by Parag Deulgaonkar on Sunday, January 24, 2010 Emirates Business Online
The floor in the real estate market of the UAE is likely to come in the second quarter of this year. However, the entry of distressed assets and vulture funds is yet to materialise, according to a new report.
"The floor in the direct real estate market may come in the second quarter; but recovery does not come until 2011. However, the hype surrounding the emergence of distressed asset funds has yet to materialise. Equity capital remains sidelined and property is a business that makes money when there is leverage attached – otherwise there is not enough return for 'vulture funds' – unless of course prices are sufficiently discounted," Chet Riley, Equity Research, Middle East, Nomura International, said in a report on the UAE real estate market.
"The emergence of vulture investing in 2010 may mark the low point in the current pricing cycle, but it is probably not enough to absorb oncoming supply, so any recovery may be muted," he said.
On the sector outlook, Nomura believes that pricing of real estate will remain "depressed" and may see another dip into rental deflation due to increasing supply of vacant property.
"Capital values are driven more by capital flows than rental values, but we are not seeing new capital yet," Riley said. Although 2009 was a difficult year, Nomura expects 2010 to be just as hard. "The UAE services a regional population of more than 1.5 billion and arguably is the trade hub capital of the world, so we believe it is difficult to dismiss Dubai [and the wider UAE] on long-term fundamentals," the report said.
The UAE is positioned well ahead of competing interests in the Gulf Co-operation Council in terms of timing and delivery. The valuable infrastructural framework is in place and the lead time to develop what has been installed locally is probably around five years, and this assumes that such large-scale developments could ever be financed again to the same degree.
This gives Dubai some breathing space to absorb the current excess and normalise the real estate market, but it will take some time. We are seeing signs of stabilisation, but the residual risk has not fully unwound yet, Nomura said.
"When the risk does unwind, the financially weak developments are sidelined for good and the looming oversupply situation is resolved, we will become more positive on the macro real estate fundamentals," the global investment bank said.
According to Nomura, the sector is currently in the mid-cycle with real estate secondary prices stabilising, but project financing for new or stalled developments is still virtually impossible. Until the financing of these developments can be bridged, there will be a sector stalemate – with real estate trying to transfer the purchasing risk and the banking sector not willing to accept it. The fourth quarter 2009 results and corporate commentary from real estate companies may not be as interesting as those from the banking sector, where Nomura house view remains that loan-loss provisions will expand rapidly as real estate risk is more fully recognised.
Dubai at least does capture some underlying market data points (the Land Department), and there is an increasing number of house price indices emerging. Land sales are not representative of the secondary "built" market, and there is significant variation between the value of land based on location and "in place" infrastructure and so forth.
Land sales (by transactions and value) peaked in May 2008, and the residential market peaked in August 2008 (Colliers monthly HPI). With house price indices starting to become more prevalent, Nomura said it will start to measure the causal relationships to see if land sales are an early (albeit not significant) indicator for house prices.
At the peak, Real Estate Regulatory Agency estimated that there were 800 developers in Dubai alone. The last official count suggested 473 and, intuitively, the investment bank thinks this number will shrink to fewer than 100 as "boom" cycle developments get delivered into "trough" conditions.
Nomura also believes that the fractional ownership model of commercial property in Dubai is flawed. Strata titled buildings represent around 85 per cent of the total office supply (existing and forecast) versus approximately 15 per cent in Abu Dhabi. Typically these buildings command lower rents, higher service charges, sinking maintenance funds and, therefore, lower values. "We think funded property investors will increasingly try to consolidate the ownership of commercial real estate to maximise a building's value with management-light buildings more valuable than management-intensive ones," Riley said.
The report points to property companies increasingly selling equity stakes in ongoing developments in order to "round trip" equity and de-risk balance sheets.
"We like the strategy if it diversifies the funding base and the development risk, without necessarily affecting returns. Assuming there is no shareholder dilution, third-party arrangements can be mutually beneficial; 2010 could be the year of partnering and joint ventures. We expect to see sales of development stakes and completed assets. We expect routes into new markets to take the form of joint ventures with local partners," Nomura said.
According to Nomura, development is relatively finite and capital consumptive, whereas investment properties (occupied) are cash-flow positive almost immediately. "Union Properties may buck this trend and sell mature assets to fund its current development programme. We think corporate disclosure needs to improve to re-establish investor confidence. With the evolution from developer to investment property owner, we expect to see corporate disclosure improve.
"If we have one generic criticism of UAE real estate companies, it pertains to the disclosure on property portfolios. We think occupancy, lease structures and covenants, net operating income yields, equivalent and reversionary yields should be disclosed along with relevant independent valuation summaries," Riley added.
Rental Portfolios
UAE developers have been forced to evolve rapidly and build up rental portfolios in the current market situation with Emaar and Aldar being the most advanced with revenues doubling year on year.
"Rental streams can be capitalised to provide alternate sources of funding [the securitised market remains shut, however] generally at a lower cost and increase the longevity of the business," the report said.
In November 2009, the then Union Properties Vice-Chairman Khalid bin Kalban said the company expects recurring revenues from its leasing portfolio to more than double to Dh500 million from 2010 onwards from the current Dh160m.
"About 2,000 units not sold or defaulted will be transferred to our rental portfolio. And so we expect our rental income to increase to Dh500m from next year onwards," he had said.
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