In our last blog, we examined alternative finance mechanisms which could see a significant rise in market share in the GCC over the coming decade including mezzanine finance and private equity. Assuming these alternative finance mechanisms become available in GCC markets at levels close to those seen in international mature markets, the effects for GCC real estate developers will be significant.

The Impact of Alternative Finance Mechanisms on Developers and End-users

Access to alternative finance mechanisms such as mezzanine finance and private equity comes with a price – a portion of the development profits – in return for significant risk reduction and less financial exposure. GCC developers will thus need to increasingly assess their projects on a risk scale, rather than simply a profit scale. The key question for GCC developers will be, how much is risk reduction and reduced financial exposure worth? The answer to this question will drive the deal terms offered by both mezzanine and PE funds.

• Developers

If GCC developers begin to utilize these alternative finance mechanisms, the market’s development dynamics will also shift accordingly. SME developers, with access to alternative finance mechanisms, will be empowered to compete with larger developers – as they will no longer be limited in their ability to deliver large projects due to a lack of developer equity. However, this situation will also increase market risk as SME developers will need to professionalize and modernize their operations to successfully deliver larger-scale projects. For larger developers, access to alternative finance mechanisms will allow them to limit their equity exposure on projects, freeing-up developer equity for investment into innovation (e.g. alternative construction technologies) or for expansion into new markets and new project types.

• End-users

However, the introduction of alternative finance mechanisms comes with increased risk for the end-user / unit buyer. By essentially allowing developers to leverage a smaller equity investment and still complete projects, developer accountability becomes a serious issue, as is the case with international mature markets. Government regulation of the mezzanine and PE sector would need to be carefully crafted to ensure that the individual unit buyer / investor remains protected. In addition, it is likely that in the initial stages, foreign funds with significant experience in mezzanine and private equity real estate (PERE) will be the first to enter the market, leaving local GCC-based funds at a disadvantage to grab market share. The risk of local-based funds being ‘’pushed out of the market’’ with the introduction of alternative finance mechanisms, is a key risk factor.

• Outlook

In summary, alternative finance mechanisms for real estate development finance represent both an opportunity and a risk for GCC real estate markets. Considering the increasing market maturity and evolutionary ‘’growth curve’’ in GCC markets, it is likely that alternative finance mechanisms will enter the market during this decade, and both local funds as well as government regulators will need to move quickly to stay ‘’ahead of the curve’’ and ensure that the introduction of these finance mechanisms is executed in a manner that benefits the entire market.