David Williams: Dubai is experiencing the downturn of its first property cycle
David Williams from property wealth managers Circle 196 takes a look at whether Dubai remains a good bet for investment
When it comes to investing, the savvy investor realises that a recession is when you buy, not sell. You only sell in an era of stability and should not fall in the trap of following the masses.
A recession creates boundless opportunities at discounted prices. The shrewd investor knew that, once the banks were to be bailed out, that was their chance to sweep up and make their fortunes. One such investor was the Abu Dhabi government playing with their vast sovereign wealth fund of nearly $1 trillion, the largest in the world. They made a £1.5 billion profit in seven months when investing in Barclays shares.
This opportunity is the same for property as it is for equity. The fall in property prices globally has awoken the investor in their droves to take advantage of those bargains sales.
The British have recently concentrated their efforts on the UK market. The auction houses are packed and the true opportunity has almost disappeared. Confidence is slowly returning in the UK and average property prices have risen.
This concentration on the UK and a sudden forgetfulness regarding the lands beyond our shores has created bigger and better distressed opportunities abroad than what you would now find in the UK. The British are amongst the largest buyers of foreign property in the world, therefore if the British are not buying many foreign property markets that have relied upon foreign investment will fall hard. The distressed market in the UK is becoming tricky, most investors have expectations which cannot realistically be fulfilled, but they can if they look elsewhere.
Nightmare stories of buying property abroad infiltrate the public consciousness. Hopefully, these recessionary times have taught property investors not to buy on empty promises or dubious locations. The lack of legal reinforcement has bitten many investors.
The financial crisis was considered a ‘western disease’
Since the collapse of Lehman Brothers and some of their fellow competitors during late 2008, the world seems to have changed. Developed economies such as the UK and the US have felt the full force of these turbulent times. For the United Arab Emirates, they became guarded against being infected by this ‘western disease.’
Their financial institutions restricted lending to new foreign customers; a re-structuring of the banks has taken place while they decide when and how to relax their mortgage market again to lend freely to foreign nationals. Observers are expecting mortgages to be readily available during late 2009 as liquidity will surely return to a market where foreign investment is important in their plan for economic diversification.
Of course all these issues of global recession and restricting of finance have melted the black gold somewhat. Property prices in Dubai took a nosedive as the global recession hit, Dubai being hit harder than almost anywhere else. Credit Suisse stated that the UAE economy would contract 2.4 per cent during 2009. However, measuring the economy of the UAE is similar in nature to trying to give an average picture for the whole of the United States. The UAE has separate emirates with separate rulers and mini economies of their own.
Dubai has taken the hit whilst emirates such as Abu Dhabi have not seen a contraction and are expecting to post double-digit growth by 2010.
Those who bought property in Dubai in its heyday will have made substantial returns on their investment, due to its rapid growth. Interestingly, even now many professional commentators believe that Dubai, along with the rest of the UAE, will recover faster than Western economies due to oil and liquidity.
If investors are not desperate to sell they needn’t panic as it’s highly unlikely that other oil-rich powers such as Abu Dhabi, Saudi Arabia and Qatar will let Dubai collapse for reasons linked to funding. After all, Dubai is the brand of the Middle East, the proof that dreams are possible and that the UAE nationals are capable of bigger and better than anything we have seen.
Abu Dhabi has learnt fromDubai’s mistakes
Dubai has bitten the speculators and rightly so. No property market can continue growing sustainably if the economic fundamentals don’t stack up. When it comes to investing in property, the astute investor must be aware of what is driving the economy and, correspondingly, the property prices. Otherwise, they will soon lose cash and confidence in their bricks and mortar.
The Dubai property market has reached a relatively mature stage and will continue to grow slowly but sustainably over the long term – it is fair to say that Dubai is experiencing the downturn of its first property cycle.
The days of huge capital returns are over – anyone aware of the economy of Dubai will have seen the end coming. Dubai is reliant on foreign investment to fuel its boom. Unlike its oil rich neighbour, Abu Dhabi, Dubai’s economy has grown on tourism, glamour and the image of the playground in the Gulf. The emirate has only 20 years’ worth of oil reserves left whilst Abu Dhabi has enough for the next century. Abu Dhabi is also encouraging Western investment, so they too can diversify their economy away from hydrocarbons. Attracting thousands of multi-national corporations adds further revenue to a bulging sovereign wealth fund.
The energy super power of Abu Dhabi holds the world’s fifth-largest oil and gas reserves – they attract investment only because they want to whilst Dubai wants to attract investment because it needs to.
Of course for many oil-rich countries in recent months the crash in oil prices has created problems with their economies – take the Russians and the Venezuelans as examples. But the crash in the oil price does not give the whole economic story.
Some locations of the world are difficult as it is expensive to drill for oil, particularly in Russia’s case when drilling in the frozen Siberian tundra. However, when the petrol for your 4x4 is sat under a hot desert just waiting for someone to pierce a whole in the ground to release the pressure your cost of production per barrel will be only $23 yet the IMF’s baseline projection sits at $68 per barrel. Therefore, Abu Dhabi, understandably, is not panic-stricken by the drop in the demand for oil. It knows Opec will step in long before prices start scrapping the bottom of the barrel.
