Sand, Steel and Sentiment: Real Estate Cycles in the Gulf
Market Cycles and Fundamentals Series | Edition 1 1
Real estate cycles matter
Explaining the real estate cycle
The story of Atlantic Yards in New York is both instructive and sobering. Billed as the largest real estate project ever for the city, its launch timing was excruciatingly poor. Announced in December 2003, the planning delays and the design phase dragged out over more than four years. By the time construction began in earnest, the Global Financial Crisis had descended upon it. From then on, the project has remained mired in controversy and doubt, the assets of its original developers acquired by others and the vision they promised now as far away as ever from helping to solve New York’s housing crisis or gracing its skyline with eye-catching new towers.1 As the lead developer admitted in 2008, at the heart of the project’s failure was poor forecasting of real estate cycles.2
The standard cyclical pattern is well-known. As demand for real estate increases, whether fuelled by demographic changes or rises in real incomes, supply restrictions quickly emerge. Unlike many others, the real estate market cannot respond immediately. Lags in the construction system often accentuate cycles despite countercyclical moves by central banks, such as interest rate management. Eventually, sufficient or often more than sufficient construction takes place to meet demand, and the market peaks and reverses. At this point in the cycle, it is unlikely that sufficient inbound investment will be available permanently to counter downward market pressure, even in a highly desirable jurisdiction.
The Atlantic Yards story might have happened a long time ago in a place far, far away. But we should be intimately familiar with it. Developers and investors alike ought to be concerned with the real estate cycle if they are to avoid the same fate as those developing Atlantic Yards. The largest building projects are often underway – but not completed – at the time that the real estate cycle peaks and the financial crisis ensue. Ignore the real estate cycle at your peril. What do we know about them? Real estate cycles occur in four distinct phases: Recovery, Expansion, Hypersupply and Recession, which indicate the state of commercial and non-commercial real estate markets. These cycles are important to developers and investors as they serve to predict and make assumptions about properties.
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Sand, Steel and Sentiment: Real Estate Cycles in the Gulf
What is less well understood is the intimate relationship between capital flows, real estate speculation that drives oversupply, collapsing land prices and financial crises which repeat in 18-year cycles. Speculative building that is driven by anticipated rather than by actual demand, contributes to oversupply. As capital flows into markets, such as in Dubai during the Global Financial Crisis, it acts as a catalyst for this speculative boom, and is sufficient evidence for this assertion.3 But when the flow of credit slows, a market correction inevitably follows, bringing down the banking system and leading to a financial crisis. This has been the story in Dubai, for example: as the cycle progresses, speculative building takes place based not on actual demand, but on anticipated demand. Tax incentives and Government policy are key since they act as catalysts for speculative building. History is replete with examples. For example, the office boom in Manhattan in the late 1920s was largely driven by speculation on future demand, while in Japan in the 1980s, urban development programmes, such as theme parks, were built in anticipation of future growth. Bank and non-bank credit follows the speculative frenzy, thus facilitating
the 270 massive oversupply. But the flow of credit that drives supply will not last forever, and when it slows, a crash is inevitable. This brings down the banking system, leading to a financial crisis. 260
Trends in markets, however, can be reinforced by the flow of capital. In markets like the Gulf, where capital continues to flow in, demand is 250 reinforced, leading to higher price points and a long-term positive trend superimposed on the cycle. This, however, may only reduce the volatility and lengthen the cycle, as evidenced by the chart. 240 230 220 210
Index Value
200
Lehman Brothers Bankruptcy
190
Dubai to Dubai to host host Expo 2020 Expo 2020
180
Covid restrictions Covid restrictions eased eased
Brexit Brexit announcement announcement
Covid Lockdown Covid Lockdown started started
170 160 150 140 130 120 110
Indexed to Base Value 100 (Jan-2008)
100 90 2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
Source: Property Monitor (2025)4
The role of land prices When demand for real estate rises rapidly, the difficulty of finding suitable land to develop will constrain the new supply of properties by as much or more than the capacity constraints in the building sector.5 If for this reason alone, land prices are intuitively likely to increase sooner and to a larger extent than property prices themselves. There is a second possible explanation for this phenomenon. When property prices are increasing, developers may find it more profitable to postpone construction and sit on their land banks instead. In this way, holding land provides an option to developers. The value of such options may be calculated using methods applied to real options theory. Alternatives include decision trees and applying the usual methods of valuing financial options (e.g. on shares or currencies), such as the Black-Scholes model.6 This method employs key variables such as how long the option will last, the volatility of the underlying market, and the cost of construction, which can all be combined to generate a value for the land that can be added to a residual land valuation. At a macro level, this calculus contributes to supply restrictions that drive further price increases.
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Sand, Steel and Sentiment: Real Estate Cycles in the Gulf
Real options theory is also useful in explaining why, although building in a declining market is harmful to the developer, it is less harmful than developing second in a declining market7 , as the first developer captures the remaining demand before conditions further deteriorate. This real option land value is, however, very sensitive to market expectations. If confidence leaves suddenly, real options values can evaporate quickly as future development is no longer more profitable than developing now, but less. This happened in the salutory case of Berlin, where nominal house prices in 2007 were back to their 1989 levels, real prices of course being even lower.8 Other such options, such as abandonment and redevelopment, may only compensate very partially for such a dramatic flight of value9 and they themselves may also evaporate quickly.10 Late-cycle behaviour in real estate markets often exacerbates this issue. The ability of landholders to hold on to sites during periods of uncertainty, along with the ease of credit flow that increases demand for land, often leads to inflated land prices. When market confidence drops, inflated values could crash. Therefore, it leaves landholders with fewer viable options for development or redevelopment, further accelerating the collapse in value.
