Dubai Property Report - SICO

10 September 2008
Rental yields from small housing units such as studios and one-bedroom apartments in Dubai are higher than those achieved from larger homes, says a report.

And the rental income from a studio more than covers the mortgage payments, says the new study by Bahrain-based investment bank SICO.

Falling bank deposit rates are causing more investors to shift their focus to the property sector to earn a higher yield on their capital.

"Dubai's rental yields are higher than a global average of 5.5 per cent," says the report. "An investment opportunity exists in the market since the rental yields are similar to the mortgage rates of about eight to 8.5 per cent, thus allowing investors to hold the property while making mortgage payments from the rent."

More than three-quarters of Dubai's population lives in rented housing and this has led to significant demand for units for rental purposes, leading to high rental yields obtained by investors.

Rents in the city have increased from a range of Dh50,000 to Dh180,000 for one- to three-bedrooms in 2006 to Dh130,000 to Dh222,000 in mid-2008.

"Property has become a popular investment in its own right over the past six years, just as it has in the United States and the European Union. In Dubai, real estate markets have been opened to citizens of countries outside the GCC.

"Falling interest rates have led to more borrowing and while rents and prices continue to rise steeply it is generally believed that the sheer number of newly built properties completed and brought on to the market will lead to an orderly moderation in rents and property prices in the medium term," says the report.

Prices of three- and four-bedroom villas in Dubai are currently 12 to 13 times what they were in 2002 while the prices of apartments are six times higher than in 2002. "Average prices of villas in Dubai have increased from Dh850,000 in 2002 to Dh10.7 million in 2008 and the average prices of apartments have increased from Dh650,000 in 2002 to Dh2.9m in 2008," adds the SICO report.

The price increases have been driven by the introduction of freehold properties, high oil revenues leading to ample liquidity and negative interest rates.

SICO says there is a significant pent-up demand for mid-low end housing as many mid-high end units are currently under development. "We feel that the strong housing demand and the resultant real estate boom is backed by factors other than sustainable domestic demand, which have led to price hikes. Investment by foreigners is a major factor in driving demand with key motivations being a zero-tax regime, and strong domestic and international marketing campaigns."

The report, however, does not anticipate similar price hikes going forward as the market matures.

According to Dubai Government estimates there was a shortage of 90,000 housing units in 2007, which is expected to be filled in the next five years.

The UAE's relatively low mortgage-to-GDP ratio - currently at eight per cent in comparison to developed countries - will favour strong growth in demand for housing units.

"The real estate mortgage-to-GDP ratio, according to numbers provided by the UAE Central Bank, has posted a steep increase, at eight per cent in 2007 from 3.6 per cent in 2000."

The value of mortgages obtained by residents and non-residents increased at an average of 30 per cent and 60 per cent, respectively, over the past seven years.

SICO says, however, that loans to non-residents contributed just 1.6 per cent to the UAE's mortgage total. Mortgage loans in 2007 grew by 90 per cent compared to 80 per cent in 2006.

In July the Fitch Ratings report said banks had been increasing their exposure to the real estate sector, particularly in Dubai. Since 2005 some of the largest UAE banks have set up subsidiaries to manage, provide brokerage services and/or invest in the property sector.

Exposure to non-residential real estate has been growing year-on-year and now represents a substantial proportion of most large UAE banks' lending portfolios.

"Islamic banks tend to have a higher exposure given that all their transactions are asset-based," said Fitch.

On the supply side, the Dubai Government is the key market player through large developers that it either fully or partially owns.

The Fitch report said: "Indeed, given that an estimated 50 per cent of supply over the next few years is under such central control, it is difficult to envisage that the authorities will deliberately flood the market with an over-supply and erode market fundamentals and their own projects' profitability."

Fitch Ratings identified a number of key drivers of Dubai's economy - the inflow of foreign investment, low interest rate and limited supply in all sectors.

During the first quarter of 2008 the main developers continued to report strong gains in revenue, margin and profitability, while their credit ratios showed more reliance on external debt.

The SICO report also feels the ratings of Dubai real estate firms reflected a stable outlook for the construction and real estate industry.

"The majority of the large developers and key market players in Dubai are fully owned by the Government of Dubai, such as Nakheel Emaar, Deyaar Development Company and Union Properties," says the study. "It is worth noting that the large state-owned developers are likely to retain better access to raw materials and labour than smaller developers."

Meanwhile, the UAE has maintained, on average, a strong real gross domestic product growth rate of more than nine per cent over the past five years. The share of both construction and real estate sectors has been more or less stable during 2005-2007 at about eight per cent each year.

Secondly, high stable levels of income and well-established social security systems in the developed countries are reflected in the high ownership of housing units.

Dubai compared to these countries shows a relatively higher disparity in income levels and there is no social security system for expatriates who form the major portion of the population. Therefore, merely comparing Dubai's GDP per capita of $38,785 (Dh142,465) in 2007 to those of developed countries does not provide a true picture of the standard of living, says SICO.

"Abu Dhabi contributed 60 per cent to the UAE's total GDP in 2007 backed by high oil revenues, backing our assumption of it having a low mortgage loan-to-GDP ratio. The contribution of the remaining emirates is estimated to be minimal.

"Based on this, the mortgage loan-to-GDP ratio for Dubai stands at 23 per cent, which is more than twice the UAE's eight per cent. However, when compared to developed economies the ratio is below an adjusted global average of 33 per cent excluding outliers from highly developed Mortgage markets."

"Nonetheless we do not expect Dubai's mortgage market to grow to the levels of developed economies due to Dubai's unique demographic mix and social restrictions and reasonable levels of other loans, indicated by a loan/GDP ratio of 98 per cent, which is close to international levels."

The report says the real estate boom is being driven partly by investment by a small segment of the population for rental yields and price appreciation and speculation for short-term gains in a bull market.

"We believe that the zero-tax regime in Dubai has been a major attraction for foreign investors in the emirate. This encourages businesses to move to Dubai and has created a demand for business centres in the emirate.

"According to Emaar Properties only 11 per cent of the total sales made by them in 2007 were to UAE nationals," says the report.

SICO says stakeholders have been taking various steps to prevent speculation, such as limiting the number of transfers, increasing transfer fees, lowering maximum mortgage amount to 70 per cent from more than 90 per cent earlier.

The report adds that a delay in the delivery of units would be a silver lining for the residential property market post-2009. During 2007 only about 50 per cent of the total announced units were actually delivered due to construction and utility constraint delays.

"The top three developers are government affiliated, and in case of weakness in the market, developers can play a major role in providing support."