate price growth. In the retail segment, strong growth is expected due to the current undersupply. Strong purchasing power (GDP per capita: ~USD 43K), a growing population, and a per capita retail mall space 59 percent lower than GCC peers (excl. UAE) will drive growth ahead, in both the rental markets and in capital gains. By 2016, supply is expected to grow by 262,000m2 (on top of the existing 460K sqm). In the office segment, oversupply is putting downward pressure on rentals. In 2015, an additional supply of 176,000m2 (current stock: ~1.2 million sqm) is likely to keep rentals stagnant in the medium-term, unless Kuwait diversifies its economy and attracts foreign companies. The segment might benefit from some replacement demand expected to come from ageing government buildings. Key risk are a delay in implementation of Kuwait Development Plan (KDP), a sharp decline in oil prices (~50% over the last 12 months) and the expected changes in regulations (the proposed five-year expat residency cap might impact the residential demand of the 2.7 million expat population).

Iraq’s housing shortage is due to demand growth and supply constraints. In the residential segment, there is a large housing shortage. Population growth, rising at 3 percent annually, coupled with increasing urbanization (at 69% in 2013) will increase the current shortage from about 2.9 million units in 2015 to 4.7 million in 2018. The gap will be further accentuated by supply-side constraints, led by the ongoing ISIS crisis and lack of foreign investment in the sector, leading to a rapid increase in prices and rents in Baghdad and in the northern regions. Key risk are the current ISIS-led crisis, which will inevitably deter foreign investors, and the sharp decline in oil prices (~50% over the last 12 month) which can strain government resources, much need to provide impetus to real estate sector.

Lebanon: in Beirut, all segments are suffering from political uncertainty. In the residential segment, demand is timid at best. In 2014, political turmoil and an unstable security situation deterred foreign investors (sale to foreigners declined by 1.7% in 2014 vs. 1.9% in 2012) leading to a 20 percent correction in prices for luxury apartments. However, the demand for affordable housing remains strong, driven by favourable policies, a subsidy by the Central Bank of Lebanon (CBL) and an influx of middle-income refugees from Syria. Overall, after a continuous decline over the last three years, in 2014 the number of real estate transactions grew by 2.3 percent. In the retail segment, because of a high vacancy rate, rentals are to remain subdued. A sluggish economy led to a decline in demand for retail space, with average rents falling 15-to-30 percent in 2014. The office segment is suffering the volatile political environment. In 2014, the demand for office space, especially the large ones, was under pressure due to a diminished interest from foreign companies (net FDI inflows declined from USD 4.3bn in 2010 to USD 3.0bn in 2013), with rents declining by up to 10 percent in Beirut’s Central Business District (CBD). Key risks are the ongoing civil war in Syria, the current crisis in neighbouring countries, political instability, and the unpredictable security situation – which are likely to keep foreign investors at bay.

In Libya, housing is becoming difficult to afford. In the residential segment, a significant undersupply is hampering affordability. The current shortage of about 350,000 units is expected to further aggravate, due to supply side constraints – driven by political instability, an unstable security situation and the concentration of land ownership in the hands of government. Rentals in central Tripoli are already barely accessible to the majority of the population, given an average monthly rent of USD 2,000 for one bedroom apartment and the median income of USD 600 per month. Key risks are the recent sharp decline in oil prices (accounting for ~70% of GDP), which may impact the government’s commitment to real estate, while political instability and an unstable security situation are likely to shy away foreign investors.

