Dubai's Changing Skyline II (page 1 of 2)

One of the biggest concerns in recent times for the outlook for the UAE economy has been the risk that a property bubble is developing and could later implode leading to a sharp deterioration in the outlook for the local economy. We feel this argument is oversimplified for several reasons, which we outline below. We also unveil our new Dubai residential real estate index, which tracks price changes for the market as a whole and has villa and apartment sub-indices.

In April 2004, we wrote about Dubai's changing skyline. At that time, the emirate was already planning two artificial Palm Island developments, 190 new residential towers in Dubai Marina and the tallest building in the world (Burj Dubai). Since then, a third Palm has been added to the list (Palm Deira, due to be completed in 2010), as has The World development (which features
250-300 small islands in the shape of the world map) and another contender to the tallest tower in the world (Al Burj - Burj means 'tower' in Arabic). Meanwhile, in November, the emirate saw the opening of the Mall of the Emirates, which includes the region's first indoor ski slope and is claimed to be the largest mall outside of North America and the third largest in the world.

To the uninitiated, this sounds like a bubble. Normally, when a small country or a city is building the tallest building in the world, such decisions are viewed as a signal of excess rather than being grounded in commercial realities. So with Dubai having two rivals for this slot, surely this is a boom that is in its final stages?

Clearly property markets are booming. Property prices have approximately doubled in the past three years. Meanwhile, despite many rumours about the property market having weakened in recent times, our new real estate index, which covers almost 2500 properties, suggests that property prices rose further in January by 3.7% (while prices for villas fell 2.8%, apartment prices rose over 10%). Therefore, it appears as if market sentiment remains solid.

The reason for this strength is a demand-supply imbalance. Demand has grown due to four factors. First, and most important, has been the dramatic increased need for housing for people moving to Dubai to take advantage of the huge acceleration in economic activity. At the regional level, this is largely due to high oil prices. However, for Dubai, this is much less important as even following the recent bounce in prices, oil production accounted for an estimated 5.8% of GDP in 2005. For Dubai, the more important driving factor, ironically due to the fact that its oil reserves are due to run out in the next decade or so, is the accelerated efforts to diversify its economy into the areas of finance, tourism and commerce.

Second, the liberalisation of real estate ownership laws means foreigners are now allowed to purchase property in Dubai. While some of the legal issues have yet to be fully clarified, this has encouraged those who have moved to the emirate to purchase property rather than rent it. Meanwhile, indications that property owners in the emirate will be allowed residency status has led to significant purchases from elsewhere in the region due to the UAE's perception as a financial safe-haven.

Three, high rental yields have encouraged purchases by true investors as even leveraged investors can achieve a good positive cash flow. Indeed, in the past year or so, rents have gone up as much as 40% and the pace of rent inflation has been addressed by a government decision to cap rental increases at 15% for the year to December 2006.

Finally, there is no doubt that speculators have also played a significant part in the rise in property prices.