Thursday 16, February 2017 by Jessica Combes

Another tough year for UAE real estate market amid currency woes

The UAE’s real estate sector faces another difficult year after a correction in 2016, according to ratings agency S&P.

With the fallout from low oil prices, a weak pound sterling, and the rising cost of tourism, it is no surprise that 2016 was a tough year for the real estate market. Dubai's residential prices dropped between eight and 11 per cent on average, and rent fell by six per cent according to, with most areas of the city affected. The struggle is set to continue into 2017 as currency pressures persist and residential prices and rents are likely to continue to fall.

The pound declined by 17 per cent versus the US dollar in the past 12 months due to Brexit fears. The evolution of the pound remains a concern for the UAE as the UK is traditionally among the top three source markets for visitors to Dubai, and UK nationals were the fourth largest investor in residential real estate in the first half of 2016. The UK, specifically London, is a preferred market for value-driven Gulf Cooperation Council (GCC) investors and, some investments were diverted from the UAE. Nevertheless, the UAE still appears to be a good market for investors seeking yield–despite the strong dollar–as rents have held up better than residential prices, however, we expect this to change soon.

The UAE is becoming increasingly expensive for tourists and shoppers as the US dollar continues to appreciate. Along with the pound, the euro, Chinese yuan renminbi, and Indian rupee have declined by three per cent, seven per cent, and two per cent, respectively. If currency pressures persist, Dubai could potentially lose its coveted status as an international shopper's paradise and have to concentrate its customer base on GCC travellers.

The profile of visitors is shifting to a value-conscious tourist who might spend less per trip than a tourist the year before. This thwarts growth in the retail, restaurant, hospitality, and entertainment sectors. Therefore, international retailers will need to adjust prices in the market to keep shoppers spending.

The UAE is considerably dependent on oil with 30 per cent of GDP derived from oil-related activates, despite many measures to diversify its economy, especially in Abu Dhabi, where 50 per cent of GDP relies on oil. With oil at about $50-$55 per barrel, which is just half of what it used to be at its 2014 peak, economies are still adjusting to the new price environment both on the revenue and expenditure side.

 Dubai's economy has very little direct dependence on oil, however, indirect effects of low oil prices in 2016 include diminishing purchasing power, weakened investor sentiment leading to lower investments from the region, and slowing business activities of non-oil private companies. Although the January 2017 UAE Non-Oil Private Sector Purchasing Managers' Index did show signs of steady growth and posted the highest reading since July 2016, signalling output expansion and new order growth, this is nowhere near its September 2014 peak.

Despite multiple macroeconomic pressures, S&P upgraded two UAE real estate companies during 2016. The rating on Aldar Properties PJSC was raised to 'BBB' from 'BBB-' on the back of its improved financial performance thanks to the transition of its business model, which now generates significant profitability from more stable and predictable rental and development activities.

DIFC Investments LLC (DIFC) was also upgraded to 'BBB' from 'BBB-' as it continues to outperform the wider office market due to its strong competitive advantage of being located in the only financial-free zone in the Emirate of Dubai where most tenant demand is concentrated.

While 2016 was a tumultuous year, some positives can be drawn. Tourist arrivals remained resilient, even growing by four per cent to 13.3 million, year-to-date November 2016, according to the Department of Tourism and Commerce Marketing (DTCM Dubai).

Oil prices seem to have stabilised. S&P revised its oil price assumptions upward in December following an OPEC agreement to cut production by 1.2 million barrels a day in concert with a reduction of 558,000 barrels per day by non-OPEC members.

For the coming year, S&P sees no signs of market improvement for the UAE real estate sector, despite housing affordability improving from the current price environment.

Residential prices and rents Are expected to fall by another five to 10 per cent in Dubai in 2017. In 2016, approximately 15,000 housing units were delivered in Dubai, according to Jones Lang LaSalle's 2016 report, adding three per cent to overall supply. In 2017, the two largest rated developers, Emaar Properties PJSC and Damac Real Estate Development Ltd., together representing about 35 to 40 per cent of total project launches, are expected to deliver between 5,000-5,500 units in Dubai.

Assuming the remaining competitors deliver a slightly lower volume, the market may absorb a residential supply of at least 10,000 to 11,000 units in 2017, which is more or less in line with the long-term average. Therefore S&P does not expect this steady supply to act as a catalyst to currency effects, but could potentially add further downward pressure on residential prices.

While a decline in sale prices is likely to affect the older stock more than the newly-built units, this is subject to localisation. In Abu Dhabi, weak investor sentiment is expected to weigh on residential prices while rents will decline due to suppressed demand, and most weaknesses are likely to concentrate in the areas with lower asset quality and think the flight to quality assets will continue in 2017.

