Costs, Chains and Consequences: How Gulf developers are adapting
Gulf1 Infrastructure and Supply Chains Series | Edition 2
Twin strains for Gulf developers Construction costs across the Gulf have been rising steadily for several years.1 2
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Global shipping insurance premiums and freight costs have also risen. Ports outside the Strait of Hormuz such as Fujairah, Khor Fakkan and Sohar are highly congested, and there are backlogs, high freight rates, and suspended bookings.8 Major freight companies have begun to introduce land-bridge solutions,9 but cross-border e-commerce remains expensive and transit times are many times that of sea transport.
As a result, the principal constraint for GCC construction is unusually in global terms now supply, not demand.
When has this combination happened before? But the conflict in the Gulf is accelerating this trend. Cost escalation has remained relatively contained compared to Organisation for Economic Co-operation and Development (OECD) countries. Even so, Linesight now estimates that: ▪ ▪
Overall construction costs in the UAE are rising by 5.5–6.5% this year, compared to 3–4% last year. In Saudi Arabia, costs are rising by 6.5–7.5%, compared to 5.5–6.5% last year.
Long-lead equipment costs have risen across the GCC by around 12% since the beginning of 2024.3 At the same time, the need to maintain Internal Rate of Return (IRRs) for institutional partners is complicated by the fact that the real estate cycle appears to have peaked throughout the Gulf, with prices themselves in jurisdictions throughout the Gulf levelling off4 or even showing slight declines.5 Second, logistics pressures have also demonstrated that the GCC developer-relevant supply chain remains susceptible to geopolitical strains. Most peer‐reviewed studies place logistics costs at roughly 20–30% of material costs, with transportation the largest component, and materials themselves account for 50–60% of total project budgets.6 In congested urban environments, logistics inefficiencies can push total logistics burdens significantly higher. This reinforces the importance for Saudi Arabia of demands of the giga projects such as NEOM and Qiddiya, which had already stretched breakbulk and heavy lift capacity,7 even before the conflict exacerbated existing problems. The pressures are visible across the supply chain: ▪
Disruption to shipping in the Red Sea and the use of alternative trade lanes have raised shipping times by more than half.
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Costs, Chains and Consequences: How Gulf developers are adapting
Periods of rapid construction cost inflation and logistic squeezes are far from unknown in real estate development markets worldwide. How have developers responded? A country like Nigeria always faces these problems. Analysts have constantly urged it to: ▪ ▪ ▪ ▪
Address planning deficiencies. Curb fraudulent practices. Enhance contractor capacity. Develop resilient procurement sustainable project delivery.10
systems
to
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But in practice the response of Nigerian developers has all too often been optimism bias and strategic misrepresentation.11 More recently the Ukraine War in particular elevated costs and brought the importance of supply chains to the fore for developers worldwide.12 It exposed the fact that despite the critical role of logistics, the construction industry has historically underinvested in resilience, lacking the necessary understanding and systems to effectively manage logistics and lagging other industries in leveraging logistics for competitive advantage as a result. In response, developers in countries such as the US, UK, and Australia have adopted digital technologies, Building Information Modelling (BIM), and data analytics to improve forecasting accuracy. The advantages in countries such as Egypt have been well documented.13 These are welcome improvements, but it must be conceded that they did not help predict the effect of the Ukraine War or the conflict in the Gulf. And one key problem that remains, however, is that outsourcing construction cost risks simply passes the default risk to the construction contractor. Even last decade however, research suggested that instead of pricing in contingencies, construction companies even in OECD jurisdictions priced in risk through contractual mechanisms. This always runs the risk that contractors may not fully account for the cost of risk in their bidding price to avoid inflating their price with risk allowances and become uncompetitive.14 The result is that construction contractors are still very prone to default. The default of Carillion in the UK is an especially instructive example of the consequences of over-zealous bidding.15
Fortunately, Gulf developers have largely followed historical best international practice, even setting new standards in some cases. The explanation lies in the fact that hydrocarbon price volatility – a reasonable proxy for geopolitical uncertainty - has always featured prominently in the past in lists of causes for Gulf construction cost escalation or logistics crunches,16 17 whilst the pandemic provided further evidence of likely strains.18 They also have firm allies in their governments which have continued to invest heavily in infrastructure throughout the conflict, in many cases as a direct response to the supply chain problems it has generated.
