Dubai's developers and investors alike on the road to recovery

With a robust rate of economic growth over the past year contributing to rapidly increasing residential sales prices, confidence has gradually returned to Dubai’s property market despite the impact of the global economic crisis of 2008-09. In late September 2014, at the 13th annual Cityscape Global exhibition – an informal barometer of the real estate climate in the emirate – the business-to-business element of the show was in full swing. Development launches and transactional activity were on full display and exhibitor numbers were the highest in five years. Given the importance of the sector to Dubai’s overall development agenda, this is welcome news.

However, the relief at the improved performance of the property market is also tinged with an element of caution, given the crash experienced in 2009 by the emirate following six years of rapid price increases. In the first three months of that year, property values fell by 40% – the biggest drop anywhere in the world. For those in the local industry, the crisis is not easy to forget and the fear of repeating past mistakes is hard to overcome. -However, while recent price trends in the residential segment may prove to be unsustainable, much has changed in the last five years. Most notably, regulations are tighter, developers are taking a more measured approach and fundamental demand in the market remains strong – all factors that point to the maturing of Dubai’s property sector.

Economic Contribution

Property development and investment have remained integral components of Dubai’s economy as a whole. In the first quarter of 2014, real estate and business services contributed 14% to the emirate’s GDP. As a result, the sector is now the third-largest contributor to the local economy, behind the “wholesale, retail trade and repairing services” categories and “transport, storage and communication”, according to the Dubai Statistics Centre. Real estate was growing at the third-highest pace, above the overall GDP growth rate of 4.2%. This suggests that while the property sector has without doubt been a leading beneficiary of the strong economic performance in Dubai, it is also a prime engine of economic growth in its own right. This is unlikely to change anytime soon. In November 2013 the city won the right to host the World Expo in 2020 – the first time the event will be held in the MENA region.

The responsibility of hosting a global event of this scope will inevitably bring with it a focus on real estate supply, encompassing everything from the city’s hotel room stock to new apartments and offices. The government expects that the six-month event will attract 25m visitors, 70% of which will come from overseas. It is also expected to create 277,000 jobs in the lead-up to the opening in 2020. “We have confidence and trust that Dubai will keep growing, especially with Expo 2020,” Mahmoud Hisham Al Burai, CEO of the Dubai Real Estate Institute, a branch of the Dubai Land Department, told OBG.

Preparations for the event – the third largest globally after the Olympics and the FIFA World Cup – should act as a stimulus package. The government has allocated as much as $8.7bn for the event, according to the law firm Jones Day. This could lead to a windfall of up to $17.7bn if the event is a success. Expo preparations are expected to generate $23bn, or 24.4% of current GDP, between 2015 and 2021, according to Jones Day, with economic growth forecast to jump from the current rate of 4.2% to 6.4% between 2014 and 2016 and as high as 10.5% by 2020.

Ensuring Sustainability

While Expo 2020 has generated excitement in the sector, there is concern that the event could mask the underlying dynamics of demand in the market. “The Expo is great for Dubai in that it will drive infrastructure spending and expansion, making Dubai a more attractive place to live and do business. However, it is important to remember that it is only a six-month event and there has to be a valid and sustainable case for all the planned property expansion,” Matthew Green, the director and head of research at CBRE Middle East, told OBG. As with the World Cup in South Africa, there are increasing concerns that the Expo has the potential to contribute to a real estate bubble in Dubai in the coming years. Rising prices led the Central Bank of the UAE (CBU) to issue a warning in June 2014 that the real estate market was “overheating” and that it featured “growing imbalances”. This was echoed a month later by the IMF, which said that the rapid rise of real estate prices may even necessitate action.

Nonetheless, the current demand profile of the emirate leaves little reason for concern. As expatriates make up 87% of the UAE population, the local property market is to a large extent driven by economic performance and job creation. In this regard, demand would appear to be robust in the short to medium term. New trade licences issued by the Department of Economic Development (DED) have been increasing substantially. In 2013, for example, the DED issued 18,757 licences, a 12% rise on the 16,791 licences issued in 2012, according to the DED.