Despite a number of new attractions and malls opening in Dubai, improving its appeal as a tourist destination, there has been a small decline in the length of hotel guests' stays to 3.6 nights from 3.7 as of November 2016, according to DTCM Dubai. Hotels continue to cut average daily rates (ADRs) in order to keep occupancies high. Quoting the same report, ADRs were down by more than 10 per cent while occupancies remained high at 78 per cent, up from 77 per cent in 2015. The situation is not dissimilar in neighbouring Abu Dhabi where prices and occupancy rates are also declining. Due to the number of hotel rooms in the delivery pipeline ahead of Expo 2020, we think hotel operators and owners will continue to struggle as supply should continue outpacing demand, at least for the next 12-24 months, weighing on ADRs and occupancy.

Rents could stabilise in the office segment's top-tier assets thanks to the limited supply in 2016. Grade B assets continue to struggle with vacancy and lower rents both in Dubai and Abu Dhabi, while corporate activity is likely to be subdued during most of 2017 and with a continued stabilisation trend. Sales have declined for most retailers in 2016, indicating lower average spending when footfall is stable. Both the Dubai Mall and Mall of the Emirates reported flat footfall versus 2015.

The most affected segments include luxury products, electronics, furniture, and jewellery. Due to the strengthening US dollar and prevailing softer market conditions, we think that retail rents will stabilise in 2017 and turnover rents will reduce as a percentage of total rents. While GCC online sales only account for one per cent of total sales, ecommerce penetration has increased in 2016 and poses a potential threat to brick and mortar retail.

S&P does not foresee major negative movements in its real estate sector ratings over the next 12 to 18 months. This view is reflected in its stable outlook for all of the seven UAE real estate companies rated across different segments.

S&P’s rated developers will probably be able to absorb the anticipated decline in house prices in 2017 due to their strong balance sheets and low debt burdens. Rated developers are also shielded because they primarily operate on the pre-sale model, which means the property investor effectively funds the construction. While pressure is building, it is likely margins will decrease going forward because the rate per square foot for new product seems to be softening by five to 10 per cent. However, due to the recent adoption of IFRS15, which allows for revenue recognition on the basis of the percentage of completion of units under construction, a staggered effect on margins over the next few years is expected.

Developers need to maintain the asset quality of developments and therefore seem to be economising the size of villas and apartments to make new product affordable for buyers. Therefore, many products are on offer for AED 1 million - AED2 million to cater to the middle-income market. S&P has also seen an easing of payment terms on some off-plan properties weighing on developers' balance sheet funding. A significant expansion of such schemes could therefore prompt the agency to review its outlook on the sector. Developers' ratios of average debt to EBITDA are forecast at about 1.2x and funds from operations to debt of more than 80 per cent in 2017.

In our view, UAE real estate companies will not be negatively affected by the stabilisation in rents, for both retail and office, and will maintain high occupancy rates. This is based on companies' significant competitive advantages, including desirable locations, very high asset quality, long-lease structures, brand reputation, and a prudent cost structure. We expect real estate companies' ratios of average debt to debt plus equity ratio will remain at about 25 per cent and interest coverage will remain at more than 6.0x in 2017. All of S&P’s rated real estate companies have secured lease structures with long-lease tenures and more than 90 per cent occupancies across the portfolio.

The government's commitment toward tourism is evidenced by the large number of projects that have been delivered or scheduled, such as multiple theme parks in Dubai and the Louvre Museum in Abu Dhabi. Recently, the UAE extended visas on arrival to Russian tourists making Dubai slightly more accessible. According to the Dubai Expo 2020 Bureau, it is understood that a large number of contracts were awarded in 2016, investing more than AED2 billion into the economy. The Dubai government's latest budget promises more infrastructure related expenditure in 2017, including construction contracts worth AED11 billion on the Dubai Expo site and as many as 3,500 new job opportunities to support the economy.

It is considered a positive that the government is making a conscious effort to help the real estate market develop and flourish by introducing new regulations that promote transparency and security for international investors. For example, Abu Dhabi introduced new property laws with escrow accounts, regulations on off-plan sales, mortgage limits, and compensation for delayed projects, and there is a growing share of mortgage financing in the secondary market, which is a sign of market resilience, although it remains at a moderate level. For example, the mortgage-to-sales ratio in Dubai improved to 50 per cent in 2016 versus 28 per cent in 2010. Such initiatives demonstrate that the operating environment in the UAE is much more stable than during the last economic downturn in 2009 and that, with the right support, the real estate market should eventually emerge more mature than ever before.


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