Speculative investment is most evident in the regional land market, with plots being bought and resold within a matter of months at potentially very attractive profits, according to investment bank Morgan Stanley.

"There is a lack of data on historical land transactions and selling prices in most of the Mena markets, with the exception of Dubai. The recent hikes in land prices have made land cost a major component in developers' total costs. Land cost is highest in Qatar, while Egypt still has the lowest, despite major price increases," the bank said in a report titled "Winners and Losers in Middle East and North Africa (Mena) Property".

In Dubai, the Land Department has recorded a fourfold increase in land prices since 2000. Although this is driven in part by genuine demand, speculative investment has also contributed to the price rises. This land price inflation has extended to other markets, most obviously Egypt. In May 2007, the Egyptian Government held an auction to sell land plots.

Prices have since risen dramatically, driven in part by demand from foreign developers, particularly from Gulf countries, seeking expansion opportunities in Egypt's growing market. Local speculative investment is also likely to have contributed to the price increases.

According to the report, prices have been driven by a combination of genuine demand, speculation and, most recently, escalating construction costs.

Although construction costs have been rising since 2005/6, price increases have been more marked since 2007. Before that, demand and speculative investment were the primary factors driving property price increases. "We believe this trend has held throughout the GCC nations and cities, with Dubai the most prominent example."

Construction costs have been a principal concern among contractors and developers since 2007, and this has been especially evident in 2008. The construction process from a developers' perspective has many moving parts, which are mainly passed on to the contractor once the construction contract is awarded. Thus, choosing the right contractor is key for a developer.

In today's contractor's market, it can be difficult to find a contractor who will deliver with the required quality and on time. Thus, contractors with a good track record in delivering agreed-upon quality and delivery dates have busy schedules and require higher profit margins.

Building material products, including steel and cement, and the subcontracting element make up 70 per cent of total construction costs. Moreover, the subcontracting component is continuously increasing as a percentage of total construction costs, especially in high-end luxury housing units.

Basic building material products are a higher contributor to cost in low/middle income housing.

Labour has been the principal driver of cost inflation for contractors over the past 18 months.

Securing skilled labour is increasingly challenging. Despite its relatively small contribution to total construction costs, labour costs have been rising in double digits since 2006.

"We estimate that a 20 per cent increase in labour costs would inflate construction costs by four to five per cent."

Cost pressure has been increasing across the region, but is particularly pronounced in the UAE. Rising building material prices, higher labour cost and the scarcity of quality contractors have all contributed to higher construction costs.

Labour costs and contractors' margins are likely to remain high in the short term, given the planned investments across the region in real estate assets. However, Morgan Stanley thinks this should be more than offset by lower prices for building material products, especially cement and steel, with planned capacity expansion across the region. "Additionally, we expect land prices to correct downwards in the medium term, as speculative demand softens. Thus, we expect recent cost inflation to lose momentum."


Common trends

Companies in Morgan Stanley's coverage universe have adopted a wide range of sales approaches and strategies for growth, which tend to reflect the respective market and age of the company. The report highlights companies' sales and growth strategies by geography and business line. There are some common trends:

Selling land to fund development: This is especially evident in Gulf companies with a short operating history. Thy include Sorouh, Aldar, Barwa, UDC and Emaar Economic City.

Targeting sales to multiple income segments in the local market: The investment bank favours such a strategy as companies in their coverage predominantly target the upper income segment, which it thinks will face oversupply in some countries where escalating prices are making real estate less affordable. Companies that target buyers from multiple income segments include Emaar, Sorouh, Talaat Mostafa, Barwa, Union Properties and Emaar Economic City.

Expanding investment portfolio base: Companies are attempting to leverage current lucrative rental markets in the majority of their core markets and are expanding their investment portfolios. All companies in its coverage have adopted such a strategy, although Qatari companies are most advanced in this respect.

Exposure to hospitality: Companies are diversifying away from real estate development and trying to secure recurring income streams through exposure to the growing tourism sector. Companies that have exposure and/or planned exposure to the segment include Emaar, Aldar, Union Properties, Barwa, Talaat Mostafa, Palm Hills and Emaar Economic City.

Geographical expansion: A number of companies have been proactive in international expansion, while others are waiting for the right opportunities. Emaar has been the leader in this regard, with Barwa and Talaat Mostafa also pursuing expansion.


Inflation threat

Rising inflation has clearly been a global trend, but it has been particularly marked in Mena countries. Higher prices for energy, food products and housing have all contributed. Egypt and Qatar have seen the highest inflation rates so far this year.

Although the main factors driving inflation vary among countries, Morgan Stanley believes housing is the major driver in the UAE and Qatar. A recent survey in the UAE showed the average household spends around 40 per cent of its income on housing. In Qatar, housing cost inflation has been running above 25 per cent per year since 2005.

Rising inflation rates have not been accompanied by increases in interest rates in the Gulf Co-operation Council states, with currencies pegged to the US dollar.

This has resulted in increasingly negative real interest rates that the report believes fuel property demand. Egypt has adopted an inflation-targeting monetary policy, and thus escalating inflation would lead to higher interest rates.

"However, we note that real interest rates are still negative. As the regulatory framework becomes more structured, the current negative real interest rate environment should continue to support demand for real estate assets, at least in the short term, given that it is a natural hedge against inflation in the region," the report said.