Demand Concerns

This high rate of growth for businesses, largely concentrated in the commercial and professional sectors, is set to have a dramatic impact on both residential and commercial demand. A building trends study compiled by Emirates Specialities Company (ESCO) has estimated that an additional 38,377 jobs were created in 2013, compared to 24,632 in 2012 and 20,098 in 2011. These figures would translate into a conservative estimate of demand for 17,269 one-bedroom apartments within the emirate, out of a total new-unit requirement of 36,450.

This trend looks set to continue over the coming years. the first quarter of 2014, new trade licences were up 16% year-on-year (y-o-y). Including cancellations, net additions were up 28.7%, at 4471. Using the ESCO multiplier formula for job creation, this would suggest the economy created an additional 9626 jobs in the first quarter alone, placing additional pressure on housing and office supply. Income indicators also suggest that demand should remain strong in the market despite these concerns.

Further to this, a report published in March 2014 by the recruitment firm Gulf Talent calculated that professional salaries in the UAE increased by 5.3% in 2013 and should grow by a further 5.9% in 2014. While inflation has been increasing, growing by 3.07% in the third quarter of 2014, as compared to 1.02% for the same quarter of 2013, wages are increasing at a faster rate. Although there has been some upward pressure on prices, the IMF inflation estimates of 2.2% and 2.5% for 2014 and 2015, respectively, are not widely regarded as causes for alarm.

The UAE is the workplace of choice for 65% of expatriates in the Gulf – the highest figure since 2008, according to Gulf Talent. Moreover, within the UAE, Dubai is the most popular location, with 48% of expats outside the city hoping to relocate there. For those who already live there, 88% intend to stay. As such, the survey suggests confidence in the market is high and demand for residential units should remain strong. Growth in demand could be expedited by the emirate’s mortgage market, whose performance has been robust in the last two years.

In the 18 months to the end of the first quarter of 2014, mortgage purchases as a percentage of total residential sales increased from 15% to 28%, according to research by Reidin and Unitas. Since 2006, mortgages have tripled as a share of total transactions, accounting for 32% of total transactions by May 2014, according to the Dubai Land Department, although they are still well below the peak of mid-2008. This illustrates the strong demand in the market over the past few years for mortgages as a tool with which to finance property purchases.

Handle With Caution

The potential for further growth is limited to some extent. The banking sector, which was burnt by the positions it took prior to the property crash in 2008, has remained a little more cautious in its exposure to real estate during the latest cycle. In its annual financial stability report in June 2014, the CBU stated that bank lending across the federation was not a decisive factor in recent property price escalation. According to the bank, financing from the commercial banking sector for residential property purchases rose by 12% in 2013 to Dh12.7bn ($3.46bn). For the real estate sector as a whole, lending was up by 10% in 2013 – only a single percentage point above the growth rate of the sector’s overall loan book. Real estate accounted for less than 23% of the banks’ total loan exposure, with a value of Dh287bn ($78.12bn).

After The Crisis

Relative caution, and greater restraint than was seen in the period leading up to the 2008 crisis, are likely to be maintained, suggesting that credit will not fuel additional demand in the market. Even before the economic crisis of 2008-09, the government had tried to introduce regulations to ensure the stability of developers and prevent overreach. For example, Law No. 8 of 2007 requires developers to complete 20% of construction, or hold 25% of construction costs in an escrow account, before sales begin. Developers must also own the land upon which they are building before selling off-plan. Even so, these measures could not prevent a raft of unfinished projects and undelivered units for customers who bought off-plan and developer bankruptcies once the crisis hit. The government has also taken measures to ensure that this demand is kept in check and that the market does not overheat. In October 2013, the CBU announced a much-anticipated cap on mortgage lending. Under the new regulations, the loan-to-value ratio (the percentage of the total value of a property that a buyer is eligible to borrow) was capped at 75% for expatriates and 80% for nationals for a first investment of less than Dh5m ($1.36m). The limit was set at 50% for off-plan sales. The regulations state that the maximum term of the loan cannot exceed 25 years and must be repaid by the age of 65 for expatriates and 70 for nationals.

