Supplied demand: Pre-crisis projects flood the market, while new opportunities emerge in niche segments

With a large supply of residential, office and commercial space having come onto the market in recent years, the real estate sector in Bahrain is going through a period of transition as it works to absorb excess capacity. While development has slowed, financing has become easier for developers to obtain, thanks to higher levels of liquidity in global capital markets.

Banks are increasingly willing to lend, although they are acting cautiously and requiring developers to put up more of their own money. One segment that faces significant demand and little supply is affordable housing, an area that could present substantial opportunities for local participants in the real estate sector.

RESIDENTIAL: Like many of its GCC neighbours, the Kingdom experienced a surge in real estate development in the years up to 2008. A number of large, high-end residential and mixed-use developments were begun during this period, mainly on reclaimed land to make them eligible for sales to foreign nationals. Some of these projects – such as the Amwaj Islands and Reef Island – have been partially completed and are now home to a number of Bahraini and expatriate residents.

As units from these and other developments have become available, this has depressed an already soft residential market. While a weak global economy contributed to the post-2008 downturn, the social unrest in the first half of 2011 also had an effect. Many middle- and upper-income Bahrainis continue to buy homes, but expatriates, who in the past would have purchased an asset, are choosing to rent instead. For this reason, the rental market is more active than the sales market, according to Harry Goodson-Wickes, the head of the Bahrain branch of UK-based real estate agency Cluttons. But there are factors weighing on this segment as well, including an increase in supply, as home owners seem unwilling to reduce sales prices in the hope that they can recoup their purchase price while leasing their property instead, Goodson-Wickes told OBG.

RENTAL PRICES: According to a report released in the fourth-quarter 2011 by the Bahrain office of real estate firm CBRE, monthly rental rates for a standard two-bedroom apartment in Juffair, an area that is popular with expatriates, fell from BD750 ($1980) in the fourth quarter of 2008 to just above BD600 ($1584) in the final three months of 2011. Similarly, the rental price for a three-bedroom villa located in a compound declined from around BD1100 ($2904) to BD900 ($2376). Compounds – which have been popular with upper-income expatriate families and are generally located in the north-western part of the country in areas such as Budaiya and Saar – have been particularly affected by the social unrest, with many people choosing to move to gated developments, such as the Amwaj Islands.

Sales prices are down too, according to a first-half 2011 report from Knight Frank, the global property consultancy. The average apartment price has fallen to BD790 ($2087) per sq metre, down from around BD1300 ($3432) in the first half of 2008. Villa rates have seen a decline over the same period, from BD850 ($2244) to BD625 ($1650) per sq metre. However, the downward trend started to slow in the first half of 2011. Average asking prices decreased by around 6% between January and June 2011, compared to 13% for the second half of the previous year. Knight Frank’s report also notes that villa prices are declining more rapidly than those of apartments, as owners have been reducing their prices to attract buyers.

The experiences of individual developers OBG spoke to are consistent with market data. In January 2011, for example, Alargan, a Kuwait-based developer, launched sales for its most recent project, Jeyoun, a mixed-used development. Khalil Saleh, the general manager for Alargan, told OBG that following the political unrest in February 2011, all of their reservations, which accounted for about 30% of the project, were cancelled. Sales have since returned, however, and approximately 35% of their units had been sold as of late 2011.

EXPAT BUYING ACTIVITY: Sales for local developer Orchid have also dropped, according to Bashar Ahmadi, the company’s managing director, who believes this reflects an overall lack of demand in the global real estate market. The developer had sold around 25% of its latest project, Dream Tower II, as of August 2011. Ahmadi noted that the firm mainly targets expatriates, who have become less willing to buy and are instead choosing to rent. This opinion was echoed by R Lakshmanan, the CEO of Sakana Holistic Housing Solutions, a local mortgage provider, who told OBG there has been little activity in sales to expatriates; for now, they are keen to hold on to their cash, rather than invest in real estate.

