Desert bloom

In recent years, the Middle East has been witness to some amazing feats of real estate, including expansive luxury resorts built on reclaimed islands, master-designed cities growing up out of the desert and plans to build the tallest skyscraper the world has ever seen.

Thanks to attractive demographics and high oil prices, the region is also drawing attention for its buzzing stock markets and burgeoning private equity industry. But the economic excitement is perhaps best personified by the region's real estate, seen in the large, colorfully named resort and residential projects of the United Arab Emirates (UAE), the large infrastructure developments found throughout the nations belonging to the Gulf Cooperation Council (GCC), and the upgrades taking place to logistics and office properties all over the Middle East.

Much of this interest has been directed towards the GCC countries, a bloc comprised of the UAE, as well as Bahrain, Kuwait, Oman, Qatar and Saudi Arabia. Other investor groups have also expressed interest in the countries of the greater Middle East area, stretching west along the Mediterranean Sea from the Arabian Peninsula and Egypt.

“The real estate market in the GCC region has demonstrated incredible growth over the past two years,” says Jawad Ali, a London-based finance partner with King and Spalding, a law firm with a focus on the Middle East. Ali adds that, because of strong liquidity, Dubai and the rest of the GCC have been “doing phenomenally well.” Real estate developers have also been able to attract some institutional investment to their projects, particularly in Bahrain, Saudi Arabia and Kuwait.

Skyrocketing oil prices have brought record amounts of capital back into the hands of Middle Eastern investors. At the same time, given the depressed returns available in markets overseas, that capital has been reinvested in the region.

“Four years ago, a lot of GCC capital came back into the region,” says Abdul Aziz Al-Marzooq, senior vice president for investment at Muthanna Investment Company, which focuses on corporate finance activities, as well as real estate and equity investments. “That capital came looking for a lot of opportunity.”

Ali offers the example of the investment banks in island-nation of Bahrain, which have seen a certain amount of investment from nearby Saudi Arabia. Following the US- and UK-led invasion of Iraq in March 2003, Ali points out that there has also been an increased feeling of security in Kuwait. “That has encouraged Kuwaitis to invest in the country and you see more Kuwaiti capital pouring into Kuwait,” he says.

Another driver that has not been lost on real estate investors has been the remarkable demographic trends shaping the region. In Saudi Arabia, for example, the world's largest producer of oil, more than two-thirds of the country's population has been born since 1975 and the country has one of the world's highest population growth rates.

WHAT—AND WHERE—TO BUILD
Market participants say some governments in the region are eager to promote economic growth—sometimes in an effort to squash fundamentalism—and are busy building publicly financed projects and lessening restrictions on direct foreign investment. Ali, of King and Spalding, notes that institutional investors, including some foreign participants, have placed capital in some of these projects, including communications systems, ports and airports. Al-Marzooq adds that these large-scale infrastructure developments have supported the growth of mega-malls and shopping centers and encouraged the expansion of Starbucks and other fast food outlets, as well as the development of local chains.

Qatar, for example, is planning an energy and infrastructure building spree, with hopes of spending more than $133 billion by 2012. Last year, the government also created the Qatar Financial Centre, which hopes to lure multi-national corporations and financial institutions by offering a Western-style legal framework in Doha, the country's capital. The initiatives being floated include $13 billion in infrastructure improvements, encompassing $3.8 billion for a five-year public works plan, $5.5 billion for a new airport and $1.8 billion for the Qatar-Bahrain causeway. As in many of the neighboring GCC states, there are also plans for tourism and cultural projects, including new hotels, museums and the $2.5 billion Pearl-Qatar development. Like other splashy, high-end projects in the region, The Pearl-Qatar, a luxury residential development planned by the United Development Corporation, will be located on a man-made island in the Persian Gulf.

As the real estate market in the region continues to evolve, it is also becoming more sophisticated. This includes the increased role of mezzanine debt in financing property deals, as well as governmental reforms to gain membership in various international trade groups. Last year, Saudi Arabia liberalized some of its foreign ownership rules and customs requirements as part of its—ultimately successful— bid to join the World Trade Organization.

But like any large region encompassing a number of distinct national profiles, niche plays abound, from a burgeoning market for distressed deals in neighboring Turkey, where transactions have been overleveraged, to the GCC countries, where large-scale resort projects have picked up traction with investors.