Further to this, in another move meant to guard against indebtedness, the bank set the maximum repayment at 50% of a customer’s monthly income. “The central bank is seeking to ensure that banks and other financial institutions have and maintain effective business standards and control frameworks in place for the granting of mortgage loans,” Sultan bin Nasser Al Suwaidi, the governor of the CBU, said in a statement accompanying the decision.

Keeping Cool

At the emirate level, the Real Estate Regulatory Agency (RERA) and the Dubai Land Department have taken a number of measures to prevent rapid overheating of the market similar to what occurred in 2008. In October 2013 the land department increased the transaction fee for property registration from 2% to 4%.At the same time, Sultan Butti bin Mejren, the director-general of the Dubai Land Department, informed the local press that the move intended to put a halt to property-flipping, a practice which leads to sudden price increases and negatively affects the market. “The decision has come at the right time,” he said. “The market has matured and investor confidence is growing. The move is not likely to have any negative impact.” The fee increase was supplemented in May 2014, when the department introduced regulations mandating the use of standard property contracts for all transactions relating to the sale and purchase of property in the emirate. Such a move is likely to make the rapid resale of off-plan properties through the use of memoranda of understanding much more difficult.

The Dubai Land Department has also been active in supporting the supply side of the market. The department’s real estate investment promotion and management centre launched the Tanmia initiative in September 2011 to match incomplete real estate projects with potential investors. By September 2014, the programme had been successful in relaunching 37 projects with a combined value of $2.5bn.

For the authorities that are keen to restrict excessive speculation while at the same time maintaining the momentum that foreign cash inflows have brought to the property market, such regulatory action presents a difficult balancing act.

The increase in transaction fees will have some impact on speculation, but it will also make property more expensive for end-users. “We still need tighter laws on off-plan transactions, perhaps with some restrictions on exactly when units can be sold within the construction phase. The recent change in transaction fees from 2% to 4% has certainly helped to restrict the speculative actions of flippers, although there still remains too much volatility in the market,” Green told OBG. “However, ultimately the doubling of fees has probably changed the dynamic more for an end-user than it has for a speculator.” Indeed, the new transaction fee remains highly competitive when it is compared to other international markets. In the UK, for example, fees are levied on a sliding scale from 4% up to as much as 15%, while the charge stands at 8% in France and 7.3% in India.

Monitoring Transactions

Although the government has continued to monitor the situation closely, it nevertheless remains confident it has brought the excessive speculation of concern to many under control without slamming on the brakes. “We do not want the market to be too free or too controlled. Now all properties have to be registered at the land department so flipping is very difficult,” Mahmoud Hisham Al Burai, CEO of Dubai Real Estate, a branch of the Dubai Land Department, told OBG.

It can be a difficult task to fully gauge the collective impact of government efforts to cool demand in the market. For instance, total real estate sales, including land and commercial property, dropped 7.6% to Dh218bn ($59.34bn) in 2014. In total across the emirate in 2014, 53,871 land- and property-related transactions were registered, of which those defined as sales accounted for 51%. However, even so, the rapid price escalation witnessed in the market over the last 24 months is still a cause for concern.

“There has been a 56% increase in average residential sales prices in the two years to July 2014,” Craig Plumb, the head of research for the Middle East and North Africa at Jones Lang LaSalle, told OBG. “These growth rates are unsustainable and can only lead to a correction at some point. I think the residential market is very close to the top.”

