Weekly Q&A: "The GCC construction sector is showing the first signs of recovery"

Welcome to Zawya Markets. Each Sunday we will be featuring an interview with a different analyst or markets expert from around the region.

If you would like to participate please email gerard.aoun@refinitiv.com.

1. What is the general outlook for the real estate sector in the MENA region?
Giving the cyclicality of the sector, currently characterised by an oversupply in most of the countries in the regions, the global picture for the real estate sector has taken a serious hit. Apart from the significant pressure on margins, due to a severe price decline in properties and soaring prices of construction materials, the outlook is less rosier than we had expected following the oil rebound.

Another aspect that the majority of market observers neglect is the collapse of the purchasing power among youth taking their first steps in the world of work and that access to credit is even more problematic (particularly with the tightening of capital requirements). It is a structural problem, where the solutions are not easy to implement.

Globally, signs of an eventual recovery in the MENA region are taking time to materialise, given the persistent bearish global market sentiment.

2. What are the biggest risk factors for the real estate sector in the region?
Geopolitical uncertainties represent the principal risk element for some of the GCC countries. Now that the global economy is facing an increasing risk aversion toward economic protectionism, the United States-China trade war is threatening the economic stability of the region. Indeed, it can indirectly affect oil demand. Another cycle with a price per barrel of around $40 is likely to weigh on an already weak demand.

This is coming in conjunction with the strengthening of the dollar following the rise of interest rates, which is a lower risk due to the dollar peg.

Clearly, rising interest rates will make access to bank loans more expensive, another drag on demand. However, we cannot ignore the possibility of a liquidity risk derived from a decline in foreigners’ purchasing power. A strong dollar is not good news for foreign investors.

3. If you were to pick one real estate stock that you think will outperform over the next six months, which one would it be (and why)?
We believe that Emaar Properties is a good investment opportunity. Indeed, the company has a highly resilient business model with an enhanced profitability and a sustained growth over the last 6 years amid a weaker property market.

We bet on a significant Earnings per share growth over the next two years and a better cash generation capacity for both its retail and development businesses. Benefitting from an appealing brand and a diversified business, the company proved its ability to sustain its growth path.

The stock is trading at an attractive 49 percent discount to NAV. As per now, the stock is showing a negative momentum. Thus, it is better to wait for a favourable one.

For the “pure-play” developers, we are expecting 2019 to be a difficult year with a continuous drop in prices, consequently a negative effect on margin.

4. What is your view for the real estate sector in the UAE?
A bearish market sentiment is continuing to weigh on the UAE equity market (23 companies under the AlphaMena coverage, €104,143bn), which has lost -8.14 percent YTD on average, mainly pressured by the real estate developers which displayed an underperformance of -21.41 percent YTD.

The excess supply is expected to widen, and we believe that the anticipated absorption effect of the EXPO2020 has been overstated, at least for the moment.

The significant slowdown in the real estate sector makes us less optimistic about the growth prospects and the potential boost during EXPO2020.

5. What about the GCC construction sector? What differentiates Kuwait from the whole region?
The GCC construction sector is showing the first signs of recovery. In our opinion, it is still a weak one as it still depends on the price of crude oil. The fiscal reforms implemented by the governments of the region have not yet succeeded in limiting the impact (weight) of oil revenues.

The whole picture became rosier, mainly following the oil price increase, the government’s diversification efforts and the rising private investments among higher expat population. In this context, Kuwait lagged its regional peers in the development of its non-oil and private sector. However, the country managed to experience a better growth in the construction sector during the 2011-2015 period at a CAGR of 5.23 percent. In fact, Kuwait’s state-owned oil companies continued to heavily invest in new facilities despite lower oil prices since 2014.

Actually, what really makes a difference for Kuwait is the fact that its fiscal breakeven oil price is the lowest in the region, currently at $50.4 per barrel. Thus, Kuwait has a more comfortable room for maneuver; allowing it to pay the contractors. However, this was not the case of Saudi Arabia, limiting the cash-generating capacities of the contractors, especially the most indebted ones. In addition, some of the contractors (precisely Saudi Arabia but also Emirati) have been dreaming of an infinite growth; while expecting oil prices to remain at above $100 per barrel for a long period of time. It took a different turn and reality hit hard!

Now that the commodity prices rose, we expect that the pace of development will generate a higher growth (or will drive GCC growth). However, Kuwait is facing some challenges related to its credit risk because of its high exposure on the commodity’s prices volatility.

6. What is your view for the real estate sector in Egypt?
The Egyptian market is characterised by fast growth and volume due to its increasing population (organic growth around 20 percent; 500K new residential units demand on annual basis).

With the resilience of the EGP against the emerging currencies risk fears that have invaded the markets, we were pleasantly surprised. Thus, we believe that the property market in Egypt is becoming attractive and that the good growth prospects (the best in North Africa) would have a positive impact on the purchasing power of Egyptians (and their borrowing capacity).

7. How is technology expected to change the dynamics in real estate going forward?
Investment in technology will make the difference between real estate developers. Those already embarked on this journey will rapidly generate long-term growth. Be it employed in cost reduction plans, rapid progress on construction using 3D painting, for example, or in empowering marketing or the property management embracing digital technologies. Furthermore, the adoption of Blockchain technology has the potential to revolutionise the real estate market.

Also, self-driving cars are expected to reduce parking spaces need by 2030, due to a possible decrease of individual car use. The following will allow more space for construction, resulting in additional supply, hence, a downward pressure on prices.

8. What is the outlook for the hotel industry?
Our long-term outlook for the hotel market remains positive due to growing developments in the entertainment sector and business-friendly resolutions. However, the economic slowdown would remain a significant risk.

Technology will also have a deflationary impact on the hotel sector. In Saudi Arabia, this sector is still at an early stage. At the time being, it is mainly about local tourism with the development of the religious tourism. In the UAE, the sector would witness a real boost with the approaching EXPO2020.

9. Are easing regulations beneficial to the GCC markets?
Absolutely! More flexible regulations are aiming to bring back a balance between property supply and demand. In fact, some of the strict regulations came to prevent a 2008 crisis recurrence and protect investors. Having achieved a significant improvement in regulations, developers faced major challenges.

A key example is the recent UAE central bank replacement of the 20 percent cap on real estate loans by a more flexible policy. Customers enjoying a low loan-to-value will help revitalise the demand. Loosening the rope makes sense in such a difficult context!

10. What can you tell us about delayed projects in the region?
Arabs do have strong points, however, punctuality has never been their forte. As a matter of fact, there are several aspects that affected the MENA real estate sector in recent years. We would argue that the common characteristic of those countries (in which we see delays in handovers) shows that the offer is not adapted to investor’s needs. Also, the prices’ downward trend is widespread in the region, besides the tendency to move to more affordable houses. Simply because of this gap, oversupply for luxury real estate becomes obvious.

On one hand, investors may delay purchases, waiting for better deals, and on the other hand, developers may delay projects in order to liquidate current inventories, reimburse debt and achieve desired returns. It is a matter of adaptability and innovation. Indeed, what is the point in multiplying projects and ending up with huge finished inventories?

Any opinions expressed here are the author’s own.

If you would like to participate in the Zawya Markets Weekly Q&A please email gerard.aoun@refinitiv.com.

Our Standards: The Thomson Reuters Trust Principles

Disclaimer: This article is provided for informational purposes only. The content does not provide tax, legal or investment advice or opinion regarding the suitability, value or profitability of any particular security, portfolio or investment strategy. Read our full disclaimer policy here.

© Opinion 2018