Thursday, 3 January 2008

Dubai Property: The brow of the hill

Concerns about property bubbles abound around the world. Dubai is no exception. In recent years, we have seen a dramatic price appreciation. By the end of 2005, we estimate that property prices had doubled in the previous 3 years. There have been several causes of the boom. First, the dramatic expansion in non-oil activity led to an increased demand for housing as more and more people relocate to the city. Second, high rental yields (estimated at around 8-10% for the apartment sector and 6-8% for the villa segment) have attracted investors into the market.

Third, the excess liquidity generated by the region's petrodollars has led to a sharp increase in speculation in asset prices around the region. We have already seen the bursting of the stock market bubble, which resulted in the Dubai financial market index losing over 65% from its peak a little over a year ago.

Finally, we have identified a fourth category of buyers - insurance buyers. There are indications that many buyers are actually buying a property in Dubai - which brings with it the right to reside in Dubai - in order to have somewhere to go should the situation deteriorate in their own countries. This buying, we believe, is particularly prevalent from South Asia, Russia and Iran.

Given these sources of demand, there is still currently a shortage of supply.

This demand-supply imbalance has led to a significant rise in valuations and rents. We have argued before that residential property prices are likely to come down around 20-30% in the next 2-3 years. And we believe that we are getting close to the peak in residential property prices. While demand is likely to remain strong in the coming years, as Dubai continues to focus on diversifying its economy away from oil, the key is supply.

The good news, for those who have had to stomach sharp increases in rents in recent years, is that supply is set to grow rapidly in 2007, outstripping demand growth. Prime Group has estimated that, taking into account delays in the delivery of properties, 52,000 and 63,000 properties will be delivered in 2007 and 2008, respectively. Given a reasonable assumption of 7% population growth for the emirate, it suggests this will lead to an excess supply of around 6,000 units in 2007 and 33,000 units in 2008. This is likely to mean that we will see property prices and rents falling in the coming 24 months.

There are scant signs of this happening in the immediate future. Our updated residential property market index suggests prices have risen an average 18.8% so far this year. However, what is extraordinary is the 12.9% jump we saw in October after weakness between July and September, when we saw prices fall over 1.0%. The data is fairly volatile (for notes on how the index is constructed, please see the Appendix). What is interesting is the fact that the overall property price index has fallen in five out of the last eight months, but two of the rises, in July and October, were dramatic. The first can be explained by the announcement by the government that foreigners would be able to buy freehold properties.

The jump in October may have come from a realisation that estimates for the release of properties reported for the second half of the year are unlikely to be attained. Indeed, one developer at one point suggested it would be releasing 60,000 units onto the market in the second half of 2006 and Prime Group now estimates the full year market figure will only be 40,000. There may also be a seasonal effect at play here.

We break down our property index by type (apartment and villa) and by geography. On the former, it is conventional wisdom that the villa segment is unlikely to be affected significantly by any downturn in the property market as most of the supply coming onto the market is in the apartment sector. Our property indices indicate that villas (up over 30% year-to-date) have indeed outperformed apartments (10%) by a significant margin. However, we continue to argue that the two segments are not totally isolated from each other. While a family may have a preference for living in a villa, should the relative pricing change significantly (as apartment prices fall, say) we would expect some to migrate to the apartment segment. That said, we do agree the apartment sector is likely to lead any weakness and this is reaffirmed by the fact that villa prices have risen over 20% in the past three months while apartments have risen by just over 3%.

In terms of geographies, we have highlighted three main areas: Offshore Dubai, New Dubai and South West Dubai (see Appendix for more details on the developments included). The best performing have been the most developed; that is, those that have more of the projects completed. South West Dubai prices have risen 34.1% year-to-date. This was by far the top performer. While part of this out-performance is due to the fact that 86% of this sub-index is made up of the outperforming villa segment, it is still worth noting that this district outperformed the overall villa index in the first ten months of the year.

New Dubai prices were up 23.7% over the course of the year, a very strong performance given that it is comprised of 76% of apartments. However, it is important to note that prices rose a whopping 31% in October and before this increase prices were down over 5% year-to-date. This huge volatility, together with the large supply due to come onstream in the coming months in the form of the Jumeirah Beach Residences, may suggest this is a last hurrah for this district.

Finally, Offshore Dubai, which includes the Palms, has seen prices remain relatively lacklustre so far, up a relatively meagre 3.3% year-to-date, all of which can be accounted for by the rise in October. Therefore, we expect property prices, particularly in New Dubai, to peak in the coming months.

However, we believe the impact on the economy will be limited for several reasons. First, we expect the property price correction to be gradual as the developers avoid releasing properties too quickly into a declining market. Second, the Abu Dhabi property market is heading in a different direction with a supply shortage likely to be seen well into 2008. Third, we expect oil prices to remain firm, ensuring that liquidity in the region remains ample. And fourth, the diversification and investment drive is likely to remain very strong. Therefore, while the property sector may start to weaken from here, we expect economic growth to remain firm.

The data used to build Standard Chartered Bank's residential property index is taken from betterhomes Property Listings magazine and the indices are are based on AED per sq foot. A note on the data This data is not a comprehensive data source of all Dubai properties. It focuses largely on the new buildings still under onstruction or recently completed. The three zones covered in depth are 1) Offshore Dubai (the Palms, the World and Maritime City), 2) New Dubai (Dubai Marina, Springs, Meadows, Gardens, Lakes, Jumeirah Islands etc) and 3) South West Dubai (Arabian Ranches, the Investment Park, Sports City, Green Community).

The composition of the properties changes from month to month, with some properties not being present for a few months and then returning. Therefore, there are two sources of changes in prices. First is the fact that different properties are covered from month to month. And second, the price of the properties can be revised, as perceived market conditions change. As an example of the breakdown of properties, the October index is based on 956 properties. Of these, 370 properties were new additions to the spreadsheet, 391 were updating September data and the remaining 195 were updates of previous monthly data.

It is also important to note that the prices are those at which the seller is offering the property to the market while the actual transacted prices may be very significant. There are two implications of this. First, it may increase the volatility of the data. Second, it may provide a delayed response to actual market conditions. Generally, when the market turns down in property markets, it takes some time for ellers to wake up to the fact that the cycle has turned and their perspective of market conditions is out of date. However, in the absence of a better methodology, we comfort ourselves with the fact that over time they should give us an nidication of where the market is heading.

Please note the May and August data were interpolated.