Qatar: Doha’s residential sector is booming, while prices are likely to soften in the retail and office segments. In the residential segment, a significant undersupply is pushing up rents (+14% in 2014) and prices (+6% in 2014). Housing demand is driven by a high population growth – rising at about 9 percent per annum, mostly due to an influx of expatriates – and a declining household size (4.4 persons in 2014 vs. 5.0 in 2002). In 2014, Doha had a housing shortage of 37 percent or 47,500 homes. During 2014-18, the supply is expected to grow at a meagre 3 percent per annum, which could lead to a shortfall of 85 percent by 2018 and further pressure on rents and prices. In the retail segment, incremental supply is likely to put downward pressure on rentals. Currently the market is fairly balanced, with a low vacancy rate; however, a strong growth in supply (~16% during 2014-18) will put downward pressure of existing rental rates, ranging today at around QR 180-275 sqm per month. In the office segment, supply is likely to outpace demand, and put downward pressure on rentals. During 2014-18, the demand is expected to grow at about 7 percent CAGR, driven by strong economic growth (~6.8% in 2015-16) and ‘FIFA world cup’-related activities. Although in 2014 rentals remained stable despite a high vacancy rate (~25%), the expected strong growth (~8.0% CAGR) in supply over 2014-18 will put downward pressure on rentals (Figure 10.4). Key risks are a sharp decline in natural gas prices (~35% over the last 12 month) and a significant oversupply in the office and retail segments.

Tunisia: prices are rising in Tunis, pushed by steady demand. In the residential segment, despite demand, the vacancy rate remains in double digits. In 2014, the total housing stock was estimated at 3.2 million units (vs. 2.7 million households) with a vacancy rate of about 15 percent. Prices rose at 8 percent per annum, above the about 5.5 percent inflation rate. Going forward, population growth (~1% per annum), increasing urbanization (at 66% in 2013)and foreign investment led by HNWIs from GCC will drive demand, estimated in about 77,000 units per annum. Rental yields are expected to improve to 9 percent, largely due to increase in demand from Syrian refugees. Key risks are the economic slowdown resulting from continued weakness in EU (accounting for ~75% of exports) and the current political and security crisis in neighbouring countries.

In Turkey, price stability is expected in the residential, retail and office segments. In the residential segment, the near term outlook is positive. In 2014, despite political uncertainty, a challenging economic environment and high mortgage rates, the market remained stable; a marginal oversupply held back prices – which grew by 0.7 percent, considerably below inflation – and residential yields. However, the long-term outlook remains promising, driven by favourable demographics (49% population aged under 30), rapid urbanization (at 72% in 2013), an increasing number of households (17.5 million in 2013 vs. 18.6 million in 2017F) and a growing foreign appetite. In Istanbul’s retail segment, a marginal oversupply is likely to keep prices stable. In 2014, supply grew by 5.5 percent, up to 10 million sqm, and it is expected to reach 12.5 million sqm by 2017, slightly outpacing demand growth. Hence, prices will remain in check. Low retail density (129 sqm per 1,000 vs.198 sqm in Europe), strong growth in retail sales (~ 3.2% p.a. during 2014-18), a large consumer market and the young population will drive growth in the years ahead. In Istanbul’s office segment, vacancy rates and rents are expected to remain stable. In 2015, demand is expected to pick up in Istanbul, especially on the European side, led by an influx of multinational companies and the consolidation of banks’ head office facilities in the CBD. Supply is expected to grow at a CAGR of 16.1%, from 4.1 million sqm in 2014 to 6.5 million sqm by 2017. However, the delay in completion of new projects will avoid oversupply in 2015 and will keep vacancy rates (~20%) and rents (EUR 35/sqm per month) in check. Key risk are political instability (parliamentary elections are likely to be held in the Fall 2015) and an economic slowdown, due to monetary tightening by the Central Bank of the Republic of Turkey (CBRT) in H2-2015, after the expected increase in rates by the US Federal Reserve.

