Dubai property still stands tall

In Dubai many investors typically focus on no more than the week ahead. But in matters like real estate it is more relevant to look at the long- or at least medium-term when making investments. So how is Dubai property likely to perform three to five years ahead?

The Dubai real estate market is incredibly youthful, just six years old this May, the anniversary of when the then Crown Prince General Sheikh Mohammed bin Rashid Al Maktoum said foreigners could buy property for the first time. His word sufficed until the Dubai Property Law followed three years later.

It has been a remarkable boom ever since, and in early 2008 the Real Estate Regulatory Authority – itself all of seven months old – reported that about 500 developers are active in the Dubai market. How many units are under construction or have been completed is far less certain. The Rera has embarked on a serious accounting exercise to determine the statistical state of the market. It is quite clear that the delivery of new property has lagged a long way behind the numbers promised by over-optimistic developers. Take The Palm Jumeirah, for example: Nakheel initially said it would be fully completed by the end of 2007, and yet even a cursory glance reveals it is less than half finished.

Meanwhile, new residents continue to arrive in Dubai at a phenomenal rate. One recent study suggested 250,000 new arrivals per annum for the next three to four years. Where are they all going to live? Well as you look around Dubai there are hundreds of residential towers going up, and while not everyone will want to live in a mid- to high-end apartment, or be able to afford to, this is where the majority will go. The profile of the typical expatriate resident has shifted towards white-collar professionals.

However, construction projects are running far behind schedule, and physical shortages of men and material make it hard to catch up. The balance between supply and demand is not expected to be met before 2010 at the earliest, according to a convincing study from Meed.

Where does that leave real estate prices? Clearly the rental inflation of recent years is unlikely to go away, except in so far as rents have reached a limit as to what people can realistically pay. There is also upward pressure on capital values from the demand side but yield compression is expected to be the most significant factor in raising real estate prices. What this means is that the rental returns on Dubai property will have to adjust downwards towards the cost of money. In a world where the UAE base rate has just fallen to three per cent – thanks entirely to the dollar-pegged dirham – logic suggests that capital will pursue the higher yields available on Dubai property (7-10 per cent) and drive them down towards the cost of funds (three per cent) or even below that level.

You would not find this sort of four to seven per cent yield gap in any advanced economy, and the market mechanism will ensure that the Dubai real estate market matures and closes this gap. We have already heard that local hedge fund Evolvence plans a $1 billion (Dh3.67bn) fund to take advantage of this anomaly.

With the US heading into a recession, and possibly a nastier one than generally believed, it is likely that interest rates will head lower and could stay low for some years. Imagine what kind of force that would exert on this valuation equation: the upward leverage on the already tight supply of Dubai property would be enormous. So unless the price of oil drops like a stone and the Middle East is plunged into a recession, or America attacks Iran, then the outlook for price growth in Dubai property has to be excellent in the medium term. Some commentators see all the cranes hanging over the skyline and conclude that a crash is imminent. But they don’t understand that Dubai is the most prosperous city in the middle of the world’s fastest growing population. And the very youth of the local property market is also deeply confusing.

The valuation leaps from 2002 have indeed been tremendous. But this was an artificially depressed, closed real estate market before then, and it took some big discounts to get the market rolling to begin with. Those prices were the anomaly, not the prices in the local market today. A recent HSBC survey showed that real estate prices in Abu Dhabi and Dubai were among the lowest for per capita GDP in the world.

The next step is for a leap in values towards those of comparable global cities, and perhaps beyond given the rate of growth in Dubai, which at 13 per cent per annum, has been above China’s for the past five years. But let us end on a note of caution. Property markets do not go up in a straight line for ever, and there will be a correction in Dubai one day, just like anywhere else and those who have bought close to that date will be caught out. But you probably need to look towards the time when a lot of the big projects are finished to begin to see when that might be. It could be 2010 when the Burj Dubai and the $20bn Downtown are finished; that would also be the time when the Dubai Marina is pretty much complete. Or it could be when the first phases of Dubailand are ready in 2011-12.