Dubai property: Down but not out

The UAEÆs sound long-term potential will help revive real estate investments after the financial crisis eases and spending resumes.

There is nothing unique about Dubai property. Yes, the emirate experienced a property bubble, but so did more mature markets in the US, Europe and Asia. Dubai's property-related industries will smart over the short term, but in the long term, the market is likely to emerge leaner, meaner and stronger.

As if to spite the downturn, Dubai's skyline remains speckled with cranes. The slender Burj Dubai, rising at least 629 meters into the sky -- it will top out at around 818 metres when complete -- sits amid the construction site that is Emaar's Downtown Burj Dubai development. At other grade-A office centres throughout the emirate the noise of hammers still interrupts three-hour lunches.

Here's the catch. What was already under construction when the financial crisis hit is being completed but new projects have screeched to a halt. New commercial and residential property starts in Dubai are down by as much as 50%, according to Jones Lang LaSalle -- a drop equal to approximately 34.5 million square feet of office space and 100,000 residential units.

Zawya Project Tracker reported the value of cancelled or delayed projects in Dubai to be $263 billion in February. At the peak of the market in September 2008, developers had nearly $1.3 trillion worth of new properties in the pipeline.

"We have a real estate market that's under a contraction but what is important to note is that this is the first time there has been a contraction in the region," said Kamran Butt, director and head of Middle East equity research at Credit Suisse. "Dubai hasn't experienced a correction of any shape or form before. Since the freehold property laws were developed, it's been an absolute bull run where investors have experienced between 50% and 60% annual growth."

How foreigners got into the UAE property game

Dubai first opened its property market to foreigners in 2002. But it was Law Seven of 2006 that allowed for Dubai's property bubble. Otherwise known as the property ownership law, this seminal piece of legislation allowed foreigners the almost unlimited right to own real estate in the Emirate. Recognising an opportunity, investors descended on the emirate to buy properties off-plan, sparking the building boom.

"The government has [historically] owned a lot of the land and, particularly in Dubai, saw this as a great asset to leverage off," said Steven Henderson, a Dubai-based lawyer with the law firm Clifford Chance. "The only way they could do that, given the relatively smaller population of the UAE and in particular Dubai, was to offer some sort of ownership rights to foreign investors."

Since 2000, Dubai land values have risen four-fold to a market average of Dh13 million ($3.5 million) per plot -- the size of a master developed community, according to Morgan Stanley.

Under the new law, citizens of Gulf Cooperation Council (GCC) members -- Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates -- can own property anywhere in the Emirate. Non-GCC nationals were allowed the right to own property in designated areas, typically the large developments owned by Dubai's master developers, including Dubai Holding, Emaar and Nakheel. Outside these areas, non-GCC foreigners can enter long-term leases on land.

Abu Dhabi beat Dubai to the punch by passing its own free-hold property law in 2005. However, the Abu Dhabi law was more limited than Dubai's, creating a three-tier property ownership system. UAE nationals could own land anywhere in greater Abu Dhabi; GCC nationals in three designated "investment zones" and non-GCC citizens could only buy a building ownership (the underlying land would be leased) in the three investment zones.

Abu Dhabi and Dubai represent two poles on the urban growth spectrum. Further limiting real estate growth after its property law, Abu Dhabi took its time drafting an urban development plan, delaying the city's first major developments from entering the market until late 2007. By then, Dubai's land grab had long since taken off.

Dubai's bubble

"Foreign investors would sometimes invest in office and residential development projects off-plan without even visiting the country or ever seeing the properties," said Michael Atwell, head of Middle East operations for real estate consultancy Cushman & Wakefield.

Off-plan refers to units sold off of the developers' master plan, often before construction starts. Off-plan sales tend to go to investors intent on flipping the properties for a quick buck. It's impossible to know exactly how many off-plan buyers were speculators but industry experts agree to their culpability. "Off-plan sales absolutely fuelled the boom," said Henderson at Clifford Chance. "What added to the boom fire was that there were a lot of speculators entering the market."

Off-plan speculators were the driving force behind the astronomical real estate price increases for which Dubai became legendary. Morgan Stanley's property index recorded a 79% rise in prices during the 18 months to June 2008.

Investors are only partially to blame for fuelling Dubai's property bubble. Needing large amounts of up-front capital to build city-size master developments -- the tagline for Nakheel's Waterfront development exclaims: "Twice the size of Hong Kong [island]"-- developers sought large amounts of foreign investment through Dubai's nascent capital markets and off-plan sales.

Buoyed by the apparently sound fundamentals, investors flocked to Dubai. Other strong enticements included Dubai's 6.9% average annual population growth and the Emirate's plans to expand its traditional role as the Middle East's logistics hub into a global financial, logistics and leisure destination. Growth looked inevitable.

As much as two-thirds of foreign investment in Dubai went to the property market and developers owe the majority of the emirate's approximately $69 billion of non-bank debt. But the emirate had little hope when credit markets dried up and investor sentiment faltered. Property prices in Dubai have fallen over 30% since their peak in September and the Dubai Financial Market's real estate share performance index is off 77% since June.