Saudi Arabia: in Riyadh, the residential and retail segments enjoy good prospects, while the office segment is oversupplied. The residential segment remains upbeat, but prices are likely to cool down. Demand, especially for affordable housing, is driven by population growth (2.8% during 2009-14), increasing urbanization (at 83% in 2014) and low home ownership (30% vs. 65% in the US). Over the next five years about 1 million units are required, but in 2014 supply fell short of demand, resulting in a price increase of about 10 percent. In 2015, the new mortgage regulations (cap of 70% on mortgages) might hamper price growth. In the retail segment, the outlook is stable after a strong rentals growth in 2014. In 2014, high demand coupled with delays in projects’ completion resulted in a fall vacancy rates (10% in 4Q2014 vs. 12% in 4Q2013) and an increase in the price of rentals, especially for shopping centres (up 22% YoY in 2014). However, in 2015 the vacancy rates may increase – especially in older malls – as about 241,000m2 of new supply will come on stream. In the office segmentrentals are expected to soften in 2015. With a total stock of 2.3 million sqm at the end of 2014 and vacancy rates at 16 percent, the market is oversupplied. In secondary-grade buildings, the vacancy rate is expected to increase and rental prices to decrease (down 0.5% YoY in Q42014) as new supply (1.4 million sqm expected during 2015-17) with better parking ratios is built in less congested areas. Further, low oil prices are also likely to hurt demand, especially from the government sector. Key risks are the sharp decline in oil prices (~50% over the last 12 months), which may slow down government infrastructure spending and the cap on mortgage lending, which may lead to a shift in demand – from owning to renting.

UAE: in Dubai, prices are expected to soften. The residential segment is overheated, and a correction is expected in 2015. In Q4-2014, both residential prices and rents remained flat, after rising by 60 percent over the last two years. In 2015, an additional supply of 25,000, the doubling of transaction fees from 2 to 4 percent, and the introduction of a mortgage cap (loan-to-value ratio of 75% for expats and 80% for UAE nationals for properties below Dh 5 million, and 65% and 70%, respectively for properties above Dh 5 million) are likely to lead to an about 10 percent correction in both prices and rentals. The vacancy rate is expected to remain stable at about 13 percent, while the demand for affordable housing will remain strong, driven by population growth, expected at about 3 percent annually. In the retail segment, rentals are not expected to grow in 2015. Increasing demand and an influx of new brands is driving growth in the retail segment. In Q4-2014, rentals increased by about 28 percent YoY, while vacancy rates dropped from 12 to 8 percent in Q3-2013. In 2015, rentals and vacancy rates are expected to remain stable as incremental demand will be absorbed by additional supply, expected to grow at 8.6 percent CAGR during 2014-17. In the office segment, oversupply is likely to keep rentals stable. In Q4-2014, CBD rentals increased by 1 percent YoY and the vacancy rate declined from 29 to 24 percent YoY. The segment’s prospects are subdued: high vacancy rates and an additional supply of about 1.6 million sqm coming to the market during 2015-17 will put further pressure on rentals. Key risks are an imminent correction in prices after years of rapid increase and negative investment sentiment due to fall in oil price (~50% over the last 12 months), the introduction of a mortgage cap and the hike in transaction fees.

No doubt, in most MENA countries, the short-term outlook is clouded by risks. A downbeat market sentiment is likely to impact 2015 prospects, because of: 1) the recent sharp decline in oil prices (~50% over the last 12 months), hindering growth in oil-exporting countries; 2) a deteriorating political stability and security (Iraq, Libya, and Yemen have severe security challenges); and 3) below-potential growth at home and in key markets abroad – such as the Euro area and major Emerging Markets (EM), i.e. India, Russia, and China.

Yet, in the long-run, the MENA real estate sector is expected to perform well and remain an attractive destination for investors. Future demand will be sustained by the increasing urbanization trend (at ~60% in 2013 – by 2030 nine MENA countries will have more than 90% urban population) and the commitment of almost all governments to provide financing for primary housing. Once security constraints are resolved, rising influx of tourists (71 million in 2013, up 2%YoY) to the region will keep supporting the hospitality industry and attract top-retailers. Also, the large fiscal buffers (~3tn in sovereign wealth funds) will sustain government spending in most economies, supporting economic growth and maintaining financial stability.