Empirical evidence That’s what theory tells us about land prices and real estate cycles. Does it stand up to scrutiny in the Gulf context? Cavendish Maxwell’s monthly data for Dubai over the period between January 2019 and December 2024 shows extremely high correlations between land prices and transaction values for offices and residential property, 93% and 95% respectively. Using land prices as a one-year leading indicator even produces a slightly better correlation. As to real options, evidence certainly has supported the theory elsewhere in the past. One study suggested that up to half the value of land in Athens is explained by its option value.11 Another from the US calculated that for the most attractive towns for development in a sample, up to a third of the land price could be explained similarly.12 A third more recent study from Singapore found that land prices are correlated with increased property price volatility.13 If studies of this kind have not been repeated much, that is primarily because property prices themselves have not exhibited sharp upward trajectories. For the Gulf, the methodology remains relevant: the high correlation between land and property prices and the way in which time adds no value to the connection suggests that options are being exercised very quickly in what is certainly a fast-moving market.
What should developers and investors do? The most obvious step they need to take is to focus much more on forecasting and timing risk. Developers and investors need to ensure that either they, their advisers or both have the macroeconomic and market data on which to base forecasts. There is little excuse for not doing so: the required data is now plentiful across all Gulf markets. Having the data itself however, is obviously insufficient. When consultants produce forecasts, developers and investors must have the skills to interrogate them on their methodology. They must gain confidence that the data has been put to work as part of qualitative analysis, such as expert Delphi sessions, time series forecasts and constructing regression models, ideally all three to enable triangulation between the results of forecasts based on different methodologies. There is also little evidence that developers approach real option value quantitatively, or even that they assess it at all, even in Organisation for Economic Co-operation and Development (OECD) markets.14 The issue is, however, partly one of governance. It is one thing for management to use forecasts and risk analysis to become aware of what stage in the cycle the market is at; it is quite another for them to be sufficiently motivated to act appropriately on that knowledge. It takes courage for a developer to tell its shareholders ‘now is not the time’ and many prefer to carry on and hope for the best instead. Real options value may as well not exist under such circumstances. The performance metrics tied to remuneration are, moreover, an even greater reason managers’ interests are often not wholly aligned with the long-term benefit to shareholders. Firstly, a project cannot succeed unless it goes ahead: there are rarely any rewards based on retrospective assessment of the gains achieved by postponement. Second, once projects are launched, many remuneration metrics revolve around construction performance rather than project Internal Rate of Return (IRR). Finally, the problem is exacerbated by the Gulf’s favoured model of develop-and-hold, as computing the IRR of a development project still lies very much in the future even after completion. So one clear recommendation needs to be aligning remuneration much more closely with long-term project performance.
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Sand, Steel and Sentiment: Real Estate Cycles in the Gulf
Conclusions Developers and investors alike ought to pay much more attention to real estate cycles and the role of land prices as leading indicators than they do. This is especially the case given that historical data and forecasting methodologies are both readily available. Consultants such as Cavendish Maxwell with extensive analytical and forecasting capacity stand ready to guide the board with respect to market sectors, but they can only respond to requests to do so, and there are still many disincentives for both developers and investors to take timing risk sufficiently seriously. This is all the more pressing given the increasing global nature of real estate cycles. Recent data shows that the 18-year real estate cycle is becoming more interconnected across markets, influenced not only by supply and demand factors but also by global capital flows. This suggests the next cyclical downturn is likely to impact markets globally, which means that investors must not only understand these cycles in their local context but also prepare for more challenging global conditions ahead, which could be even more pronounced due to these international linkages. The time to start preparing is now: after all, the world’s tallest building is being built in Jeddah.
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Sand, Steel and Sentiment: Real Estate Cycles in the Gulf
Authors Julian Roche
Ali Siddiqui
Chief Economist Cavendish Maxwell julian.roche@cavendishmaxwell.com
Research Manager ali.siddiqui@cavendishmaxwell.com +971 50 877 0190
Guest Author Akhil Patel
Director, Property Sharemarket Economics
Key Contacts Kevin Duffield
Ronan Arthur
Siraj Ahmed
Zacky Sajjad
Director, Head of Built Asset Consulting kevin.duffield@cavendishmaxwell.com +971 56 344 2177 / +966 59 496 3815
Director, Head of Residential Valuation ronan.arthur@cavendishmaxwell.com +971 50 296 1411
Director, Business Development and Client Relations zacky.sajjad@cavendishmaxwell.com +971 50 644 5089
Director, Head of Strategy and Consulting siraj.ahmed@cavendishmaxwell.com +971 50 382 4409
Dubai +971 4 453 9525 dubai@cavendishmaxwell.com 2205 Marina Plaza, Dubai Marina, P.O. Box 118624, Dubai, UAE Dubai
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