The global financial crisis has exposed the debt-laden Western countries as ill-prepared to rescue their economies; the shift in economic and financial power has become evident in the markets. Being a net lender rather than a borrower has enabled Abu Dhabi to cushion its economy against the global recession.
Despite all these great fundamentals to show Abu Dhabi as the perfect place to invest, there will be the worry amongst property investors that it will jump on the bandwagon, creating an over-supply of property and little thought to its development plan. Dubai has experienced an over-supply of property, causing prices to freefall in a recession whilst its citizens can do nothing but sit in traffic on Sheikh Zayed road and watch.
Investors will be cautious that they are not caught out again. However, since Abu Dhabi helped fund a large part of Dubai’s construction boom, they have sat back and made notes as the skyscrapers penetrated the clouds. The result has been the creation of Plan Abu Dhabi 2030, a grand master plan dictating the development of Abu Dhabi city in considerable detail.
Despite projections that the population of Abu Dhabi will rise from more than one million to more than three million by 2030, the city of Abu Dhabi is being built to incorporate expected demand. However, developers cannot build fast enough to meet demands of the current growing population, never mind those that are expected to call Abu Dhabi their home in 2030. Developments are restricted, making over-supply virtually impossible. Developers do not have a free rein of where and how much to build, the plans are meticulous, building work remains on schedule no matter the global economy. Furthermore, $200 billion is being spent to ensure the infrastructure is built first.
Investors have the benefit of hindsight – but not for long
The fall in property prices in Dubai had a natural ripple effect on Abu Dhabi. However, new investors in Abu Dhabi effectively have the benefit of hindsight, where they can expect excellent yields as well as capital appreciation over the medium to long term. Prices are not expected to correct much further in Abu Dhabi due to the cost of construction.
In summary, now those speculators have cleared out of Abu Dhabi and the artificial inflation of prices has abated, the future growth of Abu Dhabi is expected to be more organic and subsequently more sustainable. Abu Dhabi is considerably under-priced when compared to other major world cities. The capital of the UAE is still cheaper than Dubai, for now at least. This should alert investors to the price expansions yet to come, especially when considering their gross domestic product is greater than either London or New York. The emirate of Abu Dhabi contributes to 60 per cent of the UAE’s economy. An investor seeking an off-plan property in the city should aim to hold the property at least until completion, to extract its full value. When the market returns to prices seen before October 2008, an investor could potentially earn triple-digit returns if buying while prices are still depressed.
The recession has created apprehension for consumers to spend money – worries about job security, home repossessions and household debts are encouraging people to save and wait until the financial crisis disappears. Consumer confidence creates behaviour resembling a flock of sheep; everyone is waiting for everyone else to move.
Taz Sandhu, managing director at Circle 196, recently suggested that, in the case of Abu Dhabi, it would be unwise for an intelligent property investor to follow the crowd; otherwise the window of opportunity will close. This lack of liquidity and restriction in credit lines has temporarily given power to the cash buyer to negotiate and pick up a real ‘true’ bargain. In some select cases up to 60 per cent off the average peak last year and 25 per cent below even current market valuations are available. This window of opportunity is only short because in February 2009 Abu Dhabi injected $4.4 billion into five of its banks to ensure they would remain liquid during the global credit crunch. Dubai also out-stretched its ‘palm’ to receive $10 billion from Abu Dhabi via the sale of its five-year bonds to bail out their banks. This was the first sign indicating that, once these banks begin lending freely again, the opportunity for Westerners to buy prime property as cash buyers or through cash funds will evaporate.
Overview by real estate sector office market
The impact of the global financial crisis hit Dubai hard. The sectors being hit the worst include financial services, real estate and construction. Coincidentally, office vacancy rates have topped 80 per cent and office rental rates have plummeted up to 45 per cent in some cases since last years’ peak. Selling prices also dropped on a similar scale whilst projects were cancelled or delayed across the emirate.
Abu Dhabi is in a different position simply because the majority of its stock is not yet built. Vacancy rate still hovers at about only two per cent. The ripple effect from Dubai has meant some correction in pricing. Office rents have taken a hit of 20 per cent whilst the selling prices have decreased on a similar scale. Due to the economic downturn, 58 per cent of the office stock scheduled for completion between 2009 and 2011 has yet to commence.
During 2008, the growth of Abu Dhabi’s, Ajman and Sharjah’s real estate prices were fuelled by the same speculation and irrational exuberance that characterised the meteoric rise of Dubai’s property prices. However, since Dubai’s crash with prices declining 40 per cent on average, it is expected that prices will stabilise this year, with the smaller Emirates effectively waiting for growth in Dubai to resume.
Hotel performance in Dubai has been impacted not only by global market conditions but by concerns that the market has reached supply-demand equilibrium. A downturn in tourism has meant a drop in hotel room occupancy of 25 per cent. Room rates have therefore dropped by an average of 30 per cent since the start of the year. Dubai’s building boom and concentration on tourism to diversify its economy has created on over-supply of hotel rooms, particularly in the five star sector. This will continue to intensify with more than 9,000 more hotel rooms appearing in the next three years. Therefore. occupancy rates will drop below 70 per cent this year – 13,000 new hotel rooms will be completed by late 2011, so competition will be intensified.
The UAE will most definitely bounce back, and this time the leader of the pack will be Abu Dhabi – a Global Capital City in the making!