Supply Adjustments: Are we done?

26/04/2009

Kuwait Financial Centre “Markaz” in its recently released research note has analyzed supply adjustments in GCC focusing on real estate sector given the contraction in demand the sector experienced due to the current economic slowdown. M.R.Raghu and Venkateshwaran Ramadoss, the authors of the report, note that real estate and construction sector, which constitute the bulk of projects in the region (74%) experienced severe cancellations.

Project cancellation is a function of market’s realization of oversupply, the occurrence of which now depends on the visibility as to how the economy is expected to move forward. Lack of such visibility impedes the judgment of future demand and increases the vulnerability of projects getting cancelled in the process of sharp downward supply adjustment when market realizes the oversupply.

Supply adjustment in GCC Real Estate

The available estimates of the extent of fall in real estate asset prices in the GCC region clearly indicates the fact that the demand for real estate in the region has contracted and as a part of the dynamic demand/supply adjustment process, holding on/cancellation of RE&C projects were inevitable. A significant contraction in activity due to cancellation/delaying of the projects should be painful for the sector and the pain would as well be felt in the overall economy depending on the extent of the sector’s contribution to the economy.

The report increases the scope and depth of the study in RE&C sector as it accounts for c.82% of all projects put on hold/cancelled and also in UAE as 80% of all projects put on hold/cancelled were in UAE.

UAE accounts for 91% of RE&C projects that are either put on hold or cancelled in GCC. Around 31% of the total RE&C projects worth USD 1.1 Trn got cancelled/put on hold of which 72% was due to the current slowdown and occurred between Oct-08 and Mar-09. This quick and huge contraction in supply was mainly on account of Dubai, which accounts for 91% of the USD 249 bns of projects that got put on hold/cancelled. The below table indicates the extent of supply adjustment so far in GCC and the future supply pipeline.

Country UAE KSA Qatar Kuwait Oman Bahrain
Total supply in pipeline (USD bn() 1126 369 119 215 68 49
Cancelled/Hold (%) 30.7% 6.0% 2.5% 1.6% 1.6% 3.8%
Under construction 22.4% 14.1% 29.8% 4.0% 23.5% 21.0%
Pre construction
  • Current 20.2% 6.5% 20.0% 31.9% 22.6% 17.2%
  • Future 26.8% 73.4% 47.8% 62.5% 49.9% 58.0%
Are we done with the adjustments??

54% of the total RE&C projects in GCC are future projects and 62% of them are in pre construction stage. The sword of cancellation swings above these projects and an assessment of their vulnerability is imperative. A stoppage in projects getting put on hold by itself would be a positive sign as that would mean that the supply has adjusted enough and that the market has a clarity on the extent of demand contraction. Rather than doing a micro analysis by attempting a project wide study which would be time and resource consuming, the report intends to figure out macro (country level) factors that could drive more cancellations/holds from here and weigh each country against those factors to estimate their vulnerability for more downward supply adjustment.

Lack of clarity in demand for real estate is essentially a function of uncertainty in economic prospects, as in GCC, even population growth is closely correlated to economic growth due to expats flow. On the supply side, past over supply, supply adjustment that happened so far (evident from the current stock of held up/cancelled projects) and the extent of future supply impacts future delay/cancellation potential. Historical oversupply coupled with future demand uncertainty should indicate a higher potential for future delays/cancellations. Apart from these two, financial conditions in a country lubricates the process and can influence the timing and extent of delays/cancellations.

Factors Measures used Rationale
Economic growth clarity Variation in consensus real GDP growth rate and the degree of slowdown in growth Lack of clarity in GDP growth expectations and a sharp slowdown will create uncertainties in demand expectations
Demand clarity Extent of reliance on expat population Uncertainties in demand will get exacerbated by the extent of reliance on expats
Past oversupply Our previous report titled “Dubai Real Estate Meltdown” Past oversupply would indicate vulnerability to misjudgment regarding the extent of oversupply
Supply adjustment so far Projects put on hold/cancelled so far Lower cancellations with past oversupply indicates higher possibility of future cancellation
Future supply Country’s share of GCC construction projects The more the share, the more the vulnerability
Financial condition Recent trends in
a) Money supply
b) Lending to RE&C sector Lower lending levels will hinder supply while higher levels could sustain oversupply

A study of factors leading to supply adjustments including degree of economic contraction, reliance on expat population, extent of past oversupply, and lending scenario indicate that UAE and Bahrain may have to go through more pains of project cancellation while Kuwait and Oman may have been done with the adjustment process. Cancellations/holds are expected to continue in UAE mainly as a result of past oversupply and huge future supply pipeline while past oversupply with fewer cancellations so far could lead to cancellations in the future in case of Bahrain.

Demand clarity in residential real estate should deter major future cancellations in Saudi Arabia. However, bank lending to RE&C sector continues to get tightened and could hamper future supply. Real economic growth and higher reliance on expats works positively for Qatar’s residential real estate segment. However, expanding bank credit, if goes to prolong the supply adjustment, can prove to be dangerous.

Lack of immediate pressure on forthcoming supply due to past avoidance of oversupply would deter cancellations in Kuwait and dismal activity levels in the past should prevent future cancellations in Oman provided the sector puts up with the tightening bank credit.

Summary of expectations
Country Variation in expected GDP growth Degree of contraction Reliance on Expats Past oversupply Projects put on hold so far Share of future GCC projects Money supply Growth in lending to RE&C Future cancellation prospects
UAE High High High High High High NA NA High
KSA High High Low Low Average High Average Low Average
Qatar Average Average High Average Low Average NA High Average
Kuwait High High Average Low Low Low High Low Low
Bahrain Low High High High Low Low Average Low High
Oman Average High Average Low Low Low Average Low Low
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About Kuwait Financial Centre “Markaz”
Kuwait Financial Centre S.A.K 'Markaz', with total assets under management of over KD. 880 million as of December 31, 2008 was established in 1974, and has become one of the leading asset management and investment banking institutions in the Arabian Gulf Region. Markaz was listed on the Kuwait Stock Exchange (KSE) in 1997; and was awarded a BBB+ corporate rating by Capital Intelligence Ltd.
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