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Better access to financing and lower mortgage costs will drive rental yields lower, as the pace of price acceleration will slow in the next three years as more supply enters market, according to a new report.
Although the UAE is currently at the low end of the range for real estate prices in countries of similar income levels, it can support levels of $7,200 (Dh26,438) per square metre against an average price of $4,066 per sq m, Al Mal Capital, a Dubai-based investment bank, said in a report on the UAE real estate sector.
For countries with per capita gross domestic product (GDP) in the $30,000 to $40,000 range, (the UAE’s per capita GDP is $35,100) the range is $3,595 per sq m to $14,600 per sq m.
At the top of the range is France with a top marginal tax rate of 40 per cent and at the low end is Germany with a top marginal tax rate of 42 per cent. The prevailing value in the UAE is at the low end of the range at $4,066 per square metre.
“While real estate values have come a long way over the past five years, on a relative income basis there is still room for higher valuations.”
Average rental yields in the UAE are at 7.7 per cent, which are substantially higher than the levels in countries of similar income levels.
Rental yields, according to the report, tend to decline as income levels improve. This tendency is driven by the increased ability of the population to finance the purchase of real estate rather than rent.
Though rental yields are high relative to global peers, rental costs are near relative fair value. UAE annual rent payments currently average $314 per square metre, compared to $194 per square metre (Germany) at the low end of the $30,000-$40,000 per capita GDP group and $588 per square metre (France) at the high end.
The combination of high rental yields, rental costs per square metre near global relative fair values, a growing mortgage market, and purchase prices still low relative to income levels will drive yield compression over the next four to six years.
“We expect rental yields to decline approximately 240 basis points on average over the next four years. We expect most of the yield compression to come in the low- to mid-price range of the market.”
According to Al Mal Capital, the dilemma that it faces when looking at the UAE real estate market is to assess the “true” demand for the future housing supply, while judging the reliability of planned supply.
Planned supply of housing units is not expected to exceed demand for the next three years. It estimates that unit supply will be 180,000 units for the three-year period between 2008 and 2010.
However, in 2007 it projects that only 30 per cent of planned units were actually delivered, as the industry was hit by several production constraints.
Most notably, contractors were constrained by an extremely tight labour market compounded by a new labour law that required much of the existing labour force to return home and reapply for residence visas.
“As these issues have, for the most part, been resolved we should see gradual improvement from contractors meeting delivery schedules.”
In Dubai, the bank expects cumulative supply to overtake cumulative demand in early 2011. Actual deliveries are expected to ramp up from an estimated 17,000 units last year to peak at 66,000 units in 2010.
While on the demand side, incremental household growth is expected to taper off in 2009 and 2010, before picking up again in 2011 as much of the required personnel for the expected hotel launches and other tourism-related projects begins to offset declines from financial and development sector growth.
Slowing growth in terms of new household entrants to Dubai should relieve some pricing pressure in 2009. However, much of that relief will be mitigated by existing pent-up demand through 2010, according to the report.
“In Abu Dhabi, a supply shortage is substantially clearer. Cumulative supply is not expected to match cumulative demand until beyond our five-year projections. In fact, we do not expect a significant ramp up in deliveries until 2011,” the report said.
DEMAND DRIVERS
The UAE population has grown at a compound annual growth rate (CAGR) over seven per cent since 2002 and is projected to grow at a CAGR of roughly five per cent over the next five years.
In terms of household units, the investment bank expects 202,000 new households in Abu Dhabi and 154,000 new households to come to Dubai over the next five years.
However, new households are not the only driver of demand. In fact, the investment bank expects price appreciation in the secondary real estate market to be driven primarily by affordability ratios rather than population growth.
“Essentially, we feel that the biggest impact to demand is the move from renting to owning property.”
In this case, both the availability and cost of mortgage finance are key drivers of demand. According to data from the UAE Government and the International Monetary Fund, mortgage finance is still at low levels relative to global norms.
It currently stands at 5.9 per cent of GDP in the UAE, compared to 130 per cent in the US, 70 per cent in the UK, and even 10 per cent in Mexico.
At prevailing mortgage rates (seven per cent to 7.5 per cent), a monthly payment (including principle payments) will be between Dh115 and Dh120 per square metre, compared to Dh98 per square metre cost to rent.
Embedded in the premium to own is not only the principle payment but also additional utility value for aspects such as predictability of future payments, potential future property appreciation and general enjoyment from ownership.
Additionally, the combination of declining interest rates and increasing rental charges make the cost/benefit trade-off even more attractive.
As the trade-off between renting and owning continues to become more attractive in the UAE, the investment bank expects a further enhancement to demand beyond that of new households moving to the UAE.
Buying vs Renting
“The improved attractiveness of buying versus renting should pressure rental yields over the next few years. Rental costs in the UAE are higher than those in other markets, but property prices are substantially lower and rental costs are near the global average,” the Al Mal report said.
“This supports our expectation rental costs should be relatively stable going forward, rental yields should decline, and property prices should appreciate,” it said.
The pace of price appreciation is expected to accelerate in 2008 at 28 per cent as inflationary pressures are passed on to consumers. Price appreciation should begin to slow 2009 as more supply is delivered.
The gap between the high and the low end of the market should widen, as lack of affordability is likely to impact the low end of the market first, and consumers will further differentiate developments by location and quality. The difference between the fifth and 95th percentiles is anticipated to grow from 165 per cent in 2007 to 204 per cent by 2011.
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