Opportunities appear to be increasing as Middle east states create a more accommodating environment for foreign institutional money. Ownership reform is driving the change, as this is probably the area of greatest concern for overseas buyers. Currently foreign investment in Middle East properties is agreed on the basis of a promise from the ruling family or the Sheikh who is at the head of the local developer. But change is occurring around the region as its bid to attract institutional capital. Bahrain was the first gulf state to establish a trust law, Abu Dhabi has recently introduced laws allowing 99 year leases and Dubai is leading the way in developing a formal property ownership law. Haiyan Mujarjech, a senior officer at government-owned developer Dubai Properties, says: “Dubai recognises that there needs to be clarity. International investors need paperwork and documentation that conforms to their idea of freehold title.”

The Middle East has been a traditional exporter of capital. Total Arab investment overseas totals something like $1.3trn annually. The Gulf Cooperation Council (GCC), the economic bloc comprising Saudi Arabia, Kuwait, Bahrain, Qatar, Oman and the UAE and representing 32 million people, has a budget surplus for 2006 estimated at $337bn. That’s about half the US federal budget, that will be looking for an investment home this year.

Now capital is being re-directed, or invested into the region as FDI. Analysis by Dubai-based advisory firm Istithmar suggests that Arab investors have pulled more than $200 billion out of the US since 9/11. Crucially for the Middle East, they estimate that around $600bn will be re-directed to the region in the next 10 years. Naji Boutros of Colony Capital in the Lebanon suggests there is $2.3 trn of private capital and several trillion of government agency money funding current developments or seeking suitable projects. This is the weight of money that underpins the development of the region. And that capital is focused on the relatively safe and stable parts of the region, not the war zones.

There will always be those who consider that an investment in the Middle East is too high-risk in view of the situation in Iraq or the tensions over Iran and Syria. But as one of the major development areas of the world over the next 20 years, certain parts of the region will be hard to ignore. Jones Lang LaSalle’s global research assesses the low–risk Middle East economies as the United Arab Emirates, Bahrain, Qatar and Oman. Medium risk would be Lebanon, Kuwait, Egypt, Saudi Arabia and Jordan.

Hassan Buhlaigah of the Saudi Arabian Oil Company says simply, “What we need now is the institutions”. The challenge for the region’s lawmakers is to create a framework that foreign investors will feel comfortable operating in. Khalid Nazir, head of investment banking at the Abu Dhabi Islamic Bank, spells out the issue facing the region’s lawmakers: “To get normal institutional fund flows, you have to have a clear regulatory framework. Investors need to be able to rely on the rules for direct investment and for those rules to be equally applicable in Dubai, Kuwait, Bahrain and so forth, just as they are in London and New York.”

Dubai and Abu Dhabi are in the midst of a development boom that is largely supported by private capital. It would hard to find a bigger development site than Dubai anywhere outside of China. Japanese investors are reportedly buying into projects off the page and Dubai has created a buzz around the world for its ambitious expansion and the artistic endeavour of its landmark buildings. Demand is still strong for residential units. Rents increased by 26% in 2005 and 7% in the last quarter. The population is growing at around 8% annually and is expected to double in the next five years. Cap rates of 10-15% in Middle Eastern companies are attractive to investors used to 4% and 5% in Europe and the US.

Behind the façade of the boom town with limitless potential, there is concern that the scale of development will result in many vacant or unfinished buildings. Expected population growth levels may not be sufficient to soak up supply, with a resultant lowering of yields.
David Jackson of Istithmar comments, “We see a shortage of supply lasting to at least 2010. The trend is that demand will still outstrip supply in residential, less so in office and other mixed-use properties.” If there is to be the bursting of a bubble, it will occur at the level of lower quality developments.

The problem of putting some perspective on the real estate cycle is exacerbated by the absence of standards for valuation and research in the market. The international firms with a local presence such as CBRE have teams researching the market but good quality research is still thin on the ground. Mohammed Al Hashimi of Amlak Finance comments: “Right now we are in a market that is changing so fast, it is an exercise in itself to come up with meaningful valuations.” Wael Ahmet Al Lawati of Waterfront Investments in Oman adds “there has been so much happening in the region that I don’t trust any of the statistics.”

Recent entrant Morgan Stanley is surprised by how little foreign investment has occurred. Rich Stockton, executive director of Morgan Stanley’s investment banking business says: “If we look at a chart of the global real estate market of $14trn, the Middle East doesn’t even figure.” Morgan Stanley expects that to change quickly and Stockton suggests in the short term, “there is a market in indirect private equity that is poised to grow.”
Syed Tariq Hussain of The Investment Company in Dubai adds that corporate governance will be one of the most critical issues, especially once the region develops its own Reits market: “It implies a transparency in the system. Investors want that stability before they will commit. This is an issue for the region to tackle as it seeks to compete for international capital.”

Foreigners can have full ownership now in some parts of the UAE. For example in the Ras Al Khaimah area, between Dubai and Oman, the Crown Prince has issued a decree granting foreign investors complete ownership of properties in projects developed by RAK Properties in the emirate. The decree says RAK Properties is allowed to sell its residential, commercial and tourism units as freehold and without a lease.

Haiyan Mujarjech of Dubai Properties says, “The whole Middle East is an under-valued investment opportunity, but Dubai is especially well-placed in terms of a dynamic environment with good infrastructure.” That infrastructure is being put under intense by the scale of the development along the Sheikh Yayed Road, the city’s main artery. Coping with the traffic is just one of the new growth problems Dubai has. When you arrive at 7am on a Sunday morning, you don’t expect to find yourself in a traffic jam just getting to your hotel. In the next two years though, the road building will hopefully catch up, and a mass transit system has been proposed for 2009.

The fact that Islam actually encourages property ownership is a major plus point for the future growth of the region. It is in the nature of how profits are used that problems occur. According to Sharia scholar Sheikh Wizan Yazaby, “if you take your capital gain and invest it in equities, or you consume it, that is not blessed. However, if you stick to your real estate assets, because it is considered an inter-generational asset, you will have no problems.”

The region is still some way from developing its own local Reits market. Khalid Nazir comments, “We can build vehicles and products that have liquidity, which is what we all want. But the capital markets in the Middle East are limited. Added to which, we don’t have an established trust law in the UAE. Moreover, Reits are attractive in markets where you have a lot of taxation. I don’t see real estate stocks being that popular here given the current development boom. Once the boom is over, then perhaps there will be a market for Reits.”

David Jackson outlines how investors should address their strategic thinking with regard to Middle East real estate. Investors should first consider how much development risk they want to take on. “If you are really serious about this market, you may need to reconsider your attitude towards development risk. Consider instead the potential in this place. The market may lack some of the familiar patterns of other markets, but we think the return elements are there – you just need to use a little more elbow grease.”