Dubai, unlike other sovereigns in the Gulf Cooperation Countries (GCC), is not an oil economy and has instead made its name as an international business hub in the region. As with most service-led economies, the real estate sector has become an important contributor—representing about 7% of nominal GDP, alongside construction activities also at about 7%–and a barometer of investor sentiment in Dubai. The real estate sector has proven to be volatile, subject to the indirect economic effects of swings in oil prices but also somewhat to geopolitical risk. The Dubai property market's long decline since a peak in second-half 2014 has prompted speculation about when it will reach bottom and begin to rebound. We expect property prices to stabilize by 2020, but do not see any meaningful recovery in 2021.
We expect the Dubai residential real estate market to fare no better in 2019 than in 2018, in the base case scenario that S&P Global Ratings uses in its ratings analysis on entities in the emirate.
Since their last peak in 2014, prices and rents have fallen 25%-33% in nominal terms (according to Asteco). S&P Global Ratings expects prices to fall by another 5%-10% in 2019, coming close to levels seen at the bottom of the last cycle in 2010 (see table 1). While we expect prices to largely stabilize in 2020, we don't see a meaningful recovery in 2021. Relative to the previous recovery cycle, we believe it will take a longer time for prices to display a meaningful recovery.
Our latest base case is for Brent to remain flat at $55 in 2019. Furthermore, global interest rates are also relatively higher now, marking the end to accommodative monetary policies. Plus, we believe fewer ongoing developments will be stopped or delayed than in past downturns because the current downturn has been slower and more gradual, thanks to increased regulation of the sector that requires prefunding of construction and relatively high presales for ongoing developments. We think this means it will take longer for the market to reach equilibrium, in other words, a slower and more gradual decline and subsequent recovery.
Despite significant additional supply to the market in 2019 and 2020 from existing projects, several factors should help to stabilize the real estate market next year:
– We see very few, if any, major new project launches in 2019 and 2020, as developers pull back supply in response to lower margins due to falling prices.
– Improved affordability following price falls and bargain hunting by bulk buyers.
– Resurgence of Asian, especially Chinese, investors' interest in Dubai residential real estate.
– Relaxed regulations about the foreign ownership of businesses located outside of free zones supporting demand.
– The UAE central bank's removal of the 20% cap on bank real estate lending as a percentage of total deposits, together with relatively low-interest rates.
– Increased economic activity related to Dubai Expo 2020, which is expected to attract about 25 million visitors to the emirate.
– Relaxed visa rules, such as long-term residency visas for foreign investors who invest UAE dirham (AED) 5 million-10 million ($1.4 million-$2.8 million) in real estate projects.
– Reduction of government fees to 2.5% from 5% of the annual rent of commercial establishments.
Further Downside Possible If Developers Continue To Launch New Projects In 2019-2020
While not our base case scenario, a stress scenario could arise if supply isn't reigned in, especially if government and royal family-related developers (Emaar Properties PJSC, BBB-/Stable/–; Meraas; Dubai Properties; and Nakheel), with attractive land banks and economies of scale, continue to launch new development. In such a scenario, we think residential real estate prices could decline by 10%-15% in 2019 and a further 5-10% in 2020.
In our view, risks related to the real estate sectors in our base case scenario are well reflected in the ratings on banks in Dubai. They assume that banks' exposure to the sector doesn't increase significantly following the recent end to the 20% cap on real estate exposures by the central bank. We estimate banks' exposure to real estate developments at about 20% of total loans on Sept. 30, 2018, at AED305 billion. Our data include both exposure to construction (about 25% of the exposures) and the real estate sector (about 75% of the exposures).
The market is still dominated by cash buyers. Reportedly, mortgages finance about only 20% of transactions. The Central Bank of the UAE doesn't disclose the exact amount of banks' mortgage lending exposures. We estimate banks' total stock of mortgage loans was AED99 billion on Sept. 30, 2018, assuming it represents around 30% of total retail lending.
Trends In Real Estate Market Segments
We expect residential real estate prices in Dubai to continue falling this year as they have in 2018. Prices dropped 8%-9% in 2018, according to JLL and about 10%-13% according to Asteco. Residential prices have declined gradually since peaking in second-half 2014, in tandem with lower oil prices, but the trend did not reverse when oil prices recovered and stabilized in 2018, perhaps due to supply and demand imbalances or due to heightened geopolitical risk. The number of units under construction has surged in the last two years, with developers offering aggressive sales incentives, such as payments of up to eight years after handover, registration fee waivers, and service charge discounts. This means a significant amount of new stock will come to market in the next two to three years, constraining recovery in property and rental prices.
The city's property developers delivered 23,000 units in 2018, up 35% from 17,000 in 2017, according to JLL. The overall supply of residential units grew by about 5% (see chart 5). JLL estimates 62,000 units are expected to be delivered in 2019, although historical realization rates have been less than 50% of their initial estimates. If 31,000 units are delivered in 2019, residential supply will grow by about 6%.
About 75% of real estate transactions in Dubai (excluding land transactions) are conducted in cash, suggesting higher contributions from high-net-worth individuals, with about 20% financed through mortgages and 5% "others," according to the Dubai Land Department.