RIYADH: Most of us have heard the Dubai story: small Gulf emirate not rich in oil decides to diversify its economy, executes it marvelously – and suddenly has the rug pulled out from under it due to its utilisation of debt in achieving growth. Against this backdrop, a lot of people have asked me about investing in property in Dubai. This article is an attempt to analyse in simple terms whether any directional bet can be taken.
According to the International Monetary Fund, the total debt of Dubai and its government related entities (GREs) stands at $109 billion, or around 125% of its GDP – comparable to the 150% debt-to-GDP ratio of Greece. According to the Bank of America, $15 billion of these loans are due or to be refinanced in 2012. The situation is not as dire as Greece though, as Abu Dhabi has above $600 billion in assets and is expected to come to the emirate’s rescue. To the lay investor, the resolution to Dubai’s problems may simply seem to mean Abu Dhabi forking out a chunk from its fat wallet, but the situation is slightly more complicated.
The 2008 global financial crises dented investor confidence and led to a decline in real estate prices. In December 2009, when property sales had all but dried up and Nakheel (the property developer) was due for a $4.1 billion debt repayment, Abu Dhabi coughed up $10 billion. However, this payment was made at crunch time: after global markets had taken the scare and rating agencies had downgraded related entities. So, why did Abu Dhabi wait?
Even though Abu Dhabi should and most likely will help in meeting Dubai’s financial commitments over the medium-term due to latter’s immense importance to the economy, what it is unlikely to tolerate is another round of debt fuelled growth as it will result in a creation of the moral hazard problem common to insurance. This is key, in that it means that terms will be set for every bailout, and Dubai will have to be much more cautious going forward.
Let us judge Dubai’s importance here. Abu Dhabi produces 90% of the oil in UAE. In contrast, Dubai produces only 2 per cent, but accounts for 40% of country GDP. Real estate and construction (22%), trading (31%), financial services (11%) form the major part of its annual output. These non-oil sectors have helped its GDP grow by 13% per annum between 1995 and 2011.
Dubai is expected to generate $8.2 billion in 2012 in public revenue, of which 40% is to be spent on infrastructure, transportation and economic development. There are two things to note here. Firstly, revenue is a mere 10% of GDP because of no direct income taxes: oil and gas contribute 11% of revenue, customs duty 22% and 60% comes from administrative fees. Secondly, the current outstanding debt is 13 times annual government revenue. The bottom line is that investors should focus on the balance sheet of Dubai.
When real estate prices crashed, developers suffered because the value of the unsold stock fell and payments dried up on under-construction projects. Even then, going by Emaar’s books, the company still seems to be able to book some profit on unit sales. The key question is whether it can make these sales fast enough to pay off debt maturities. Similarly, for Dubai as a whole, the assets of GREs are certainly greater than the overall debt in my opinion, primarily because of large differentials in land cost and market values.
With that in mind, let’s look at real estate prices. Between 1995 and 2011, Dubai’s population growth has been a remarkable 7 per cent per annum. No wonder, then, that the real estate market was booming. Prices grew by about 25% per annum between 2002 and 2008. Unit prices doubled between the first quarter of 2007 and the third quarter of 2008 alone, according to the Collier’s index, before halving from the peak.
UBS estimates put Dubai housing stock at 360,000 for 2011. This does not seem enough for a population of two million people. However, I estimate that 30% of the population is labor, living in combined accommodations or low-income housing. Thus, taking the official average household size of 5.1, there is an oversupply of 70,000 units in middle to high-income units.
I believe that this glut may be covered in the coming years as new projects have been cancelled. Dubai’s borrowed money was generally well spent, before the over-building of luxury units became its Achilles Heel. However, the image of a great happening lifestyle and world class infrastructure combined with good law and order, aided by the spillover from Abu Dhabi’s development, may still enable a recovery for Dubai. Its pace, however, will be much more mellowed; as limited government revenue collection and spending is unlikely to drive growth.
Dubai properties as a whole may or may not have bottomed till debt issues are taken care of. Nonetheless, some properties are available cheap. I would recommend playing safe, and buy at a maximum 25% above estimated construction and reasonable land costs for a unit; whether villas or apartments. Any fancy finishing reflected in prices should be avoided. A decent rental yield (upwards of 4%) will be icing on the cake if above parameters are met. This will limit downside in case a future debt crises stalls confidence again.
The writer works as an economist and portfolio manager.
Published in The Express Tribune, March 12th, 2012.
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