A report by Swiss finance house UBS’ Investment Research analysts concluded that Dubai’s residential property market still had some way to go before beginning to recover.

‘Our proprietary analysis concludes that Dubai residential property may trough at around the Dhs500-Dhs800 per square foot level, down 57%-70% from the peak of Dhs1,850 per square foot,’ said report author Saud Masud. http://www.soledubai.com/news.aspx?id=330

The UBS report also downgraded Emaar and Union Properties (UPP) to ‘Sell’ from ‘Neutral’, while Abu Dhabi developer Aldar was downgraded to ‘Neutral’ from ‘Buy’.

The downgrading of the developers comes despite short term market rises of 40% for UPP and 33% for Emaar. This is a result of what UBS sees as weakened real estate fundamentals in the emirate from Q4 2008 to Q1 2009; listing a lack of net new demand, investor defaults, increase in project cancellations to 70%, payroll cutbacks, and a build up of inventory.

The report also states that it sees Dubai as still being in the ‘relatively early stages’ of the property downcycle, and that the risk-to-reward ratio was not yet compelling for investors.

House price fall
UBS estimates for house price falls to date put the decline at 25% down from the peak. A similar report on Dubai’s real estate sector released last week by UAE-based Asteco put apartment prices down by 39% in Q1 2009, with villa prices down by 43%.

‘We believe that the majority of investors would prefer to stay on the sidelines and revisit potential purchase opportunities in the second half of 2009,’ said Masud, although the report cautions that depreciating rental returns could dissuade some investors. ‘As we move past the summer season and potential for expat exits picks up, there is the likelihood that rents begin to drop faster than home prices thereby compressing rental yields to mid-single digits or below.’

The potential for a fall in expatriate tenants is of concern to buyers looking to use rental payments to cover installment payments, with analysts predicting a fall in the expatriate workforce as Dubai-based companies downsize.

UBS predicts population outflow equal to a decline of 8% in 2009 versus 2008 figures, and a further 2% in 2010 – leading to residential vacancy rates of up to 30% by Q4 2010.

Legal changes
The Dubai government has indicated that it is to make certain amendments to article 11 of property Law 13 2008, regulating the system of dealing with defaulters.

Law 9 of 2009 will serve to clarify how much developers can keep if investors default on payments. If at least 80% of the project has been completed prior to default, the investor loses all money paid to that point. The property will then be auctioned as compensation to the developer to account for the missing increments.

If at least 60% of the project has been completed prior to default, the developer is entitled to keep 40% of the original purchase price. If less than 60% has been built the developer is only entitled to keep 25% of the purchase price.
If construction has not been begun prior to default, but this is not due to ‘negligence or omission on the developer’s part’, the developer may keep 30% of the installment money paid up to that point.

Yields are also likely to increase in the medium term even though capital values decrease ahead of rental values, said a new report.

“As with other markets, Dubai is expected to see a flight to quality, which will make the selection of high quality well located assets with a stable long-term income stream of paramount importance in sustaining value for investors,” Jones Lang LaSalle (JLL) said in its March House View on Mena real estate.

However, real estate developers in the Middle East and North Africa (Mena) will have to move from “develop and sell” business model to one based on “securing tenancies and holding assets” to gain sustainable long-term income flows.

Although the market in the region has showed “signs of recovery” over the past three months, JLL said it expects “2010 to remain a year of relative stability before the markets experience an upturn as they move into the recovery stage during 2011.”

“New market conditions now demand a new business model. This new business model is likely to see the Mena markets become more like those in more mature western economies, with a shift away from a short-term trading mentality to a long-term perspective focussing on the quality of the income stream generated from the completed property.”

JLL said the current shortage of liquidity to speed up the pace by which real estate markets across Mena transition to a more mature, global model of financing for both development and investment.

The previous business model, with development being funded largely through off-plan sales and developer finance, has proved successful in fast tracking the pace of development and has allowed markets across Mena to develop much more quickly than those elsewhere in the world.

“The path to this new investment paradigm will be challenging. While there will inevitably be short-term pain as prices continue to adjust downwards over the next six months, the region is well positioned to emerge with a stronger, more transparent, better regulated and more sustainable pattern of real estate development and investment in the longer term.”

