Dubai real estate reflects regional boom, Part II

The surge in real estate construction is not an issue unique to Dubai. Globally, investment in real estate, real estate investment trusts and developers has soared.

US housing starts hit a twenty-year high in 2003. House prices have soared in the UK, Europe and Asia. Hong Kong residential prices are up 20% this year alone. The FTSE 350 real estate index has outperformed the benchmark FTSE 100 by 34% over the last twelve months (and the FTSE 350 by 26%).

Questions, however, have been raised over the sustainability of the current level of investment in the real estate sector. In the near term we expect it to continue as global, regional and domestic factors remain supportive.

The lack of market indicators, such as average house prices, makes an assessment hard. Anecdotal evidence points to a current supply shortage at the premium end of the commercial and residential real estate market. Many of the high profile projects, such as the Palm Jumeriah, have already sold out despite not being built yet.

The absence of real estate price inflation also makes Dubai's boom distinctive. Outside the flagship Palm projects, prices have stayed flat. It is supply that is increasing. The sheer scope of the real estate plans in Dubai has lead to increasing worries about the risk of a glut in the future.

Although projects such as the Palm have sold out, investors, seeking to sell or lease the property later, have been the main purchasers and not homeowners. Even compared to Dubai's population projections the level of future supply looks significant.

An increase in Dubai's population to 2m people by 2010 (assuming an average household size of 2.5) implies demand for 320,000 residential units. Evenly spread that equates to 45,000 units per annum over the next seven years. One real estate developer, Emaar, is expected to add 15,000 units per annum alone.

Moreover, while demand for premium property is strong, overall occupancy rates have already begun to fall, especially in the older areas. One local property market report noted in May 2003 that average residential vacancies in certain areas had risen to 25%.

There are also historical reasons to be cautious. Dubai's current growth has echoes of previous construction booms. The example of Texas during the 1980's is interesting. The sudden spike in oil prices in 1979 caused a surge of investment in real estate, as bankers and investors sought to channel the region's new wealth.

Declining US interest rates added to liquidity. The number of residential permits doubled in two years. While the value of non-residential permits rose from USD 7.6bn in 1980 to USD 12bn annually between 1981 to 1985.The boom shrugged off the easing of oil prices, a nation wide recession and rising vacancy rates.

It was not until oil prices tumbled in 1986 that the bubble burst. From outperforming the national average growth levels from 1979 to 1982, Texas underperformed until 1990. Real estate investment did not return to growth until the 1990s.

Location, location, location

There are important differences between the Texas of the 1980s and Dubai. Crucially the Texan economy was already reeling from a significant external shock before oil prices collapsed in 1986. The worse farm crisis since the Great Depression.

At the time Texas ranked second among the US states in farm income. Also, demographic pressures for more residential and commercial property in Texas were slight. Population growth averaged 2.3% from 1982 to 1986. Finally changes in Texan tax laws in 1981 and 1982 increased the incentives to invest and speculate in real estate.

By contrast Dubai's economy is growing strongly across all sectors. Tourism is expanding, trade is already benefiting from the reconstruction in Iraq and the banking sector is performing well. According to figures from the Dubai Chamber of Commerce and Industry, tourism contributed close to 17% of Dubai's GDP in 2003 and achieved double digit growth in visitors and revenue spend, despite the impact from the war in Iraq and SARS.

Holiday makers purchasing a second home may become an important driver for the real estate market. Equally important, the UAE Central Bank has in place rules limiting direct lending to the construction sector to 20% of a bank's customer deposits.

That said, events in Texas highlight the risks involved in over investment in real estate and the rising level of vacancies in some areas of Dubai point towards caution. In particular the role of excessive bank lending in Texas underlines the importance of monitoring the UAE's financial sector and maintaining tight controls on real estate lending.

Developers should be wary of adopting 'a build and they will come' approach and future supply plans need to be tied to prudent population and economic forecasts. Another issue is the continuing uncertainty regarding the exact legal nature of freehold agreements in Dubai.

Finally, the economy, and therefore the real estate market, remains vulnerable to both economic and geopolitical risk. The latter is particularly important, given the importance of tourism to Dubai. The March Madrid attacks highlight that terrorism is a risk for any city.

Dubai's real estate boom looks set to continue. A boom bust cycle is not inevitable, but the lessons from Texas should be heeded. The level of projected real estate investment alone will support robust economic growth over the medium term. There is also a sizeable multiplier effect.

Real estate and construction now directly employ an estimated 20% of Dubai's workforce. Employment in a large number of related sectors such as sales, design and finance has also grown. This has had a knock on effect on demand for service sector jobs aimed at catering to Dubai's growing professional class.

In many ways Dubai has entered a virtuous circle of high economic growth, which attracts more companies and people, whose arrival in turn boosts the economy further.