OFFICE: Rental prices are also coming down in the office-space segment. According to a report from CBRE, leasing rates in Class-A office space declined from more than BD12 ($32) per sq metre in late 2008 to around BD8 ($21) in the final quarter of 2011. The fall has been similar in the Class-B segment, where prices have been reduced from BD7.50 ($20) to BD5 ($13) per sq metre. These declines have been driven in part by an increase in supply, as projects planned during the growth years are now coming onto the market. Cluttons has estimated that about 100,000 sq metres of new office space was completed in 2011, bringing the total leasable area to about 850,000 sq metres, with occupancy rates at about 60-70% as of the end of the year. Another 60,000 sq metres are expected to come onto the market in 2012, including two major office buildings, Al Nakheel Tower and Fakhro Tower. But the demand side is playing a role as well, Goodson-Wickes of Cluttons told OBG, as tenants defer decisions to expand space, and the number of new entrants to the market declines.

Landlords have responded to this challenging market by providing incentives in an effort to attract and keep tenants. According to a report from CBRE in 2011, potential tenants were being offered up to five months’ rent at no cost. Goodson-Wickes said landlords are also reducing or eliminating service charges, which typically add another 5-10% to the price of the lease. However, the effective price change for the tenant has to be significant enough to make the move worthwhile for those who have already established operations in Bahrain. The expense of moving an office – particularly the cost of a new fit-out – can discourage many from relocating. In response, some landlords have started providing fitted-out space, whereas the market was previously dominated by shell and core space. Another feature that may encourage prospective tenants is the possibility of an upgrade in terms of quality. Businesses occupying Class-B and Class-C space in older commercial districts of Manama may consider moving to Class A space in newer areas, such as Seef and the Financial Harbour, particularly as rents in Class A buildings fall. In addition to better facilities, tenants in these areas benefit from more parking and less traffic.

RETAIL: As in the residential segment, the market for retail space has been affected by the social unrest. This is partly due to the fact that footfall at the malls declined when the King Fahd Causeway to Saudi Arabia was closed for a few months in early 2011. Rental prices have generally come down as a result, although performance has varied across the shopping malls. For example, the newest of the malls, City Centre – which attracts visitors from Saudi Arabia as well as Bahrainis – is fully occupied, and rates have remained unchanged.

Seef Mall, another major shopping destination, is also doing well and has a waiting list for tenants. Robert Addison, the general manager at Seef Properties, told OBG, “Some businesses are looking to move out of areas they perceive to be less safe. We faced challenges in 2011, including the provision of BD1m ($2.6m) in tenant relief, as businesses struggled. Nevertheless, we continued uninterrupted with our BD2.5m ($6.6m) refurbishment of Seef Mall, which we finished in December 2011.” Seef also has expansion plans for 2012, including the addition of three external restaurants. Addison said that one potential segment for growth in the retail sector is the development of neighbourhood malls, which he defined as shopping centres of around 30,000 sq metres often anchored by a hypermarket. Goodson-Wickes added that in addition to the move towards smaller malls, there is growing interest in the strip mall retail model that caters to local residents.

AFFORDABLE HOUSING: While higher-end residential developments are experiencing some challenges, one area that looks promising for the future is social and affordable housing. The former is provided at subsidised prices by the state to households that have incomes of less than BD1200 ($3168) per month. The latter is not as well-defined, but the category is generally considered to include units priced between BD85,000 ($224,417) and BD120,000 ($316,824).

Up to now, the state has provided 100% of social housing units through a design-and-build model, tendering out the construction work to local contractors (see analysis). Under this system, the Ministry of Housing (MoH) has been able to provide around 1300 units per year. However, demand has far exceeded supply, with the current waiting list officially standing at about 54,420 families. Recognising that its capacity was not sufficient, the MoH has in recent years started to consider alternative models, including public-private partnerships (PPPs). In January 2012 the MoH announced the first such deal – an agreement with Naseej, a local developer, to provide 3110 social housing units.

