Press Room
11/3/2008 Al Mal institutes coverage of UAE real estate, yields forecast to fall
Posted on 11 Mar 2008
UAE. The fundamental driver for the UAE real estate market - the existing supply and demand imbalance – should continue through 2010 in Dubai and beyond 2010 in Abu Dhabi. But Al Mal Capital said in its first research note on the sector that is expects rental yields to decline over the next four years in the UAE, driven mainly by real estate price appreciation.
The firm expects average prices to increase from AED1,400 per square foot in 2007 to roughly AED 1,800 per square foot by the end of 2008. However, the gap between the high and the low end of the market should widen over the next few.years. “We expect the difference between the 5th and 95th percentiles to grow from 165% in 2007 to 204% by 2011,” the report said.
“Within the sector, we feel Union Properties, Emaar and Deyaar represent the best opportunities for investors with 48%, 43%, and 37% up sides, respectively, to our 12 month target prices. We are initiating coverage on Union Properties, Emaar and Deyaar with an ‘outperform’ rating.”
Al Mal said the positive catalyst for these share prices should come as the market sees further proof that these companies are executing according to plan. It added that the value for ALDAR and Sorouh is for the most part already “baked into” to current valuations and therefore these firms were given a ‘market perform’ rating. RAK Properties was rated as ‘underperform’.
UAE average per square metre income levels at US$4,066 could support further rises up to US$7,200. The real estate market in the UAE has been a tremendously successful area for investors over the last five years. Looking at where the UAE real estate valuations have come from in just five years, with over 300% cumulative average appreciation, it would be impossible not to worry about current valuations.
However, Al Mal’s view is that the significant regulatory and structural changes throughout the Emirates offer more than sufficient justification for today’s real estate valuations, considering the extremely low base valuations in the earlier part of the decade. The introduction of freehold rights in specified areas of Dubai, population growth, a strong fundamental economic environment, a growing tourism and hospitality market, and substantial consumer and mortgage loan expansion have all supported the rising real estate prices.
Switch from rentals to home ownership
In order to assess the current valuations in the UAE market Al Mal compared real estate prices per square metre relative to per capita GDP throughout the world. To be conservative it eliminated London, Moscow, and New York (US$26,980, US$17,136, and US$15,933, respectively) from the analysis. It is also important to note that it has not adjusted for the 0% income tax regime in the UAE, which significantly impacts the affordability of real estate.
The UAE is currently at the low end of the range for real estate prices in countries of similar income levels. For countries with per capita GDP in the US$30,000 to US$40,000 bracket (UAE is US$35,100) the range is US$3,595 per square metre to US$14,600 per square metre. At the top of the range is France with a top marginal tax rate of 40% and at the low end is Germany with a top marginal tax rate of 42%.
Publication Type Country Circulation Date Section/Page Subject Client
Business Intelligence Online PA 300,000 11.03.08 News the Real Estate study
Al Mal Capital
The prevailing value in the UAE is at the low end of the range at US$4,066 per square metre. The implied trend value for UAE residential real estate is roughly US$7,200 per square metre. Therefore, while real estate values have come long way over the last five years, on a relative income basis there is still room for higher valuations.
Gross rental yields continue to be on the high side in the UAE. Average rental yields in the UAE, at 7.7%, are substantially higher than the levels in countries of similar income levels. Rental yields tend to decline as income levels improve. This tendency is driven by the increased ability of the population to finance the purchase of real estate rather than rent.
Though rental yields are high relative to global peers, rental costs are near relative fair value. UAE annual rent payments currently average US$314 per square metre, compared to US$194 (Germany) at the low end of the US$30,000 to US$40,000 per capita income category and US$588 per square metre (France) at the high end.
The growing mortgage market, and with purchase prices still low relative to income levels, will drive yield compression over the next four to six years. Al Mal expects rental yields to decline approximately 240 basis points on average over the next four years. However, most of the yield compression is expected to come in the low to mid price range of the market.
Difficulties of supply and demand measurement
The dilemma that we all face when looking to the UAE real estate market is to assess the “true” demand for the future housing supply, while also judging the reliability of planned supply.
