Dubai real estate entering phase of 'relative stability'

The current wave of price decline in Dubai's property market is expected to be minor compared with that in the past nine months as it enters a phase of "relative stability", market analysts told Emirates Business.

Real estate specialists from the Kuwait Financial Centre, Moody's, Al Mal Capital and Nomura International said the possibility of further drastic falls in the prices had declined.

"The fall will not be as dramatic as in the previous two quarters as the contraction in demand will be much more muted than in the past," said Venkateshwaran Ramadoss, Senior Research Analyst at the Kuwait Financial Centre's Real Estate Department.

Martin Kohlhase, Assistant Vice-President and Analyst at Moody's Corporate Finance Group, said the pace of home price falls appeared to have slowed, if not stalled.

Chet Riley of Nomura International's Middle East equity research section said the market was entering a period of relative stability but the possibility of gradual price fall remained.

And Bobby Sarkar, Vice-President, Equity Research, at Al Mal Capital, said property prices in Dubai were seeking stability but volatility was expected to affect completed properties for the rest of the year.

However, the experts disagreed about where Dubai stood on the property cycle graph. Two of them said the market had reached its trough, while the others believed the cycle was still in its infancy.

The following the excerpts of interviews conducted with the analysts.



Have house prices in Dubai bottomed out, or will they still continue to fall further? How much more are the prices likely to drop by?

Ramadoss: It is hard to comment on short-term price movements and hence, we shall look at the possibilities and their probabilities. For the prices to revive, either the demand has to re-emerge amid short supply or the properties should fall to distressed levels that they become attractive again.

We cannot expect re-emergence of demand until the market is sure of a revival in the world economy, especially of the West, given Dubai's reliance on the external economy. Signs indicate halting of slowdown and until signs of growth emerges, which is expected early 2010, we cannot expect a demand re-emergence. Given the current vacancy levels and the level of past projects, which eventually should get delivered, we cannot foresee a short-supply scenario to cause a remarkable recovery. Instead, the increased supply will lead to further contraction in prices and rentals.

A further fall in property prices, in the range of 15 per cent to 25 per cent from here on an average, is possible for different sectors mainly due to the forthcoming supply from past projects. However, the fall will not be as dramatic as in the previous two quarters as the contraction in demand will be much more muted than the past as the probability of a dramatic fall in economic activity is less from here.

Regarding the distress scenario, prices should contract to the extent that the market feels that it has gone to distress levels and then, it needs a mechanism through which desperate sellers are linked to enterprising investors. The current market lacks such a mechanism although there are some willing buyers. While the property auctions are a good conceptual step forward towards efficiency on this front, the market needs specialist brokers for it to be effective.

Kohlhase: The pace of the fall in house prices appears to have slowed in Dubai if not stalled. Over the near term, it remains to be seen how many expatriates are about to leave the UAE following the end of the school year and what impact that has on the residential property market.

This phenomenon may trigger an additional drop in prices, but it should be minute compared to the prices deterioration in the past nine months.

Chet: We are probably entering a period of relative stabilisation, but the possibility of gradual price falls still remain, entering the seasonally slow summer period and coupled with the anticipated summer exodus.

In a research piece we released in February, we forecasted a peak to trough fall of 40 per cent and this period of relative stabilisation, hinting at a bottom in fourth quarter of 2009, and this looks like occurring into the end of the year, based on both our own and local agency observations.

The purchasing power still resides with the buyer and with an average 35 per cent market fall we maintain our original forecast, expecting a further five per cent fall.

Sarkar: House prices in areas such as Palm Jumeirah have fallen significantly.

Although I don't think prices have bottomed out but certainly prices are seeking stability and in the process we might see price volatility on finished properties throughout the remainder of 2009.

Prices are likely to stabilise by the first half of 2009. On unfinished properties I think prices are yet to find a floor and this will be an area where significant moves [price fall] are likely to be evident in the next six months.



Is Dubai passing through a property cycle phase that many matured markets such as the United Kingdom and the United States have gone through? On the curve, where does Dubai stand?

