Yield compression to drive Dubai property prices higher

There are many reasons to expect the return for landlords to start falling. For one thing the cost of funds has fallen with recent Fed interest rate cuts, and therefore the cost of capital to acquire property is cheaper.

This means that landlords can afford to pay higher prices and need a lower return on capital to provide an adequate overall return. Al Mar Capital sees rental yields falling by 2.4% over the next four years.

At the moment Dubai rental yields are very much out of line with other global cities with comparable GDP, and around double the yields obtainable in traditional hub cities.

Ownership levels low

This reflects the high demand for rental property in Dubai and the lack of availability of completed property for sale, as well as high local mortgage rates.

But as more real estate is completed and local mortgage rates fall in line with US rates then the pressure to buy rather than rent will begin to impact on rental levels. At the same time there will be more buy-to-let investment and the supply of rental property will increase depressing rents.

However, what has been happening around the world is that as more investment goes into the buy-to-let market so prices are driven up in the secondary market. In short, landlords are prepared to pay more for less rental income which is called yield compression.

So it is perfectly possible to envisage a scenario in which rents increase by a slower pace than in recent years in Dubai but property prices soar to new highs.

15% house price inflation

Standard Chartered Bank this week forecast an average growth of 15% in Dubai real estate prices with net new demand for 70,000 residential units and a supply of only 57,000. That could be optimistic, said the report, noting that only a third of the residential units planned for 2007 were actually delivered.

As the bank comments: ‘There is a concern that the market is overheated, prices are excessively high and an irrational bubble has formed. In contrast, our view is that the market is underpinned by very strong fundamentals.’

It is certainly true that the sort of yield compression typically seen in a bubble that is about to burst is just not present in Dubai. Indeed, when landlords are more concerned about capital appreciation than their rents that is usually a signal to be worried.

We have most recently seen this phenomenon in the explosion of buy-to-let investment in the US and UK which as driven rental yields to historic lows, and are now seeing the consequences. All bubbles will burst but you do need to have a bubble first.