"Off-plan sales dried up when Joe Public, who might have bought an apartment or a villa, stopped buying and the credit crunch has limited developers' ability to go to the banks to increase their level of borrowing," said Mark Blanksby, a Dubai-based construction and engineering partner at the law firm Clyde and Co. "It's a liquidity issue."

Just an hour-and-a-half down UAE highway E11 from Dubai is Abu Dhabi. The Emirati capital is not as flashy as its neighbour but turning the old maxim on its head, what's gold doesn't always glitter.

The city boomed during the past decade. With 90% of the UAE's oil, Abu Dhabi's boom was driven by hydrocarbon sales - they amount to 60% of the country's total exports and were worth $104.5 billion in 2007.

While Abu Dhabi's economy was growing and its population was predicted to grow 7% annually, its real estate was artificially stifled. In the late 1990s city leaders placed a moratorium on new residential construction, resulting in today's severe under supply.

"Even with our most gloomy predictions for demand, the undersupply is still around 10,000 units a year," said John Bullough, chief executive officer of Abu Dhabi property developer Aldar. "From my point of view, the undersupply situation in [residential and commercial] is going to continue for the next few years."

With the moratorium on construction, new residents to Abu Dhabi were often forced to live in Dubai or Al Ain, both more than an hour-and-a-half's drive from the city's central business district. Demand was so acute that at the April 2008 launch of a new development, crowd control measures were used to avoid a stampede.

Now development is underway - including city-sized Yas Island and Al Raha Beach - and it's on a grand scale. "It's important to us to look at the infrastructure before we do the development,"said Bullough. "All of our projects have preserved corridors for the LRT [light-rail transit]."

But even the best urban plan, and a significant need for housing, could not stop the downturn from hitting Abu Dhabi. According to local real estate consultancy Landmark Advisory, market prices were down as much as 30% in April from their September 2008 peak. However, with fewer projects than Dubai under construction, local developers are able to slow down and stagger project completion to better meet market needs.

"We are approaching the current situation in a very measured way," said Bullough. "We're now standing back, working out our designs to a much more advanced stage and therefore designing out risk for us and our investors in much greater certainty of the costs and end value of the projects."

Silver lining

The Asian financial crisis in the late 1990s left many of Southeast Asia's cityscapes dotted with ghost buildings. Cranes were silenced and the hulks of half-completed buildings were left to rot - many remain today, reminders of a crisis past. Despite Dubai's economic about--face, it appears to be escaping this fate. The silver lining to the whole crisis is the rapid fall in commodity prices.

According to Landmark Advisory, steel prices are down as much as 60% and other construction materials 10% to 20%. With property valuations in Dubai down 34% and expected to fall further, prices and costs appear to be meeting in the centre. "What we're finding is that to match the decline in demand, there is a similar drop-off in construction costs,"said Bullough. "We are seeing a balancing and there are other things combined that could be a huge benefit to us as a commercial organisation."

The next few years will not be easy. But Dubai and Abu Dhabi's semi-private master developers will survive the downturn, likely with some form of direct or indirect state support. "Those in power realise that [critical] projects need to be delivered to the market in five years' time and in order to do that they have to build through the recession," said Blanksby. "Given the greater availability of construction resource and lower prices, now is the perfect time to be investing in building infrastructure and key projects."

Abu Dhabi is awash in construction. There are water front high-rises, a Formula One race track and a supposedly zero-emissions green city in the desert. Yes, that's right, no emissions, or so the Masdar Initiative, the city's developer, claims. Masdar City is a $22 billion green property development in Abu Dhabi, one of the emirate's answers to its massive carbon footprint. As if responding to complaints about its mega-mall, gas guzzling culture, the city is projected to use 75% less electricity and 60% less water than a traditional property development when it is completed in 2016. It will be home to 50,000 people and employ an additional 40,000 - all of whom will park their cars outside the city walls and take personal rapid transit pods or light rail to their destinations.

Despite implementing the latest solar, waste-to-energy and wind technologies, Masdar City will not be able to generate enough electricity to power itself overnight; today's energy-storage technology is just not yet capable to store that much power. Further demonstrating their concerns about generating capacity, energy-intensive industries are barred from the city limits - instead heavy industrial and other energy hungry industries will be located in Abu Dhabi's nearby industrial estates.

Its proposition of exceeding greenness may be overstated, but Masdar City will be giving something back. The city will be a test case for various renewable energy generating techniques and one of the world's first city-size deployments of dew-catching and rainwater-harvesting technologies. The Masdar Institute of Science and Technology, developed with the assistance from the Massachusetts Institute of Technology, aims to become the global leader of green technology innovation. In addition, the city plans to sell renewably-generated electricity back to Abu Dhabi during the day to counter its night energy imports.

Whether Masdar City turns out to be the Prius of property developments - energy sipping versus game changing - or the world's first zero-emissions, zero-waste city remains to be seen. Either way, it is a fantastic idea..

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