Making a killing off-plan

Indications that margin leverage on UAE brokerage accounts is about to be reduced to prevent ultra-low interest rates creating a stock market bubble are bad news for stock prices, already languishing this year amid the global stock meltdown. But this is just an additional boost for local real estate where supply is failing to keep up with burgeoning demand.

Dubai is increasingly the more mature local property market with high rentals and soaring capital values that are starting to reduce rental yields. Speculators are more attracted to Abu Dhabi where the profits on flipping off-plan properties can be huge, and to the Northern Emirates where developers are unhindered by escrow account legislation and so new project launches continue to flow.

Ironically the same interest rate considerations that are pressuring the authorities into restricting margin lending on UAE stocks are fuelling up local property prices but nobody seems very concerned about this.

Perhaps the authorities are mindful of the fact that absolute property prices in the UAE remain cheap by comparison with other global cities of comparable levels of GDP. There is also a genuine desire to see more real estate investment at a time of booming demand for property, and so allowing investors to make a profit is seen as a good thing.

A new study from the Abu Dhabi Chamber of Commerce and Industry has indicated a shortage of at least 20,000 units in the capital this year and an impending crisis in 2009. And in Dubai the slow completion of projects will also result in a continued shortage of property until at least 2010, according to experts.

NEGATIVE RATE

Meanwhile, the cost of finance is falling. Indeed, with Fed funds at 2.25 per cent and the IMF estimate for UAE inflation in 2007 at 11 per cent the UAE has a negative interest rates of around nine per cent.

Any real estate analyst will tell you the same thing: when it costs less to fund ownership of a building than the inflation rate you are onto a winner.

Moreover, with the UAE dirham apparently firmly fixed to the US dollar, and the US economy in a big mess, this is not about to change anytime soon.

The risk is that an investment bubble will be created in UAE property. But it is still on the way up, and for investors this period of a boom is one when profits are assured and easy. In a rising tide all ships will rise and almost any property investment will do well.

Even fraudulent operators like to trade honestly in such an environment to keep their business moving upwards.

But where are the best opportunities for real estate investment in the Emirates? Some locations will always do best.

The highest returns usually come with the highest risk, and that means new locations that are unproven but have a large upside potential when plans become finished projects and communities.

SURGE IN INTEREST

In Dubai, this accounts for the surge in interest in the Dubailand theme park district, where the value of land deals doubled in the first quarter to Dh38.5 billion against the same period a year ago. A similar rush is evident in the Dubai World Central development around the new Maktoum International Airport.

On the other hand, off-plan property purchases do not pay rental yields, or at least not until they are completed.

For income purposes the 10 per cent yield on a humble one-bedroom flat in The Greens, an early Emaar development, looks highly competitive.

Completed property values are also likely to benefit from something called yield compression, which means that landlords will gradually accept lower rental returns as interest rates fall, and bid up capital prices. This has been true globally with the growth of buy-to-let investment depressing rental yields and pushing house prices higher.

For example that means property prices in The Greens could double and rents stay the same if landlords were prepared to accept a five per cent rental yield instead today’s very high 10 per cent. And by global standards a five per cent yield would be reasonable, especially with US interest rates still on a downward track. 

FLIPPING OFF-PLAN

However, the biggest profit to be made in UAE real estate right now is from flipping off-plan apartments in Abu Dhabi. There are plenty of reports of speculators selling units on which a 10 per cent deposit has been paid and doubling their capital in just a couple of weeks.

But you do not need to be a speculator to make money from UAE property at the moment. Just buying a completed apartment or villa in a good location will ensure a much higher return than a bank account would offer, and the chance for a high capital gain thanks to rental yield compression.

Is it any wonder that in this environment local investors are leaving the stock market and going for real estate? There are many options in the dynamic UAE property markets, and for the time being it looks a one-way risk, with not taking part likely to prove an expensive mistake.