This view is largely borne out by broker reports, which have gone so far as to suggest that the significant growth in property values is set to come to a grinding halt. For example, Jones Lang LaSalle has estimated that average residential rents and sales prices grew by 2% and 1%, respectively, in the third quarter of 2014. In addition to this, CBRE has recorded a similarly sluggish performance, estimating that average apartment sales prices rose 3% quarter-on-quarter (q-o-q) and 25% y-o-y, while apartment rental rates decreased 1% q-o-q and increased 16% y-o-y.

Market Mismatch

However, these headline figures do not tell the whole story. Within the market there are some imbalances that could lead to problems in certain segments while others thrive. According to analysis contributed by the real estate data analytics company Reidin, of the 11,198 prime units set for delivery in the next four years, one-third of them are villas. Given that the historical average in this segment is 13%, this figure suggests a looming mismatch between supply and demand. Reidin also predicts a general misalignment in the volume of supply and demand in the “trophy”, or high-income, segment of the market. According to the company’s research, there will be an estimated supply of 3338 units in this segment in 2015, compared to a demand for 1452 units, leaving an excess of 1886 units.

In the upper-income strata of the market in particular, the task of assessing demand is nearly impossible, perhaps resembling no more than a combination of intuition and guesswork. Dubai’s safe haven status has become particularly pronounced during the period of prolonged political and economic instability elsewhere in the region following the Arab Spring in 2011. Foreign inflows, which have arrived from South Asia in addition to the rest of the Middle East, do not always follow the rationale of the market, but are driven by the attraction of a clean and secure physical asset in a stable environment. In the first half of 2014 Indian investors accounted for 28% of the Dh37.5bn ($10.21bn) of transactions in the market. They were followed by investors from the Arab world, who have contributed Dh6.9bn ($1.88bn). “Sales values are largely underwritten by cash buyers and despite the small correction in values in the second half of 2014 the level of interest in the Dubai market remains strong. In fact, there are two completely different markets; the leasing market, which reacts relatively quickly to changes in supply and could therefore soften in 2015/16 as new supply enters the market; and the sales market, driven by cash buyers and general market sentiment,” John Stevens, managing director at regional real estate services company Asteco, told OBG. Across the residential property spectrum, the sales market continues to be dominated by cash buyers. These transactions accounted for 72% of the total at the beginning of 2014, according to Reidin and Unitas. This segment is less likely to be driven by end-use, considerations of recurring rental income or rental yields and the potential carry.

There are of course various exceptions to this trend. For example, the quasi-government developer, Emaar, has built a reputation for security, delivery and quality that has attracted a strong end-user customer base. With regards to the secondary market, in three of its developments, Arabian Ranches, Greens, and Springs and Meadows, an average of 40% of transactions in the last eight years have been completed using mortgage financing – well above the market average of 28%. In the first of these developments, Arabian Ranches, the figure is the highest of any freehold development in the emirate, at 50%, according to research by Reidin and Unitas.

Exogenous Shocks

Nevertheless, it remains clear that the trend of foreign cash buyers leaves Dubai’s real estate market vulnerable to exogenous shocks. The emirate, and the GCC region more generally, remains to some extent at the mercy of commodity price volatility. Given that an increasing volume of hydrocarbons output in the region is bound for Asia, a further emerging market sell-off as a consequence of US Federal Reserve tapering would have a significant effect on the GCC, according to the credit ratings company Standard & Poor’s. The company estimates that a forecast drop of 1.7 percentage points in growth in the BRICS countries in 2015 could reduce real GDP in the GCC by 1.2 percentage points in 2016, when compared to the baseline forecast for real GDP. However, while they may have an acute awareness of the real estate sector’s vulnerability to global conditions, few analysts are currently worried. “The biggest issue is whether there will be any exogenous shocks and liquidity drying up, but at this stage I do not think this is the case,” Rehan Akbar, an analyst for EMEA corporate finance at Moody’s Investors Service Middle East Department, told OBG.