As part of the same project, Naseej will also build 990 affordable housing units to government specifications. While the social units will be purchased by the state at a set price in 20 batches over a five-year period, the affordable homes will be sold on the open market. Many developers are waiting to see whether Naseej is successful in this endeavour before entering this market, particularly in partnership with the government. According to Hasan Al Bastaki, the managing director at Manara, a local developer: “Private developers are looking very closely at how the first PPP project between the government and Naseej will develop. Other companies, including Manara, are interested in a second PPP project, depending on how the first one is structured.”

CHALLENGES: One challenge for the affordable housing market is the fact that Bahrainis typically prefer to live in villas rather than apartments, but at the prices that are required for the affordable housing market, this may not be feasible. Introducing Bahrainis to the idea of living in apartments is crucial, according to Al Bastaki. “The only way to solve the housing problem is to go vertical,” he said, pointing out that Bahrain does not have the land to do otherwise. However, he added that since the market is still not ready for this step, Manara Development’s affordable housing projects, including two that are under construction and a third that is in the advanced stages of planning, contain only villas.

LAND COSTS: The cost of land is a barrier to the development of more affordable housing. This is partly due to the fact that Bahrain is a small island, and most people prefer to live near the centre of Manama, creating a situation where demand exceeds supply. Furthermore, during the pre-2008 speculative growth period, many investors bought land at inflated prices, and they are hesitant to sell it now at a loss, according to Mike Williams, the senior director at CBRE. Despite the drop, prices are still high enough to be a deterrent for developers. According to Williams, residential land in Saar used to cost BD32 ($85) per sq metre, whereas today it is priced at around BD215 ($568). “There is an urgent need for a correction of prices, as current pricing does not allow the private sector to develop. It is now cheaper to reclaim land than to purchase it,” he told OBG.

While this problem affects developers in all segments of the market, it is particularly an impediment for those trying to provide affordable housing. Christopher Sims, the CEO of Naseej, has stated that the cost of land for any affordable housing programme cannot be more than BD135 ($356) per sq metre if it is to be viable for the developer. In the case of the affordable housing units Naseej is building under the PPP, the land has been licensed by the government to the developer at no cost. These homes will be sold to buyers inclusive of land costs provided it is their primary residence. As Sims told OBG, “The government is being more proactive in terms of making land available.” This could be an important factor in developing this segment, according to Abdulla Juma, the chairman of Bin Juma Holding Company. “The private sector can play a role in affordable housing if the land is subsidised. The government should give away land to private developers, as Bahrainis will eventually be the ones living on it,” he told OBG.

FINANCING: One factor that could boost the affordable housing market is the government’s decision to increase the maximum mortgage that Eskan Bank, the state-owned housing bank, can offer borrowers. While low-cost loans (priced at 3%), which are available to households with a monthly income of BD1200 ($3170) or less, used to be capped at BD40,000 ($105,600), this was raised to BD60,000 ($158,400) in 2011. This amount may still in many cases be insufficient to cover the cost of a home, but Eskan offers commercial loans at 8% that can be used to supplement the subsidised loan. Alternatively, borrowers are free to turn to the commercial market for additional funds, although these are classified as personal loans and the lender does not hold the title deeds. There is also an active mortgage market in the private sector, with about 15 banks offering loans to Bahraini and expatriate homebuyers. Both conventional and sharia-compliant banks are active in the market, the latter comprising 30% of the total outstanding value of mortgages, giving locals more access to financing. Sharia-compliant loans have not only proved attractive for religious reasons, but also because they offer more choice (see analysis).