“The countries [in the region] are complementary,” says Jacques Bernard, the managing director of asset management at Bahrain-based Unicorn Investment Bank, which has recently closed its KSA Real Estate Fund I, a $52.5 million vehicle to invest in a residential development in the Northern suburbs of Riyadh, Saudi Arabia. So while the demographics in Saudi Arabia may look good for residential projects, Bernard says, Bahrain offers the chance for both housing and office development, Oman has opportunities for tourism-based properties and Qatar is a good environment for warehousing projects. Meanwhile, the UAE offers a compelling case for investing across asset classes.

While many US-and Europe-based opportunity funds have yet to begin investing in the region, Los Angeles-based private equity real estate firm Colony Capital is betting on the Middle East. The firm, which has a penchant for investing in operating businesses, opened an office in Beirut, Lebanon in 2004. Perhaps this should not come as a surprise, considering Colony head Tom Barrack's recent pronouncements about the dearth of opportunities in US real estate in Fortune—and his Lebanese heritage.

“The number of cranes that are dotting the skyline in the GCC countries is incredible. It's all due to the huge liquidity found in the region.”

Naji Boutros, a principal in Colony's Middle East office, says the firm is scoping out investment opportunities in the region, particularly focusing on real estate operating companies, distressed debt deals and large-scale resort projects.

“The number of cranes that are dotting the skyline in the GCC countries is incredible,” Boutros says. “It's all due to the huge liquidity found in the region.”

Al-Marzooq's firm is also looking at opportunities in Kuwait's highly fragmented, full-service logistics and warehouse sector. He notes that economic growth in the Middle East is directly impacting the cost of warehouse space, an asset class that is in demand and has yet to be institutionalized.

Unicorn's Bernard also notes that, as capital flows into the area, blue-chip office space is highly sought after; much of the existing product, he points out, is not up to the standards demanded by global business. “It doesn't live up to the image they're trying to portray,” he says.

LOOKING FORWARD
At Colony, Boutros feels that the current economic environment could be a boon for opportunistic real estate investors. He says today's active markets could end up producing tomorrow's opportunistic deals and draws comparisons to another region that experienced a property boom that was buoyed by an abundance of oil revenues—Texas in the 1970s.

“This is going to fuel an over-supply of space,” he says. “A huge proportion is being built by speculators.”

But, unlike Texas, the Middle East is not a place for funds looking to swoop in and make a quick buck. Like any emerging market, there are plenty of nuances that must be understood by a firm before it would be able to make a successful investment. Boutros puts it simply: “Educate yourself.”

“New York is not Brooklyn,” he says, adding that political risks and economic situations can vary from country to country. “You cannot say that the Middle East is a fungible region. It's not one country.”

Investors must also be comfortable with the various legal, regulatory and governmental institutions across the region, many of which can still be quite restrictive. And as cultural, political and economic differences complicate projects at each level, finding the right advisers and local operating partners is perhaps even more critical than in the US or Europe.

“If you're looking at a resort project in the United Arab Emirates or Morocco, maybe you have fewer windows than a resort in Florida,” Boutros says, referring to the fact that regional architecture is designed with very hot temperatures in mind.

Even if US and European opportunity funds have yet to jump headfirst into the region, Al-Marzooq notes that many other Western firms are still getting a piece of the upside. “The real people who have benefited from this are the service providers,” he says. “Everyone is using US and European engineers. Everyone is using US and UK construction companies.”

Local firms are also picking up on available opportunities. Bahrain-based Unicorn Investment Bank, after closing its Saudi residential fund late last year, is looking to launch a second fund largely focused on multiple asset classes in the GCC countries, as well as a 20 percent allocation to opportunities in Libya, Morocco, Jordan and Turkey.

Arcapita, also headquartered in Bahrain with offices in Atlanta and London, has been active in the region as well. The firm is currently developing a golf resort in Bahrain as part of a joint venture with an investor group that includes the country's pension fund, its Ministry of Finance and National Economy and its General Organization for Social Insurance.

Yet despite the impressive fundamentals, many regulatory and cultural issues are keeping unrestrained growth in the private equity real estate industry at bay—at least for the moment.

When it comes to the general public, Bernard says, “The Middle East story hasn't gotten out.”