Ramadoss: Dubai's cycle is not akin to the markets such as the UK and the US and it is more comparable with Singapore, which has shorter cycles and is highly sensitive to external events. Undoubtedly, it is around the bottom of the cycle now.

Kohlhase: Dubai has a growing real estate market and hence differs from more mature markets such as the UK or the US.

The market is thus more volatile and peak-to-trough phases show different patterns. As it stands, the local real estate market currently is in its trough.

Chet: This is like comparing oranges with apples; the Dubai residential market is in its relative infancy compared with more mature markets, with the liquidity pool driven by speculation rather than the more established end-user model.

Therefore, the cycles, both highs and lows, have been more extreme. In terms of the cycle, there is a definite lag in Dubai, which I would place at around 12 months if we were talking about signs of recovery, which are becoming more apparent in the Western markets. I still do not foresee the emergence of a strong end-user market and in my opinion this will cap the recovery for some time.

Sarkar: Dubai is going through what other mature markets have gone through historically. The cycle is generally 12-18 months and it's only been six months since real estate slump actually hit the global markets.

At present, mature markets are also witnessing a real estate downturn, so on the curve, Dubai is still at an infancy stage as it is new to this complete real estate cycle, and the drivers are mainly liquidity due to high crude oil prices.

The takers are either European speculators or massive expatriates earning high incomes [affordability on the rise]. The market is now likely to see the true demand supply dynamics stemming from end users.



How much price correction do you expect to happen in the commercial property sector? Any estimate on the total leasing area to be developed in the next two years in Dubai?

Ramadoss: The commercial property sector is closely related to economic activity and hence we have to wait for a revival of the economy. Projects, which are close to completion, now carry a higher cost of construction and some cash flow is preferable to serve the capital locked up in these newly built commercial spaces.

Hence, they could as well contribute to further deterioration of rentals and price levels. Individual projects will get launched/completed/delayed based on the cost/return characteristics and given these uncertainties. We estimate a delivery of 1-1.5 million square metres of office space in the coming two years, marked by a high margin of error.

Kohlhase: Market research shows that quite a sizeable supply is expected to come onto the market within the next two years. In the current macroeconomic climate it is unlikely that this supply will meet market demand and we would anticipate rent levels for commercial properties, foremost office space, to remain at current depressed levels at best.

Chet: Unlike the housing market that is somewhat correlated to the retail cycle, the commercial sector is correlated to the economic cycle. Agency estimates of an additional 40 million square feet being added to the existing pool over the next five years are extremely unlikely, in my view.

Once the current cycle of near complete developments are ready to be delivered, we believe additional space will be capped in the interim. Space is just a commodity and is priced by supply and demand dynamics.

We see vacancy rates increasing sharply and already factor in price declines of 50 per cent at least, and see this increasing further as the lagged effect of the economic slowdown emerges. Developers trying to sell at 10 per cent yields after developing at 13 per cent will be forced to sell at 20 per cent and less than the construction costs, which is a market concern.

The pricing shock becomes more acute the further you drive from the city centre.

Sarkar: Commercial property is likely to find it more difficult to pick up as business conditions deteriorate. So in next 12 months, we might see another 10 to 20 per cent fall in commercial real estate prices in Dubai.



Do you believe Dubai has been more resilient in terms of withstanding price shocks as investors still believe that rental yields are far higher than mature markets? When do you believe the market will revive?

Ramadoss: The higher rental yields are a premium for the inherent risk of the realty assets caused by highly fluctuating economic fortunes of the region and will remain so until the economy becomes self reliant and diverse. A higher rental yield need not by itself act as a floor finder for price since the rentals can track the prices to the bottom as well.

However, higher yields are attractive if an investor has a long-term investment horizon. He will be benefited by higher cash yield, with vacancy being the only risk to manage and also can enjoy the benefit of price expansion by 2011 or after. Hence, the market offers a high cash yield with a good upside possibility and low risk of losing big for those who are deep pocketed and willing to be patient and prudent.

Kohlhase: We would argue that the higher rental yields capture a risk premium for emerging market risk. Markets will stabilise once supply and demand are in balance, sentiment is transformed from that of a fear to confidence and access to funding is restored.