In the early months of 2012, the cost of borrowing began to decline. For example, HSBC announced that it was offering 25-year mortgages for rates as low as 5%. The fact that borrowing costs for consumers have come down reflects a general boost in liquidity in global capital markets, which also makes it easier for developers to access financing. According to Robert Lee, the CEO of Bahrain Bay, the market for financing is improving, as balance sheets have been cleaned up in the wake of the global crisis and banks are ready to lend. However, financial institutions may well be more cautious than before, with Lee noting that in many cases banks now require a 50% loan-to-construction-cost ratio, whereas during the pre-crisis surge, they would routinely lend up to 70% of the cost of construction.

BIG PROJECTS: While purse strings may be slowly loosening, access to financing has been a challenge for some ongoing large-scale residential and mixed-use developments that were planned during the boom years, such as Villamar and Marina West, both of which have been delayed. However, in January 2012, Gulf Holding Company, the owners of Villamar, announced that it would resume construction work and has targeted mid-2014 as the completion date. Villamar, which consists of three residential towers, is part of Bahrain Financial Harbour, a $3bn waterfront mixed-use development that is already home to major commercial buildings, such as the Bahrain Financial Centre. Work on Marina West, a $700m development near Budaiya that includes plans for 10 residential towers plus a five-star hotel, was put on hold in March 2010 and has yet to resume.

Further major developments have continued largely uninterrupted, with projects such as the Amwaj Islands and Reef Island already partially completed. Others, including Bahrain Bay and Diyar Al Muharraq, are in earlier stages but are moving ahead. At Bahrain Bay, a $2.5bn mixed-use waterfront development, reclamation work is finished and the necessary infrastructure (roads, water, sewer, power) is in place. In addition, one of the anchor tenant buildings, the headquarters for local investment firm Arcapita Bank, has been completed and is occupied. The developer has now turned its attention to work on the Four Seasons Hotel. The main construction contract for the hotel was awarded to Belgium-based Six Construct in late 2011, with the target completion date set for April 2014. At Diyar Al Muharraq, a $3.2bn mixed-use development that was launched in 2008, the reclamation work is 87% complete in the first two stages, and 10 projects within the development are expected to be put up for tender in 2012.

LEGAL NEWS: One challenge for the sector is the absence of a robust legal framework and a specialised regulatory agency, such as Dubai’s Real Estate Regulatory Authority (RERA). For example, the Kingdom lacks laws that require developers to set up escrow accounts to safeguard investors’ money, particularly in off-plan sales. Sameer Nass of local contractor Nass Group told OBG that Bahrain also lacks strata laws, which in many countries are used to define ownership of common areas and the underlying land in apartment complexes.

The need for such laws and regulations may be less apparent when times are good, but it becomes more obvious when the market turns down, a point made by CBRE in its fourth-quarter 2011 report on the real estate market. Of unfinished residential projects, such as Marina West, the report stated that, “The liquidity that drove many of these projects is now noticeably absent from the Bahrain market, and a wide variety of both investors and developers have been left high and dry.” At Marina West, investors purchased 612 units for a total cost of around $175m, of which 75% has been collected. With the apartments having remained undelivered as of mid-2011, the owners of these units were threatening legal action against the developer.

The government is well aware of this situation and is working to remedy it. In 2011 the government issued a tender for a consulting study to evaluate the current legal framework and propose a new set of property laws and regulations. The Bahrain Property Development Association (BaPDA), which was founded in 2010, is also working with the government to address these challenges, according to Aaref Hejres, the chairman of BaPDA and CEO of Diyar Al Muharraq. As Lee told OBG, good laws attract so-called patient money, such as international pension funds that may invest in real estate developments with recurring income potential. This could do much to boost a sector that has lost some of its lustre for hot money from the GCC and elsewhere.

OUTLOOK: While 2011 was not easy for Bahrain’s real estate market, it may now be entering a period of sharp recovery. The fact that major projects like Villamar are starting back up suggests investors and developers expect the market to improve. Future growth may not match the expansion seen prior to 2008, but this could be beneficial for the Kingdom, as it turns its attention to segments that have been underserved in the past.