A fact check on Dubai realty’s yields

Image Credit: Gulf News Archives In academic circles, there has been surprisingly sparse research conducted in terms of commercial real estate affordability.Image Credit: Gulf News Archives

Investor sentiment may be cautioned by low oil prices, but the strong dollar has had the most immediate and measurable impact on Dubai property. Many foreign investors are simply priced out of Dubai, especially speculators.

The remaining investors are purchasing based on sustainable, dividend-driven investment strategies. And this benefits us all.

Property speculation creates noise that conceals the signal. According to the statistician Nate Silver, the signal is the truth or the real trend that enables prediction. A low noise level is tolerable, but if the noise masks the signal, then volatility can ensue.

After two years of compression, Dubai residential yields crept up in Q4-14. Further yield appreciation will mark a healthy adjustment for the market. Office yields have compressed as well over the past few years, then remained flat in quarter four, but this will likely change.

For large commercial and residential investments, it is difficult to justify net yields below 9-10 per cent because of risk adjusted opportunity cost. Investment into an emerging market city like Dubai usually necessitates a return premium to compensate for the risk differential. There are real estate deals in key North American and European cities that pay dividends above 8 per cent for assets in markets with significantly lower risk than emerging markets.

In Dubai, 24 per cent average office vacancy increases sector risk, which should further increase the yield premium. Dubai’s office market can be subdivided into two distinct sectors with divergent risk profiles: single owner buildings and individually titled “strata” offices.

The Dubai-wide average office vacancy rate is high, but the vacancy rate for strata space is significantly higher. For example, in Business Bay, single owner buildings have an average vacancy of 22 per cent, but strata buildings have an average of 49 per cent. Until demand growth from small enterprises can absorb the supply overhang of individually titled offices, the empty units will weigh down average rents to their baseline.

Individual office units are accessible to a far larger investor base than full buildings and, unsurprisingly, these units are susceptible to greater volatility. In quarter foul 2014, individually titled office units in a sample of free sones and investment zones had an average gross yield of 6.8 per cent and the average gross yield for individually titled apartments was 6.7 per cent.

The yields are nearly identical, but the strata office market still has a large supply overhang while the residential market is near equilibrium. Without even accounting for the systemic risk of strata office product, it is clear this trend is not sustainable and should push office yields up and sale prices down.

For individual residential units as buy-to-let properties, the gross yields in Dubai are 6.7 per cent for apartments and 4.7 per cent for single-family homes. Compare this to the UK and London where individual units generate average yields of 6.3 per cent and 3.7 per cent respectively and it seems Dubai yields have room for growth.

As supply expansion puts downward pressure on residential rents, average rents will soften in most areas and, combined with upward pressure on yields, average residential sale prices should continue to decrease in the coming year. However, this is not cause for panic, because the overall residential supply-demand is still near equilibrium.

Softening rents will help correct the rampant rent inflation observed over the past two years, which, ultimately, improves affordability, controls labour costs and helps facilitate economic growth.

Currently, residential demand is soft — sales volumes decreased 43 per cent in quarter four 2014, compared to the same period in 2013. Within 2014, volumes in the second half of the year were 37 per cent lower than the first half of 2014.

Recent transaction volume contraction was caused by reduced domestic and foreign demand. Foreign direct investment depends on factors like home country real GDP growth, interest rates, and exchange rates.

For example, the 50 per cent year-on-year depreciation of the Russian rouble impacts Russian investment and second home demand for Dubai residential real estate as well as visitor numbers and average spend, which hits the hospitality and retail sectors. Generally, the now strong dollar tempers capital flows into Dubai.

Weaker currencies create relative value in foreign markets and encourage capital outflows from Dubai. The net effect is lower domestic and foreign demand. The result: a smaller investor base with yield sensitive capital.

Dubai real estate investors are as diverse as the resident population. Investors have varied financial and non-financial investment objectives that can intensify investment peaks and troughs.

Often, events in foreign markets can amplify demand and price volatility in Dubai, which, in turn, increases our market risk. Reducing that noise, even temporarily, can help Dubai return to a more sustainable trajectory of economic growth.

Stable and predictable rents may make boring headlines, but do achieve the primary purpose of property — facilitate growth of the entire economy, not just one sector.



Source: Jesse Downs, Special to Gulf News

The writer is the Managing Director of Phidar Advisory.


For Rent


View more properties

For Sale


View more properties