Four ways Gulf developers have risen to the challenge Firstly, they were well set up beforehand. To control costs, their utilisation of Third-Party Logistics (3PL) Services as well as techniques such as Real-Time Visibility Tools and even the Last Planner System has helped project delivery, logistics efficiency and inventory management.19 Probably the most important of these changes in the past five years has been to embed cost estimation and supply chain management into BIM and corporate culture.20 21 The evidence provided by BIM to senior management has in turn led to a welcome fall in the number of client- and consultant-initiated design changes that are now well-known to be a principal cause of construction project cost overruns.22 At the same time, to manage supply chains both on land and sea the use of GPS tracking, real-time traffic updates, and data analysis has intensified.23 The reluctance on the part of many local developers to commit completely to management mantras such as
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Costs, Chains and Consequences: How Gulf developers are adapting
Just-in-Time materials delivery has proved a wise decision given the relative importance of ocean transport for construction materials in the Gulf. Finally, Gulf developer profit margins were already higher than international averages, leaving some room to manoeuvre. Secondly, they have adopted a series of adaptive mechanisms that demonstrate awareness of the problems and signal a determination to overcome them. What has worked in each case has been a range of risk management mechanisms that Gulf developers have built up over time. Modest leverage with multiple financial stakeholders; pre-sales with reliable or at least widely dispersed purchasers and a flexible workforce have been key strategic choices. Thirdly, developers have rapidly become more selective about which projects to launch and conversely which land banks to retain for now. Shorter-term measures have included extending delivery timelines, incorporating longer procurement cycles, scheduling contractors more conservatively through their project management software, delaying certain non-immediate MEP and façade packages and perhaps above all, management resolve to postpone, scale down or even cancel some projects that is rewarded by shareholders, not penalised. Within some existing masterplans, gaps between phased releases have been extended whilst revenue-critical phases have been prioritised for now. Minimum pre-sales thresholds have been raised, which accords with concerns raised recently about the systemic impact of shadow banking.24 None of these measures prevent ambitious launches – there have been plenty this year and more are expected – but they have tightened approval criteria and led to some projects being put on hold.
Lastly, as construction companies themselves have priced more risk into bids, their developer clients in the Gulf have adopted international standards for contractor bid evaluation, paying close attention to the whole range of contractor bidding, including scope, opportunities for phasing over a longer timeframe, pricing and delivery assumptions.25
Economies of scale The evidence from other jurisdictions is that prolonged construction cost inflation more than market prices is likely to lead to adjustment in the structure of the development industry. Banks that have taken a more conservative stance on construction finance, in part responding to perceived issues with Islamic financing amidst the conflict26 are more likely to lend to larger more diversified enterprises that they perceive possess a series of advantages in current conditions. Larger developers: ▪ ▪ ▪ ▪
Can absorb simultaneous cost and price shocks. Have stronger supplier relationships. Can negotiate better logistics terms. May be able to operate at lower debt margins.
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Costs, Chains and Consequences: How Gulf developers are adapting
This has resulted in higher interest costs for smaller developers.27 A greater focus on project due diligence, including more scrutiny of contractor selection and project phasing also gives developers that are proficient in using sophisticated project management software and understand bank due diligence processes an undeniable advantage.28 Investors’ expectations have also moderated. This has meant that developer share prices of major diversified developers have held up well throughout the conflict. The Emaar share price, for example, is up by 35% since the beginning of 2024.29 Dar Al Arkan is up by a very similar 38%.30 There are therefore grounds to believe that as these larger developers favour master-planned communities, they may well form an even larger share of overall Gulf development than in the past. If these trends continue, smaller integrated real estate firms and even larger developers are likely to focus more on their existing assets, whilst M&A amongst developers may even also surface, so that even fewer, larger, more integrated developers are likely to dominate future supply. These will be amongst the largest developers and real estate asset holders in the world – a short-list in which so far only Emaar features.31
Conclusion: Fortune favours the brave and prudent The combination of rising construction costs and global supply chain volatility is a significant driver of the evolving characteristics of development in the Gulf. For now, they are favourable to the larger developers and their master planned communities. Even they must adopt longer delivery timelines than they would wish and focus more on optimising the performance of their existing assets. But the silver lining is also very clear: the lessons of development resilience are embedding even more deeply across the whole of the Gulf developer ecosystem. What matters is for development industry stakeholders to ensure that these lessons learned in the school of practical experience are not forgotten when construction cost inflation abates and global supply chains function more smoothly.
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Costs, Chains and Consequences: How Gulf developers are adapting
Authors Julian Roche
Ali Siddiqui
Chief Economist Cavendish Maxwell julian.roche@cavendishmaxwell.com
Research Manager ali.siddiqui@cavendishmaxwell.com +971 50 877 0190
Key Contacts Zacky Sajjad
Kevin Duffield
Director, Business Development and Client Relations zacky.sajjad@cavendishmaxwell.com +971 50 644 5089
Director, Head of Built Asset Consulting kevin.duffield@cavendishmaxwell.com +971 56 344 2177 / +966 59 496 3815
Dubai +971 4 453 9525 dubai@cavendishmaxwell.com 2204 Marina Plaza, Dubai Marina, P.O. Box 118624, Dubai, UAE Dubai
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