Misalignment

There is a general sense that any market correction will be manageable and that it will be beneficial for the long-term health of the sector. “There is continued investment demand so we don’t think there will be a major correction,” Plumb said. “There could be a softening but it will be in the 10% to 15% range, not the 50% to 60% of last time. And this is a good thing.” The misalignment between supply and demand currently seen in the market has meant that in certain segments there is undersupply and as a result, the potential for price pressure. Reidin and Unitas have forecast a shortage of 3425 units in the mid-income segment in 2015.

The extent of undersupply in this segment, as well as the affordable segment, has been exacerbated by the active role of investors, rather than end-users, within this part of the market. “One of the major trends that has emerged over the last 18 months is that secondary locations have actually outperformed prime locations in the most part,” Green said. Furthermore, there remain lingering questions over how much of the housing stock available in these segments is being absorbed by end-users. In certain developments in the affordable segment only 5% of properties are bought using mortgage financing compared to 24% in the upper-income segment. Across the whole market, mortgages accounted for 28% of transactions by the first quarter of 2014.

Pricing Out

The interest of cash buyers, however, has been pushing up the prices of mid-income projects, creating issues of affordable supply and leading to doubts that the price rises witnessed in the last 12 months will be sustainable moving forward. “I don’t think there is price pressure here,” Plumb told OBG. “They have already reached a level that is moving out of the affordable segment.” Ozan Demir, a data and research manager at Reidin, argues that the Dubai Sports City project, for example, had initially been targeting the affordable market but price escalation has pushed it into the mid-income bracket. Similarly, Dubai Marina was a mid-income development but is now commanding prices at the higher end of the spectrum. In fact, several of these projects have suffered from what Reidin calls “inflation crowding”, a phenomenon in which units have become unaffordable for the segment that they were originally targeting.

Residenial Communities

Discovery Gardens, which was developed by Nakheel with the first units handed over to buyers in 2008, is a case in point. The freehold residential community, with a capacity for 60,000 people, saw significant price inflation in 2013 and at the beginning of 2014. Prices for a one-bedroom apartment were $160 per sq metre in 2005, a year after the project was launched.

By the end of the second quarter of 2013, average prices in the development had reached $191 per sq metre and they were still on the rise. Moreover, in the final quarter of 2013, apartments in the development had successfully achieved the highest y-o-y sales price increase in all of Dubai, jumping by a rate of 83%. “Affordable units in Dubai would be below Dh1000 ($272) per sq foot and this is the area where demand is greatest, but places like Discovery Gardens, Jumeirah Village and Dubai Sports City have already reached Dh1000 ($272) per sq foot,” Demir told OBG.

Affordability Conundrum

Unit price escalation is having a detrimental impact on the overall purchasing power of Dubai residents. A recent study by Colliers estimates that 50% of Dubai residents earn between Dh9000 ($2450) and Dh15,000 ($4083) per month. With this income range, most residents remain restricted to studio or one-bedroom properties in International City, Deira, Al Nahda and Al Qusais. Although Reidin and Unitas are slightly more optimistic, estimating median income at Dh15,000 ($4083), they nevertheless come to a similar conclusion in terms of the dearth of middle-income property available to families. Given that mortgage terms for UAE nationals include a loan-to-value cap of 80%, an interest rate of 3.99% and monthly repayments of up to 50% of salary, Reidin estimates that those on the median salary can afford property priced at a maximum of Dh1.55m ($421,910). While these calculations would allow for the purchase of a two-bedroom property in secondary locations such as Dubai Sports City, International City and Discovery Gardens, the options are limited, with little to no availability in the three-bedroom market. “A considerable undersupply is beginning to form within the middle-class segment, which will open many opportunities for developers able to deliver high-quality property at Dh600 ($163.32) to Dh800 ($217.76) per sq foot,” Mehroz Manzoor Rufi, CEO of Rufi Properties, told OBG. However, the situation has become more difficult for renters. Here the emirate faces some distinctive challenges, including the fact that the issue of affordability largely affects non-nationals. Illustrating this, a report by Aon Hewitt Middle East estimates that tenants in Dubai spend up to 40% of their salary on accommodation. With a median monthly wage of Dh15,000 ($4083), the average tenant would be limited to one-bedroom units in Dubai Sports City, Discovery Gardens, International City and Dubai Silicon Oasis, according to Reidin and Unitas. For a single-income family, the only suitable option in the two-bedroom market would be within International City, where units are currently priced at the very cusp of affordability. In the three-bedroom segment, all rental units would be out of the range of the median-income salary, according to Reidin and Unitas.