During the transition period, the local markets will diverge with a more distinct pattern of winners and losers, with those properties that are well located, well maintained and well marketed retaining their value relative to the general market. This transition will undoubtedly provide significant opportunities for those investors with access to finance who are able to adopt a long-term investment horizon, said the report.

JLL expects that after this transition period, the region will be “well positioned to emerge with a stronger, more transparent, better regulated and more sustainable pattern of real estate development and investment in the longer term”.

According to the report, no recovery in the Mena’s real estate markets can be expected until confidence returns. The company identified a total of 17 primary factors that influence the level of sentiment or confidence across the region.

“While some of these influences have now stabilised, none of them are yet showing any signs of a sustained recovery. None of the requirements listed yet have therefore yet reached the achieved status [green light].

“This reinforces our view that real estate markets are likely to decline further during the year 2009 before stabilising in 2010 and recovering in 2011.”

A prerequisite for any real estate market recovery is for the global financial markets to be recapitalised.

Governments around the world have intervened to re-capitalise the banks and those in the Gulf have made considerable and concerted efforts to underpin the financial sector over the past two months with significant levels of liquidity being injected directly or indirectly.

There is also some $2 billion (Dh7.3bn) of equity that was raised for real estate investment across the region over the first three quarters of 2008 that is currently waiting in the wings.

“Much of this capital is now seeking deployment opportunities as investors seek to take advantage of distressed asset sales, which are becoming available on an opportunistic basis.”

Additional capital is beginning to pool as investors regain their balance and refocus on regional opportunities. Some previously internationally oriented investment funds are being redirected to the region.

Institutional investors are now looking more strategically at assets with long-term contractual income generally with five- to 10-year leases with strong covenants.

Smaller deal sizes are more attractive owing to restricted debt markets and more limited and valued equity.

“This is leading to increased interest in alternative asset classes including industrial and work force accommodation as well as deals in the education, healthcare and infrastructure related sectors.”

The credit crisis has resulted in a severe downturn in demand for commercial office space in most cities across the region.

Demand has slowed to a trickle and many of the larger corporate requirements that were looking to lease or pre-lease space over the first three quarters of last year have turned into potential requirements with time-lines being pushed out to 2010.

While vacancies remain minimal in Abu Dhabi, Riyadh and Jeddah, they have increased significantly in Dubai where vacancies now exceed 15 per cent, resulting in rents halving in some locations.

“This is clearly a positive for those occupiers looking to expand their operations as landlords have come to recognise the value of their tenant’s covenant and are now becoming more accommodating of tenant’s needs for lower costs, better facilities and long-term leases.”

Regional outlook

ABU DHABI: While both demand and prices have fallen over recent months, we see significant long-term potential for Abu Dhabi market. The market is dominated by government-related companies who are beginning to proactively intervene to rationalise and delay projects, thereby avoiding potential future over supply. The financial strength of the government will also provide a solid platform for continued infrastructure spending over the next few years. As with other markets, decreased construction costs and falling land values will result in higher returns, particularly on those projects at early stages of development.

SAUDI ARABIA: By far the largest of the Gulf markets, the opportunity for developers to capitalise on the significant shortage in middle and low-cost housing abounds. While the mortgage industry in the Kingdom is currently somewhat limited, the growth of the end-user financing market will assist developers and investors in this sub-segment of the market.

Although decreased oil prices will affect the economy and the ability to fund major infrastructure projects, Saudi Arabia possess a depth of underlying demand that is missing from many other Gulf markets.

QATAR: The richest country in the Gulf in terms of gross domestic capital capita is somewhat better insulated through its large and more stable income from long-term LNG contacts.

The looming oversupply in the residential and office markets will however challenge the market in the short term.

BAHRAIN: The country is also likely to see higher potential returns due to falling prices, lower construction costs and the availability of more distressed sellers in the face of increased oversupply in the luxury commercial and residential markets.

Bahrain also benefits from having one of the most established regulatory environments in the region.

KUWAIT: With prices having fallen 40 per cent to 50 per cent for land and up to 30 per cent for built product, increasing opportunities are emerging to acquire attractively priced assets from distressed sellers. Kuwait is well positioned to benefit from the stabilisation and subsequent opening up of the Iraq market.

NORTH AFRICA: Compared to the GCC, finance for real estate development and investment remains relatively available for both equity-only investors and those requiring financing.