Two years after the “new normal” hypothesis was first applied to Dubai’s real estate market, it has suddenly become mainstream thinking. In late 2013, talk of any caution in the real estate market was met with scorn by analysts and investors alike.
Sentiments were at their zenith, and talk of any correction in asset prices, as well as any expectations of lower returns going forward, were rubbished on the grounds of the expected demand that was to be in the pipeline as Dubai marched on towards 2020. Even as oil prices fell and the dollar appreciated, reports abounded that any negative impact on the market would be minimal.
The projected stimulus by way of large construction projects was itself going to be a catalyst for further demand, and rents and prices were to march higher and all investors and developers had to do was to sit back and reap the benefits. Two years and a 25-30 per cent price correction later, the analyst community has switched gears and is now largely warning of further price “consolidation”.
Despite the change in the macroeconomic environment, valuation metrics in 2013 were already flashing warning signs that were largely ignored. Conversely, with sentiment at the lowest levels in three years, the underlying market dynamics are revealing that there might actually be a turnaround on the horizon.
It is the nature of this turnaround — and the lack of adhering to market valuations — in the first place that deserves scrutiny.
Dubai’s real estate market has been dependent on foreign capital flows. The secular dollar decline since the advent of the freehold phenomena is what fuelled phase one of the construction boom, as foreign investors flocked in to capitalise on inexpensive asset prices.
With high rental yields, a strong job market, and superior infrastructure coupled with luxury lifestyle, Dubai became a destination for second- and holiday-homes, amid a backdrop of affluent expatriates starting to buy homes for end use (this has been a more gradual phenomena). Even as asset prices recovered after the 2008 recession, valuation metrics that flashed warning signs of a luxury market that was oversupplied were ignored as developers raced to announce one superlative project after the next.
It was only when the dollar started to surge did the slowdown become apparent, and even then developers were resistant to reduce prices, instead choosing to offer payment plans to stimulate demand. However, in the backdrop of higher interest rates following the end of the QE programme and the fall in oil prices, the drying up of liquidity meant secondary market prices started to fall as investors chose to wait on the sidelines, especially as supply concerns started to become more apparent.
Talk of “affordable” housing suddenly became in vogue, and even though a select few developers started offering such products, by and large the strategy to serve the upper end of the market has remained in place. This accentuated the price pressure in this segment, causing prices to fall, as investors began to liquidate assets in response to concerns of excessive valuations, similar to the concerns of “unicorn” valuations in the technology sector.
Domestic equity markets led the way down, highlighting investor anxiety of future spending cuts and the resultant impact it would have on economic growth.
However, recent evidence has started to emerge from the transactional data that there has been a gradual accumulation of real estate assets at lower price levels, as “smart money” begins to capitalise on low price levels. The expected fiscal stimulus by way of infrastructure spending broadly remains in place, and with recent legislation, Dubai has started to open up infrastructure plays to the private sector, enabling institutional money flows to take advantage of this projected spending.
More specifically, supply concerns appear to be exaggerated as developers start to push back expected completion dates in response to the reduction of demand for off-plan projects. This implies that the market forces are already starting to self-correct by reacting to negative price signals, indicating the supply overhang is unlikely to play as prominent a role as analysts fear.
The nature of the turnaround will probably be governed by the “new normal” hypothesis. It is unlikely that prices will move substantially higher in the short to medium term. Instead there will be a snapping up of “distressed” deals but the market movements will likely be gradual.
This phenomena appears to be manifesting itself in global real estate markets as well, as property as an asset class moves away from the “flipping” model and back towards a more long term capital appreciation. And one where end users exert more influence, especially as US interest rates start to rise.
The cycle of real estate for the next few years will be one where end user demand is anticipated and nurtured, and it is this macro play that is currently underway, a play where the patient investor is rewarded for swimming against the tide.
— The writer is Managing Director of Global Capital Partners.