The report argues that in the affordable to middle-income segment of the market the ratio of salary to rent is approaching 50% and may push residents out to the Northern Emirates. “It is a sensitive market here,” Stevens told OBG. “People move quickly when there’s a movement up or down. There is quite a lot of churn in affordable areas and when rents are up, the Northern Emirates benefit.” According to a third-quarter 2014 report by Asteco, rental rates in Umm Al Quwain and Ajman were up 6% and 4%, respectively. Ras Al Khaimah witnessed a growth rate of 4%, while Sharjah saw rental escalation of 2%.

Competitiveness Concerns

The government is conscious of affordability and the challenge this poses to the business competitiveness of Dubai. “Rents are increasing and the government has instructed us to do something on affordability. We may be able to take steps on this by looking at affordable housing,” said Al Burai. One potential solution currently being considered is to give land grants to developers in return for a certain percentage of the units being developed for the affordable rental market.

Given the continuing difficulties of maintaining margins in the affordable sector, such incentives could end up being crucial to increasing supply. “Developing properties to be sold in the Dh500-600 ($ 136-163) per sq foot range was a viable business over the past few years, but given recent cost escalation the segment is quickly becoming an unworkable price point,” Irfan Godil, the CEO of local real estate investment firm Texture Holdings, told OBG.

However, opportunities do exist for developers and could push them into areas of strong demand. “There is a significant opportunity for real estate developers to begin putting more emphasis on apartments in the 450- to 700-sq-foot range, as this represents a sub-segment that has seen great success in more mature urban centres,” Saeed Mohammed Al Qatami, the CEO of Dubai-based real estate developer Deyaar, told OBG. The government is in the early stages of formulating policies for affordable housing and is therefore consulting international models.

“As a government, we cannot give money or subsidies, but we perhaps can give land,” said Al Burai. Authorities have already issued a regulation aimed at balancing the requirements of affordable units against the desire to maintain a liberal policy towards the market. In December 2013 a new decree was issued capping rents in the market. Annual rental increases have been limited to a certain percentage rise depending on the current lease rate of a property in relation to the average market price in its vicinity. The maximum allowable increase is set at 20% for properties currently rented at a rate more than 40% below the market average in that area.

Price Softening

It appears that, even without some measure of government intervention, a general market correction might ease market pressures in the short term. Rental rates within Dubai have become unsustainable and look like they are beginning to soften, bringing interest back from the Northern Emirates. CBRE suggested that residential rental rates across the market fell by 1% in the third quarter of 2014 – an assessment supported by data from Asteco. Accordingly, the company estimated that in two of the affordable to mid-income developments, Discovery Gardens and International City, rental rates fell by 7% in the period. This would suggest that the market is beginning to react to excessive price escalation in 2013, particularly given that these two projects experienced some of the highest rental growth rates in 2014. This is a good sign for the market and, coupled with sales price softening, could unlock demand in the mid-income segment of the market.

