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Real estate to see 'sustainable' growth from 2011 onwards

Dubai is the most mature market in the region. (EB FILE)

By Parag Deulgaonkar

Dubai's real estate market will experience a sustainable growth in rentals and prices from 2011 onwards, but 2009 will be a "year of correction", according to a new report.

"Prices and rentals are expected to decline across most sectors of Dubai market in 2009 before reaching an equilibrium again as the market stabilises in 2010. While some regional markets may see a return to growth in 2010, we expect Dubai to be handicapped by the significant levels of new supply and the market may not experience any sustained growth in rentals and prices until 2011," Jones Lang LaSalle (JLL) said in a report titled "Middle East and North Africa House View" released yesterday.

"We expect 2009 will be a year of correction as the Dubai real estate market transitions from the previous period of strong demand driven by plentiful capital, to the new paradigm where access to finance is much more difficult and speculative demand has all but dried up."

The impact of the global economic crises on real estate markets in the Gulf Cooperation Council has been both sudden and dramatic. As recently as October 2008, developers were competing with each other to launch ambitious projects (including the world's first one-kilometre high tower). Most of these plans have now been either cancelled or delayed as liquidity and end-user demand have dried up almost overnight.

"The region's capital markets are at risk. Banks have stopped lending and are now seeking ways to reduce their over exposure to real estate.

"Developers are experiencing severe cash flow risk from defaulting buyers and a dried-up debt market; investors are waiting for 'blood' before they begin acquiring and many have lost wealth in the stock markets. Meanwhile, sellers' expectations are still too high as they have not yet fully adjusted to the new market realities," the report said.

Even though the most optimistic observers have recognised that real estate markets across Mena are not immune to the chill winds of the global economic downturn, the major question on everyone's lips is 'when will the markets recover'?

There is no single answer to this question, as the markets are far from uniform and both the depth of the correction and the timing of the recovery will vary between asset classes and geographies.

Most of the attention has been focused on Dubai, as this is the most mature and the most visible market in the region. Dubai does, however, differ from other Mena markets in two important aspects that may exaggerate the potential correction, which may be less pronounced in other cities across the region.

According to JLL, Dubai is the most global market in Mena and is one of the most global cities worldwide. This has served the city well during a period of strong global economic growth but now possess a greater challenge in a period of synchronised global slowdown.

In contrast, Saudi Arabia and Egypt have much larger domestic economies and are, therefore, less dependent on global flows of capital and labour.

Besides, Dubai has experienced much higher levels of construction activity than other markets in the region. The completion of a large additional supply in all sectors of the market could delay the timing of any potential recovery. Other markets (most notably Abu Dhabi) will benefit from stronger short-term demand before significant levels of new supply enter the market.

"While overall market conditions are likely to be challenging across the region over the next 12 to 24 months, there will undoubtedly still be opportunities for smart players to outperform and succeed."

For investors/financiers, the key to success is to more accurately assess real risks and opportunities in order to develop a value optimisation strategy, according to JLL.

"This strategy will vary between investors – for some it will involve a decision to retain assets and manage them more intensively to extract recurring income and retain future capital values. For others, the most appropriate exit strategy may be to adjust their pricing quickly or offer some other inducement to attract a quick sale."

The current economic crisis has created an opportunity to invest in prime income-producing assets on a scale not seen in the Mena region. As the level of distressed assets being offered to the market increases over the year, smart investors are likely to focus on real estate fundamentals such as location, asset quality and its resulting income stream. There is also likely to be greater interest in tradable stock in new asset classes such as logistics, worker accommodation, education and healthcare, which may offer an attractive mix of smaller lot size, higher yield and greater cash flow security than more traditional asset classes.

The main implication of the new market realities for developers is the need to consider new business models. This could include a greater reliance on construction finance and ongoing rental income streams, rather than pre-sales.

There is also likely to be a significant shift in focus, from speculators to long-term investors and end-users that may have quite different requirements.

"As developers adopt a back-to-basics approach, we are likely to see a switch from iconic projects (built from the outside), to much more functional and cost-effective buildings (designed from the inside out). The silver lining for developers is the significant fall in construction costs (40 per cent since mid-2008), which will allow smart players to react in a timely manner to attract the more discerning tenants and purchasers that remain in the market," it said.

Occupiers are likely to be the major winners as the market shifts from landlord to tenant favourable conditions during 2009. Tenants currently housed in older and poorly located buildings can take advantage of the falling rents and the increased range of leasing incentives likely to be offered, to lock into longer term leases in prime buildings.

There have traditionally been very few pre-lets in the Mena markets, but those tenants willing to take a long term view are now well positioned to extract a share of the landlords development profit by means of an extended rent-free period or a longer lease at a fixed, discounted rent.

Encouraging signs

The current global crises began in the financial markets in 2007 and the first half of 2008, before spreading throughout the real economy over the second half of last year.

Tentative signs of an improvement in global credit markets are, therefore, encouraging. Five-year swap rates have declined in the US and Europe in 2009 and shrinking TED spreads (the difference between three month treasury bills and Libor) indicate an increased willingness of the banks to commence lending to
each other.

In the US there has also been a narrowing of spreads in the corporate credit market. And a Morgan Stanley report says almost $20bn in new corporate bonds were issued in December 2008, with some being over subscribed by as much as three to one.

Risk premiums on the best credits have also narrowed by two per cent in the US during January.

Despite the twin challenges of tight credit and weak occupier demand facing commercial real estate markets globally, there are some encouraging signs the market is beginning to adjust to the new economic realities. A prime income producing office property has recently been sold in Central London for €75m on a yield of almost eight per cent. This transaction suggests the market may have reached a level of pricing adjustment as there were 10 bidders for the reduced price (which was about 40 per cent below at which the property was first offered around 12 months ago.)

The US residential market is also showing some signs of