Planned supply of housing units is not expected to exceed demand for the next three years. It is estimated that unit supply will be approximately 180,000 units for the three year period between 2008 and the end of 2010. However, in 2007 Al Mal projects that only 30% of planned units actually were delivered, as the industry was hit by several production constraints. Most notably, contractors were constrained by an extremely tight labour market compounded by a new labour law that required much of the existing labour force to return home and reapply for residence visas. As these issues have, for the most part, been resolved we should see gradual improvement from contractors meeting delivery schedules.
In Dubai, we can expect cumulative supply to overtake cumulative demand in early 2011. We can expect actual deliveries to ramp up from an estimated 17,000 units in 2007 and peak at roughly 66,000 units in 2010.
On the demand side, incremental household growth is expected to taper off in 2009 and 2010, before picking up again in 2011 as much of the required personnel for the expected hotel launches and other tourism related projects begins to offset declines from financial and development sector growth. Slowing growth in terms of new household entrants to Dubai should relieve some pricing pressure in 2009. However, much of that relief will be mitigated by existing pent-up demand through 2010.
In Abu Dhabi, a supply shortage is substantially clearer. Cumulative supply is not expected to match cumulative demand until beyond Al Mal's five year projections. In fact, we cannot expect a significant ramp up in deliveries until 2011.
Publication Type Country Circulation Date Section/Page Subject Client
Business Intelligence Online PA 300,000 11.03.08 News the Real Estate study
Al Mal Capital
The demand side of the equation has clearly been supported by substantial population growth over the last five years. The UAE population has grown at a CAGR over 7% since 2002 and is projected to grow at a CAGR of roughly 5% over the next five years. In terms of household units we can expect 202,000 new households in Abu Dhabi and 154,000 new households to come to Dubai over the next five years.
However, new households are not the only driver of demand. Affordability must be considered in the demand equation. In fact, price appreciation in the secondary real estate market is driven primarily by affordability ratios rather than population growth. Essentially, the biggest impact to demand is the move from renting to owning property. In this case, both the availability and cost of mortgage finance are key drivers of demand. According to data from the UAE government and the IMF, mortgage finance is still at low levels relative to global norms. It currently stands at 5.9% of GDP in the UAE, compared to 130% in the US, 70% in the UK, and even 10% in Mexico.
At prevailing mortgage rates (7% to 7.5%), a monthly payment (including principle payments) will equal between AED 115 and AED 120 per square metre, compared to AED 98 per square metre cost to rent. Embedded in the premium to own is not only the principle payment but also additional utility value for aspects such as: predictability of future payments, potential future property appreciation, and general
enjoyment from ownership.
Additionally, the combination of declining interest rates and increasing rental charges make the cost/benefit trade-off even more attractive. As the trade-off between renting and owning continues to become more attractive in the UAE, we expect a further enhancement to demand beyond that of new households moving to the UAE.
The improved attractiveness of buying versus renting means that we can anticipate pressure on rental yields over the next few years. Rental costs in the UAE are substantially higher than those other comparable markets, but property prices are substantially lower and mortgage costs are near the global average. This supports the expectation that rental costs should be relatively stable going forward, rental
yields should decline, and property prices should appreciate.
High end and low end polarising
In the Al Mal projections it has assumed that the UAE will maintain its existing currency peg for at least the next 12 months. It expects the pace of price appreciation to accelerate in 2008 at roughly 28% as inflationary pressures are passed on to consumers. Price appreciation should begin to slow in 2009 as more supply is delivered. However, we can still expect a brisk increase of 17% in 2009. The gap between
the high and the low end of the market should widen, as we expect a lack of affordability to impact the low end of the market first and consumers to further differentiate developments by location and quality.
The difference between the 5th and 95th percentiles is anticipated to grow from 165% in 2007 to 204% by 2011. The main driver of price appreciation should be rental yield compression. Al Mal has projected that yields should decline approximately 240 basis points to 5.35% over the next four years, as the rental market becomes more competitive and the rent/own trade-off continues to move in favour of ownership.