Measures introduced by the Real Estate Regulatory Agency since 2008 aimed at cooling speculation have proved largely effective. Stamp duty has been raised from 2% to 4%, while new obligations imposed on developers looking to sell off-plan are now in force. Even so, from the perspective of the investor looking at the buy-to-let market, the situation in the rental market is not particularly encouraging. Even before the recent softening in rental prices, the potential for recurring rental income was limited. “The problem is that sales prices have been ahead of rental inflation, so yields are under pressure,” Green told OBG. “You could now typically get between 3% to 6% [yields], with high service charges having an impact on returns. There is a little bit of an imbalance, particularly in recent months where sales prices have been outperforming leasing rates.” Low yields have been prevalent in the apartment segment, where sales prices increased 25% y-o-y in the third quarter of 2014. By comparison, the rental market rose by 16% during the same period, according to US commercial real estate company CBRE. This phenomenon is particularly evident in a development like Discovery Gardens. In the fourth quarter of 2013, the development experienced sales price escalation of 83% y-o-y. However, in the same period rental rates increased by 44%, according to Reidin and Unitas.

With rental yields remaining in a range from 6.9% in the affordable segment to 4.4% in the upmarket segment, and the cost of borrowing for property at approximately 4%, there is some degree of carry in the market. As rental rates soften, yields are likely to become highly compressed, but the impact on the market remains unclear. “So much of the market is not driven by yield,” Plumb told OBG. “Yields are quite low but this does not matter because many purchases are as a second home, for parking cash or a capital play.”

Correction concerns

There is some concern, however, that the low rental yields are a sign of a market heading for tough times. “A correction in real estate value in any market always seems to take us by surprise and you ask yourself, ‘What did I miss? Where was the sign?’” Christopher Seymour, head of property for the UAE at ARCADIS, told OBG. “It really is the investment market. In all sectors, if the investment market dies away it shows there is no growth. The yield compression in the Dubai residential market is really telling us that story now.”

The CBU seemed to agree with this assessment in June 2014. In its annual financial stability report, the bank noted that “current average rental yields in Dubai and Abu Dhabi are approximately 70 and 130 basis points below historical averages, which could indicate growing imbalances [and an] overheating real estate market.” In general terms, however, most analysts believe that the market is reasonably well balanced. “Population and employment growth is enough to support 15,000 to 20,000 residential units each year and this is the current pipeline, so we don’t think there’s an oversupply problem,” Plumb said. Although the memory of the last crash five years ago is still fresh, there seems little reason to believe that Dubai is heading for a repeat collapse in pricing. “Between 40,000 and 50,000 units were handed over each year in the 2007-08 period,” Green said. “We’re certainly not there at the moment with around 62,000 units scheduled for completion by the end of 2017.”

Investor Interest

The consensus seems to be that Dubai is more likely to be going through a cyclical adjustment than a major market correction. As such, there is growing interest in Dubai as a maturing market, with investors looking at longer-term investment horizons. One vote of confidence for the long-term sustainability of the sector was the initial public offering of Emirates REIT, a real estate investment trust, on NASDAQ Dubai in April 2014. This was the first initial public offering in Dubai since the financial crisis and was widely regarded as a test of confidence in both the equities and property market.

The offering was 3.5 times oversubscribed and led to Emirates REIT selling up to 19.3m additional shares through over-allotment arrangements. The sharia-compliant company raised $175m, largely from institutional investors in the UAE, the GCC and the UK. The trust used the proceeds from the offering to make two new acquisitions in subsequent months. In May it acquired the Dh118.2m ($32.17m) Le Grande Mall in the Dubai Marina area. This was followed in June 2014 by the purchase of office and parking space in the Index Tower in the Dubai International Financial Centre (DIFC), bringing its ownership of Grade-A office space in the building to 67%. The trust’s portfolio includes commercial towers, retail space and school buildings and it continues to perform well. In the first half of 2014, net profit increased by 194%, to $34.15m, while the value of the portfolio grew by 73% to $559.65m. This would suggest there are still strong opportunities for investors despite some concerns over yield compression across a number of sectors. The outlook for REITs is closely tied to the structure of the market. “In contrast to the REIT market in the US, where its rise to prominence was mainly driven by tax purposes, the Middle East’s REIT market is developing primarily due to the need of investors to invest in regional property via entities that facilitate easier investment into and out of property. REITs and property trusts facilitate investors in this regard,” Stephen Atkinson, director of AREIT, the first REIT established in the region, told OBG.

