Real estate accounted for just 3.8 percent of Oman’s economy in 2007. Blue City project aims to help the Sultanate diversify its economy away from oil.

The Omani government is likely to extend a helping hand to ensure the Blue City project stays afloat.

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Bolt from the Blue

Moody's Howladar helped rate part of the $925m of debt raised to finance the first phase of development at Blue City, back in March 2007. Some 15 investors, primarily big banks, backed the scheme through the purchase of these bonds.

Back then, banks were lured by the easy debt on the money markets and willing to invest in real estate projects promising sky-high returns. Now, with the global market looking considerably less rosy, banks, or the bondholders, will be the losers if Blue City stutters due to lack of demand.
"It's long way off and we are not at this stage yet, but if the company cannot repay the bonds, the bondholders would suffer a loss," says Christophe De Noaillat, senior vice president in structured finance at Moody's, London and lead analyst for Blue City.

Last month, the Moody's downgrade was made in light of poor sales at the project. As of August, the company charged with delivering the first phase of the project, Blue City Company 1, has posted $30.6m of sales, against a target of $101m. In July, fellow agency Fitch Ratings put $526m of debt on ‘ratings watch negative', again citing lacklustre sales.

Sales at Blue City started in December 2007 during one of the biggest real estate booms the Gulf has seen. "If you couldn't sell your units in a boom, what likelihood is there that you can sell them out in a recession? Going forward it doesn't look good for the project for the next couple of years at least," says Howladar.

According to Howladar, a key mistake made by Blue City and in other local developments was building a top-end project aimed at the wealthy. The GCC has long had a shortage of affordable housing, with much of the residential property built or planned in the Gulf out of reach to low and middle income earners.

"The big flaw was catering to investment and speculative demand versus genuine owner occupier and middle income demand," he says. "The GCC is saturated in real estate projects, but there are those on middle to lower incomes who are desperate for housing."

Of real concern to analysts at Moody's is the risk of exposure in the project. The insurance against Blue City Company 1 defaulting on paying back the bonds is not unconditional, meaning the insurance company is likely to contest any claim, explains De Noaillat.

"This is clearly what insurance companies can do; this is the assumption we have to make. That is a duty to their shareholders, not to pay all claims."

Howladar agrees. "Any insurer will try and dispute the claim and wriggle out of it. It's a large exposure; $399m. You can imagine them trying to find a way not to pay [and] that is why there is a risk of exposure to the project.

"If, for whatever reason the insurance doesn't pay, then you are exposed to the project despite the insurance you thought you had."

Weighted in Blue City's favour, however, is its value to Oman's economy in terms of labour capital. Should the project stall, says Nicola at Standard Chartered, the government would be likely to extend a helping hand to ensure the development - and its potential 200,000 jobs - stays afloat.

"A lot of these projects are going to be prioritised on the basis of what is important for the long-term future of the country," she says. "The Economic City in Saudi is important for the long-term future of the Kingdom, because it intends to provide a lot of jobs. For the same reasons, the Blue City project could be prioritised for its labour potential."

Oman's diversification into real estate is still in its embryonic stages and is not yet a key driver of the economy. Economists and analysts agree that any further setbacks to Blue City would not hamstring Oman's economy, but would certainly cast a gloomy cloud over future large-scale property developments in the region.

"You are catering to speculative demand," Howladar notes. "That speculation has now gone as those people have lost money in falling markets. That whole demographic which was an unhealthy one, is gone."

The long-term health of Oman's economy is partly vested in whether the government can make a successful push away from oil. Blue City is a litmus test for this experiment, and time will tell whether the results are worth duplicating.

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