Riyadh, Saudi Arabia. For illustrative purposes only. Image Credit: Agency

Dubai: Weakness in the real estate market has both reflected and contributed to weak economic growth in much of the GCC, particularly the UAE, Qatar, and Saudi Arabia, according to the Institute of International Finance (IIF).

“After consciously targeting real estate investment as a key plank of their diversification strategies, these countries have experienced a persistent drag on overall growth due to the real estate slowdown since the 2014 plunge in oil prices, and a mounting challenge to financial stability,” said Jonah Rosenthal, Associate Economist at IIF.

Prices have fallen largely in Dubai and Saudi Arabia since 2014; Qatar’s prices have seen some temporary upturns but remain well below their pre-rift levels. The weakness of the GCC real estate market in recent years stands in stark contrast to emerging markets as a whole.

“Vulnerability is a consequence of an unrealistic economic model, amplified by external developments such as a slowing global economy, real appreciation of currencies, intra-GCC political rifts, and regional tensions,” said Garbis Iradian, Chief Economist, Middle East and North Africa, IIF.

Looking ahead, the price decline is likely to persist. A recent report by Jones Lang LaSalle (JLL) notes that 570,000 units of new supply could enter the Dubai market by 2020 — an average annual increase of 8 per cent, far outpacing the projected 2.5 per cent increase in the resident population.

The Bank of International Settlements (BIS) shows that average residential real estate prices in Dubai continued to decline in the past few months to 7.1 per cent in February 2019, year-on-year.

Similar patterns of oversupply and falling prices are evident in both commercial and residential markets across the region — and as JLL notes, the correlation is no surprise.

Real estate makes up a significant portion of the consumer price inflation (CPI) baskets across the GCC, ranging from 22 per cent of the total CPI in Qatar up to 44 per cent in Dubai. Consequently, a downward trend of real estate increases the risk of deflation, which the central banks have limited ability to combat given their adherence to exchange rate pegs.

In the UAE and Saudi Arabia real estate prices have fallen steadily since 2014. According to IIF economists UAE weakness reflects a slowdown in foreign demand given the small share of citizens in the total population. In the case of Saudi Arabia, a more insular market with less penetration of foreign buyers, weakness in the real estate market is largely due to fiscal consolidation as a response to lower oil prices through withdrawal of housing subsidies, along with the steady exodus of foreign labourers associated with the Saudisation of the private sector workforce.

Exchange rate movements have also discouraged prospective buyers. Due to geography and transportation linkages, a significant fraction of the consumer base comes from Europe and India, but properties are priced in the GCC countries’ domestic currencies, which have long been pegged to the dollar. Political tensions within the region have played a mounting role since 2017.

Pressure on banking sector

Dubai: The real estate weakness in the GCC could pose threat to banking sector profitability and stability in the region according to Institute of International Finance.

Real estate-related loans make up one of the largest segments of consumer credit in the GCC. It is about 20 per cent of total credit in the UAE, and a similar level in Qatar.

“Deterioration of real estate prices, combined with the ongoing adoption of IFRS 9 accounting standards, causes an increase in non-performing loans; in the UAE, for example, NPLs have consistently exceeded 6 per cent of total loans since 2013,” said Garbis Iradian, Chief Economist, Middle East and North Africa, IIF.

With bank balance sheets coming under increasing strain from weak performance of real estate loans, a wave of mergers is underway. Meanwhile, pressure builds on governments to provide extraordinary financial support exactly when their own revenues are taking a large hit.