Restructuring in the real estate sector clear sign of key lessons learned

Developers demonstrate that they are mindful of lessons learnt from past real estate cycles in other markets, where companies that survived have built strong differentiated capabilities and diversified across the value chain to stabilize sources of revenues. In similar markets such as Singapore and Hong-Kong, which were hit strongly by real estate cycle bursts in past decades, only two to three major developers survived and reinforced themselves.

Most regional markets have been confronted with strong oversupply - which peaked last year at over 100% in the high-end residential and commercial segments in some GCC countries. "With most property developers being cash-strapped, with banks restricting lending and homebuyers defaulting on payments, the primary aim of consolidation is to pool resources to enable firms survive the downturn", said Dr. Dirk Buchta, Partner and Managing Director, A.T. Kearney Middle East.

Announced merger plans for Emaar and Dubai Holding; within Dubai Holding for Dubai Properties, Sama Dubai, Bawadi, Remraam and the Tiger Woods golf course; Barwa and Qatar Real Estate Investment Co; and consolidation of land from distressed developers into companies like Dubai Real Estate Corporation come as no surprise to Dr. Dirk Buchta.

However, planning for a merger is paramount to its success. Almost 70% of mergers fail, often due to such basics as lack of preparation, communication, unclear strategies or poor execution. For example, in Spain recently, poor timing and planning of a merger between two major developers failed, resulting in bankruptcy for the new company within six months of the merger. Of those companies that do merge successfully only 29% achieve increased profitability. If developers are to merge, they need to ensure their company is on sound ground and research their prospective partner carefully before deciding this is the best solution.

"The main objective for a merger should not be size, which makes little sense in a quality-driven business like real estate development. The merged entities will have reinforced position on different parts of the value chain, but risks will also increase. This can be linked to a stronger focus on a risky market like Dubai, in addition to liquidity issues or "doubling" activities which will have to be rationalized. It is therefore the perfect time to review the corporate strategy of the new entities, enlightened by the new market conditions and the analysis of the growth path of most successful real estate developers worldwide such as Hines in the US, Hochtief and Nexity in Europe, or Capitaland in Asia. The time of endless growth for opportunistic projects driven solely by land and cash availability is over. Developers will compete for buyers, and they need to define a convincing strategy why buyers should buy from them and not from the other developer."

said Olivier Laroche, Senior Manager of A.T. Kearney Middle East.

Mergers in the real estate sector typically fall into two categories; merging of similar companies, or merging of complementary companies. The reasons to merge two similar companies are often to achieve synergies and operational excellence or to balance risks and diversify. While mergers focusing on achievement of operational excellence have not been common in the region, mergers focusing on balancing of risks and portfolio of assets are especially pertinent for master developers with Dubai interests, who are driven by project and investment portfolio rationalization.

The other option for companies is to use diversification along the value chain. Mergers between complementary players aiming to integrate the chain both up and downstream have occurred in the region. Most successful large western developers including Hochtief and Bouygues Group, have in the past followed this diversification path through mergers, joint ventures and organic growth. Emaar has started following this path with the acquisition of Singapore-based Raffles for its education business and joint ventures in the construction, brokerage and facilities management segments for instance.

The success of the merger lies in key restructuring actions in terms of project portfolio and customer base. Deyaar has shown a lot of maturity in this field compared to the lack of transparency in the region. A detailed strategy is paramount for the development of the core business of a new entity as well as a specialization strategy on development segments like low-cost housing, hospitality or retail, where specialized players dominate the market.

Careful geographic diversification, first at a regional rather than on an international level, coupled with a balanced portfolio of activities and assets - both physical and financial - will be pillars for success, in line with regional markets' evolution and competitive landscape changes.

Successful mergers can give leading Middle East players the critical mass and a competitive edge on the international scene, based on the regional market long-term potential and easier access to liquidity than most competitors worldwide.

"Defining a rigorous growth strategy for the merged entity will be key to ensure shareholder and customer buy-in, but this needs to happen before the merger is actually announced," concluded Dr. Buchta.