Appreciation in rental costs should slow. Al Mal projects 8% growth in rental prices for 2008, slowing to 3% by 2010. It said it expects most of the three year projected supply to be back loaded towards the end of 2009 and early 2010. However, the risks are to the downside for the three year projected supply. Inflationary pressures have forced several independent developers to delay projects until they can gain a better grasp of the cost environment. If this trend continues we would need to adjust our supply estimates downward.
Publication Type Country Circulation Date Section/Page Subject Client
Business Intelligence Online PA 300,000 11.03.08 News the Real Estate study
Al Mal Capital
Supply and currency constraints continu
Supply constraints exist throughout the UAE construction industry. Owing to significant demand on a global basis, we feel that there is little the UAE can do to address the issue of inflation other than a change in the currency regime. In the near to medium term, we expect the pricing power of the developers to continue. Hence, they should be able to cover cost inflation with price increases.
However, we can expect that in the longer term there is the threat of pricing some potential purchasers out of the market. In a worst case scenario, the pass-on effect of inflation could lead to a drying up of liquidity, followed by substantial price declines. We can expect the UAE government to address the problem prior to reaching this extreme scenario.
There has been speculation that the UAE may change its current policy of pegging the Dirham to the US Dollar. The UAE government has, to this point, stated that it would prefer to address any currency policy changes in tandem with the other members of the GCC. However, the government will have to address this issue alone in the next 18 months if inflation starts to effectively suffocate economic development, Al Mal said.
If a change in currency policy does take effect, there are three potential resolutions: 1) revalue and keep the currency peg, 2) move to a basket of currencies, or 3) move to a free floating currency. The easiest solution would be to just revalue the existing currency peg. However, this approach would improve the short term situation but not resolve the problem of importing US monetary policy to the region. Additionally, the necessary institutions (monetary policy committees or instruments) are not in place yet to manage a free floating currency.
Therefore, it would be preferable to see a move to a basket of currencies and a gradual revaluation. In the end, a stronger currency would improve the long term (beyond 5 years) outlook for the real estate sector, but would slow price appreciation in the near term. Essentially, we feel it would slow foreign speculative demand for real estate in the near term, but provide for a more stable operating environment for developers and contractors in the longer term.
Variations between the Emirates
The report also points to the wide variations in property prices between the Emirates. The government of Ras Al Khaimah granted certain plots with an aggregate area of 68 million square feet to Rak Properties. The company did not account for 52 million square feet in FY 2007 financial statements as the development work has not yet commenced on these plots of land. Currently, the balance sheet of RAK Properties is debt free and cash rich with over AED 1 billion. This provides ample opportunity to diversify into new areas and undertake additional projects beyond the borders of Ras Al Khaimah. The company may access debt markets in the near future to finance growth, and the estimates indicate that their earnings stream will comfortably meet their interest payments until year 2011.
RAK Properties has expanded its portfolio by undertaking a project in Abu Dhabi named RAK Tower. The company has also unveiled plans to expand regionally into Morocco, Egypt and Sudan in 2008. RAK Properties acquired a strategic 20% stake in Rakeen development, which has a number of key projects under development. We can expect that geographic diversification will reduce the company’s reliance on
the relatively limited real estate market in Ras al Khaimah.
Publication Type Country Circulation Date Section/Page Subject Client
Business Intelligence Online PA 300,000 11.03.08 News the Real Estate study
Al Mal Capital
Property prices in RAK provide investors ample opportunity due to its close proximity to the real estate markets of Dubai and Abu Dhabi. For investors who believe the prices of property have sky rocketed in Dubai, RAK Properties provides an attractive value proposition. Thus, investors looking to invest in a holiday home or income generating properties can look at the portfolio of RAK Properties to meet their requirement.
Construction costs are relatively similar throughout the UAE. However, property prices vary significantly among the Emirates. Therefore, the ability to pass on inflation to the consumer may be less prevalent in RAK, as in other Emirates. RAK Properties has addressed this by expanding its focus outside of RAK, which should somewhat mitigate the impact to margins.