Commercial Sector

In the commercial sector, like the residential sector, the overall figures do not necessarily tell the whole story. According to CBRE, office rents in the central business district (CBD) were stable in the third quarter of 2014, while they increased by 3% q-o-q in secondary locations. Jones Lang LaSalle provides a similar outlook. According to their third-quarter review, prime CBD rents increased by 1.6% to Dh173 ($47) per sq metre. At the same time, this broad picture does not necessarily capture the current dynamics of supply and demand in the sector. “The office market is going to be a two- or three-tier market,” Plumb said. “Some types of unit could be difficult to find and you could have rents going up even though vacancies are high.”

Vacancy Rates

A strange scenario currently prevails in which demand in the sector has remained relatively robust even while at the same time, vacancy rates across Dubai are high. Given that in the professional sector a net total of 4736 trade licences hit the market in 2013 – representing an increase of 54.9% on the previous year – it would appear that the demand for office space should be present. Yet in the third quarter of 2014, vacancy rates across the emirate stood at 39%, according to CBRE.

This mismatch of supply and demand can be attributed to a number of different factors. “At the moment the market for good-quality office accommodation in the CBD or freezones is doing very well. There is a strong demand but there isn’t really enough supply,” Green told OBG. “There is a 40% average vacancy rate across the market. However, most of that is unattractive strata space.” The issue of strata ownership, in which an office building has multiple owners, is distorting the market, Green added. “Splitting the accommodation into piecemeal chunks is an inefficient use of the space and it ultimately creates issues in terms of the property management and service charge collection,” he said. Many prospective multinational tenants require substantial space and are therefore unable to deal with multiple owners to lease that space. With a legacy of developers looking to sell smaller units off-plan to fund the completion of their office tower, the strata nature of ownership in many commercial buildings within the emirate is inflating the vacancy rate. The limitation on the availability of larger unit sizes of the requisite quality could lead corporates to develop their own office spaces.

Foe example, Standard Chartered has rented a building on a plot close to Emaar Square because the bank was unable to find any available international-standard units that met its space requirements. At the same time, not everybody is convinced that this will become a pronounced trend. “Most office occupiers are averse to taking on capital expenditure. There is still this de-risking element in the office market,” says Green. Nonetheless, lease terms could begin to increase from the current norm of five to seven years.

Facilities Management

Another potential consequence of the current state of supply in the office market is the growth of the facilities management (FM) industry in the emirate. According to a 2013 survey by the strategy consultancy Credo in association with the Middle East Facility Management Association, market participants in the $21.8bn GCC industry believed Dubai would experience the highest regional growth rate. However, as regional markets mature and rental rates stabilise, the prospects for FM operators to maintain margins will come under pressure. According to the Credo report, supplier margins in the emirate have fallen from more than 15% to a range of 5% to 10% in the last five years.

Outlook

However, this trend is not likely to be confined to the FM sector. As Dubai’s real estate industry reaches a new level of maturity, the gains made by service providers, developers and investors will all come under pressure. Tighter margins are the price that these firms will pay for less risk and greater stability. Although rapid price escalation in the residential property segment has caused worry in the last two years – particularly with the market crash of 2008 still relatively fresh in investors’ minds – it would appear that the emirate has learnt much since then. Regulations have been introduced to temper the inclinations of speculators, while the demand from long-term investors and end-users is on the rise.

Despite continued concerns that the real estate sales market has been outperforming the rental market over the past year, the mood has been one of caution rather than outright pessimism. It appears clear that the most important players in the sector are better positioned to weather any market downturn than they were at the peak of the last real estate spike, a mark perhaps of the lessons learned in a maturing industry. As such, while the market might be preparing for a period of price stagnation or softening in the coming 12 months, opportunities will still exist, especially for those with their eye on the long term who will greet it as part of the natural property cycle.