Summary: The GCC is fast emerging as the Mecca of real estate / infrastructure development firms. The growth in this sector in this region has been probably the fastest in the world, rivalling that in emerging economies like India and China. However, competition has become intense, demand is on the decline, and managers in these companies are forecasting slower growth and shrinking bottomlines in the coming 5-10 year period.What can an organization in such environment do to differentiate itself, and sustain long term growth? Diversification and integration (both forward and backward) could offer some tangible solutions.
Introduction: At the last count, almost 4,000 companies were directly involved in real estate sector in Kingdom of Saudi Arabia (KSA). The number is equally daunting in the UAE, Qatar, and the rest of the GCC. It is natural, therefore, that competitive intensity would be high and differentiation low. In an increasing ‘demand-led’ market, each company is trying to somehow sell its wares. Situation at the moment is good for the sector which is witnessing double digit growth annually for the past 6 years in the middle east. However, the question merits attention that with so many companies providing similar offerings, how long will it be before the sector sees massive consolidation? How are these companies going to sustain their profitability when the demand saturates and bigger players start drawing blood by lowering prices?
One look at the real estate advertising is a good pointer to how undifferentiated this sector is becoming – a western expat walking on the beach, a golfer driving the ball off the tee, small kids playing in the garden, and a promise of the best lifestyle on earth – this the recipe for any real estate communication that one comes across these days. The offering is the same, the terms and conditions are the same, the location is similar, and pricing is the same. This is a good indicator of the state of the sector which is becoming undifferentiated by the day. It should be of no surprise, therefore, that if you stretch the equation 5 years from now, you will have a plethora of real estate developers most probably well on their way to filing bankruptcies or gettng bought over by larger players. A glut of similar development will bring down prices and affect the market – not merely from a demand-supply scenario-much has been written about that- but from the ‘commoditization’ of the sector, where hoards of similar units will be available.
What can a company do in this scenario? Even larger players need to take stock of the situation as they have great exposure in the market (and surprisingly, their offerings are not greatly different, if they are, they are priced to high). Already, these players are showing signs of strain-delay in handing over large communities is no longer surprising. Established players are now focussing on projects in hand, and not on announcing new projects. Mortgage terms are getting revised favorably for the consumers. All these indicators point to the fact that slowly and steadily, players are taking cognisance of the fact that the sector will see an imminent shake-up, and they do not seem to know where would they be if such a shake-up happens.
Some interesting options could come in handy if considered now. Golden rule of mitigating risk is to diversify and/or hedge oneself by investing in businesses that even out the cyclicity of any business.One of the options that could become interesting for large players, or a congregation of smaller players, is to backward integrate into, say, a cement plant. The numbers seem to support such a move-it is estimated that KSA will need close to 2 million residential units in the next 10 years. That is 200,000 units annually, equivalent to 200-300 million sq.ft of space. Add to this commercial space, leisure and tourism projects, and infrastructure developments, and the number could well reach a dizzying 500-600 million sq.ft of constructed area, annually. If one assumes that one cement bag (standard size) is required to construct 500 sq.ft area, we are talking about a million cement bags getting consumed. Is that a good enough indicator to put money in a plant, one cannot say so with this data. One has to do the math in determining the project’s viability, but is it worth considering as an option. Absolutely yes. One, it provides reasonable diversification out of the core business – you can export cement but not buildings. Second, it allows cost reduction given the scales are high. Third, it allows developers a chance to explore newer markets when they export it. Fourth, in an increasingly undifferentiated market, it allows a developer to maintain cost-advantage which can be passed on to the consumer to develop and sustain a differentiation. Finally, this option is not just for large players – in a scenario where a shake-up is imminent, smaller players can come together and invest in a plant that helps them fight larger players if a price war starts. This option of ‘backward integration’ could be extended to other options like acquiring controlling stakes in businesses that offer strategic and operational synergies-Steel, Construction Management Companies, Construction-infrastructure support companies, etc. This area could be further researched.
The other direction one could take is to forward integrate into business that enable the parent company to generate annuity-based business and also tap into consumer surplus long-term. A good example in this case is to enter, say, consumer-finance specifically targeted at home-buyers. This option could then be branched out to include other financial business directly related to infrastructure and real estate – Project Financing (especially in areas where parent company does not have expertise-this would give it a hedge against fluctuations in its mainstream businesses), Asset Management (to include property management businesses that takes care of residential communities, as well as commercial spaces), etc.The idea of forward integration in real-estate sector makes a lot of sense, especially in GCC, where demand and supply are inching closer by the day, but rental situation is worsening concomitantly. It is not a paradox as it seems - sale/purchase activity is largely speculative and has resulted in multiple investments by an individual / company. With more supply coming in, demand is ebbing as the present investors want to book profits, but because the demand (to invest) is decreasing, individual customers are becoming wary to invest, instead opting a wait and watch approach, and chosing to rent. This is pushing rentals up. In this situation, if a real estate company is saddled with inventory, the best option is to start renting their properties with an option to buy later. How does it help?
1. It improves cash-flow situation, so that investors can start getting some returns
2. It locks in a customer (with higher probability to buy if ‘rent-to-own’ scheme is managed properly)
3. It allows increase in sale of commercial/retail spaces as residential communities require those.
Innovative solutions to design and manage inventory can give strong advantage to any real-estate company facing stiff competition. It is also an effective way to resist any downturn in the business, as well as look at annuity-based revenue generation. In sum, obviously, there are other ways and means to diversify business that makes long term sense and gives a strategic advantage to a real-estate / infrastructure company. It is something worth investing time and money in, and in experimenting with. Integration, be it vertical, forward, or backward, has borne long term results in sectors that are capital intensive and face a demand-supply equilibrium. Any real-estate / infrastructure company that sets its vision high, will do well to explore such options.
