Is Dubai building too much accommodation?

To the casual visitor Dubai looks like a city in the grip of a housing boom that can not last. Turn any street corner and yet another orchard of cranes tower on the horizon. But what is driving this boom in residential construction? And can it last?

At the fundamental level two things drive construction booms: demand and funding. Dubai has both. You only have to try to find a villa in Dubai to realize that supply and demand are out of balance.

A call to the Al Nakheel Villas close to the Dubai Internet City by AMEInfo revealed a two-year waiting list. At nearby Palm Spring Village an understandably laid-back gentleman said that the waiting list was over 150, with annual rentals from $23,000 to $26,000.

Likewise at The Lakes development Emaar Properties is filling its properties, although a 10% reduction on rentals for four-bed villas might suggest oversupply, or ambitious pricing. Its apartments for sale on 99-year leases at the Dubai Marina are also almost sold-out.

Part of the secret behind this demand is the replacement factor with plenty of demand from the tenants of older properties who want to move to somewhere better. This adds to the number of tenants from companies that are moving into the city and having to find accommodation for their expatriates.

Furthermore, funding construction is not really a problem in Dubai. Because of the way the city had grown historically, and the limitations placed on ownership, there is very little debt outstanding against most of the property in the town now earning good rentals. Hence it is relatively easy to find lenders prepared to fund new construction projects at modest interest rates. The local banks are, after all, the most over capitalized in the world and are keen to lend against bricks-and-mortar.

So could this residential construction boom end in tears? It is certainly possible that demand could slowdown with the world economy. But would rentals turn down? Probably not, as the 1998 downturn showed Dubai landlords are very reluctant to cut rents, and can usually afford to keep property vacant rather than reduce rentals.

This behavior pattern is another reason for investor confidence, as it gives a measure of protection when financing a new venture. Indeed, it is more likely that upward pressure on rental prices due to a shortage of supply will eventually choke off demand. Already people who used to live alone will combine to pool resources to rent a villa, but there is a limit to how many can squeeze into a given space.

So don't expect to see Dubai's rental prices crash, or a sudden crisis in the residential property market. This is not the way the Dubai property market works and investors looking into the emerging real estate sector should take note. The fundamentals are stronger than they appear at first sight.