Chet: Yields are just a function of capital value and rental value and both of these have been falling in tandem, which gives the impression of relative yield stability.

Rents may be lagging the capital markets slightly, so we have seen some 'yield decompression', but rents will probably fall further over the summer, which will see yields start to contract again.

If, as we expect, a further 40,000 to 50,000 units come on stream over the second half of 2009, which are made up of rental "handbacks" and new deliveries of developments into the rental market, then we see further declines from current levels.

This added risk probably justifies the higher yield premium, in our view. In the commercial space, overseas markets have significantly better lease covenants and therefore legitimately trade at tighter yields.

The UAE bank deposits are yielding higher yields at the moment than some rental situations; you don't get the capital kicker, but there again your capital is protected. With high bank rates, there is less incentive to chase risky yields. The recovery rate in Dubai is linked to a number of co-related factors – for these to line up may take some time.

Sarkar: Rental yields were highest in June 2008 [more than 13 per cent for commercial property and eight per cent for residential property]. But now the rents are coming down steadily in new Dubai developments and so are the prices.

As demand collapses, prices are likely to come down quicker which keeps rental yields attractive but in absolute terms, liquidity and credit markets are tight so even if prices fall – who are the real buyers – are there any? As a follow on from the bad market conditions, rents are likely to fall in a follow-on effect. By 2010, we might see rental yields to be like three to four per cent, a true reflection of what the Dubai/Abu Dhabi market should be – in line with other emerging markets.



What needs to be done to boost market sentiments in Dubai and the UAE, particularly in the property sector? Will the six-month residency visa law help the market?

Ramadoss: The widely criticised six-month residency visa would not help any fundamental revival. It is hard to expect that one would seek to live in Dubai when there is no income-earning prospect, either in terms of employment or return on investment.

Hence, granting even a permanent residency visa will not drive prices up for long unless there is visible revival in demand fundamentals. A further fall in prices could hamper the fortunes of market players such as developers, investors and contractors. The government's intervention should be targeted to prevent the system from the wither effect due to the cross effect that a player's misfortune has on the other and the market in general. Easing construction loans and financial packages will help the contractors and keep the developers from short-term liquidity troubles and have them ready to serve when the market revives eventually. However, these by itself would not cause a recovery.

Kohlhase: The six-month residency visa law is one of many potential positive drivers, but the impact is likely to be muted in the grander scheme of things. Again, supply and demand balance, access to funding and improved sentiment are likely keys to help a market revival.

Chet: Confidence is a function of both stability and liquidity. Some banks are opening their doors for business and partnering up with developers, which will aid liquidity, but banks are still mindful of carrying too much property related loans, so while there is life emerging it may take some time.

Regulatory control on property contracts and the establishment of full and proper ownership rights is also important.

The recent announcements on residency visas may not do much to overall market stability as they are directed primarily to the high-end market.

Sarkar: Ease of getting mortgages and better laws for property owners might help alleviate the real estate problems in the UAE. The six-month visa is just a stopgap measure.



Do property developers in Dubai now need to only focus on affordable housing or target niche segments to differentiate their products?

Ramadoss: Dubai developers should focus on affordable housing in a broader strategic perspective to keep the development activity and cash flow streams alive during future down-turns while concentrating on niche segments should continue as Dubai's fundamentals will always create opportunities to serve the niche segment in a positive economic scenario.

The market as a whole should have a mix of both low return/low risk affordable housing and high return/high risk niche segments in the long term.

Chet: Certainly there has to be some sort of differentiated product on offer for developers, but it is very difficult to change a development mid stream, particularly a high rise single tower.

Those large developers that have the ability to do low-rise and phased developments have more flexibility.

The number of Dubai-based developers is likely to reduce substantially by year end, so differentiation comes by default.

Sarkar: Some Dubai and Abu Dhabi developers are already planning for affordable housing. It's not something new to focus on. What developers need is the funds to finance the projects – in this regard Abu Dhabi-based developers Aldar and Sorouh are better positioned than some Dubai developers.

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