Dubai Real Estate Recovery? V, W, U, L or √?

Mohanad Alwadiya interview

Mohanad Alwadiya interview in Capital Business & Finance Magazine

Interview with Mohanad Al Wadiya, Managing Director of Harbor Real Estate Brokerage

Mohanad Alwadiya is the Managing Director of Harbor Real Estate Brokerage, a real estate service provider in Dubai. As Managing Director of Harbor Real Estate Brokerage, Alwadiya is responsible for setting business direction and focus, directing all external and internal sales and marketing strategies for Harbor and its clients and producing the Harbor Report.

Alwadiya has over 12 years of strategic marketing and sales experience servicing global corporate clients. Formerly, Alwadiya was the Managing Director of Residencia Property Consultants, the Head of the Projects Marketing and Sales division for the global real estate arm of Dubai Holding and the Communications Director at Leo Burnett, Dubai. Alwadiya shared some of his thoughts on the recovery of the Dubai real estate market.

There are a lot of conflicting stories in the news about the likelihood of a recovery in the Dubai real estate industry. Where are we really?

You are right. There had been a lot of frenzied reporting … some may say speculation … as to the actual state of the Dubai property scene and where it is situated in terms of recovery. This has led to a lot of nervousness and confusion.

Reports vary, with some analysts claiming the industry has “bottomed out” and others stating that no real improvement can be expected for 18 months or more. The variance in opinion is so wide that now some analysts are critiquing and publicly disagreeing with other analysts’ suggestions as to where the industry is now and where it is heading! I believe that the market is in a phase of fragile stabilisation. The long-anticipated recovery cannot be claimed as yet despite indications through the second quarter of 2009 suggesting that the market had bottomed and that early signs of recovery may be evident.

The problem with many analysts’ views is that the breadth of considerations as to what will initiate and drive the recovery is too narrow in scope. Many observers tend to look at the real estate industry in isolation and not consider the effects of the global, regional and domestic economic performance on the Dubai real estate industry. We need to understand that the Dubai economy, and logically the Dubai real estate scene, is strongly linked to world economic events.

The pace and magnitude of Dubai’s economic recovery and its real estate industry will be largely dependent upon the global economic recovery. To gauge the primary driver of a Dubai economic recovery, we must take a global or macro view first. Consider the following schematic, which highlights the dependency of the UAE and Dubai’s economy on world economic health.

Much has changed over the last three months. We have seen the prevailing sentiment move from doom and dread to hope and optimism. This shift in sentiment has been fuelled by what some people see as being the early signs of a global economic recovery.

So, is the world economic situation improving?

Well, in some areas of the global economy, things have been looking a lot better, indicating the imminent start of a recovery.

There was a strong rebound in most financial markets during the second quarter; however, the beginning of July saw investor nervousness halt the growth on the back of poor news emanating in the US regarding unemployment.

Globally, governments have responded quickly and expansively in implementing monetary and fiscal policies to arrest the global economic decline. The positive effects of these actions implemented in the last quarter of 2008 and first quarter of 2009 started to be felt in the second quarter of 2009.

Economists in Japan, China, the US and even Europe had begun to talk about “green shoots”, or early signs that growth in those economies will start sometime early in the new year. The broad consensus is that these major economies will bottom out in the late third to early fourth quarters of 2009, despite investor nervousness being evident in early July.

Many of the actions and restructuring measures taken by companies to improve their cost structures and balance sheets in order to survive the recession have already been undertaken. In addition, the stronger companies in a wide variety of industries are looking towards strategic mergers or acquisitions which will result in entities which can weather the recessionary storm and be well-poised to take advantage of the imminent recovery. This form of industry rationalisation is healthy, as long as monopolies are not created.

In addition, the various business confidence indices which measure business sentiment around the world have also been on the rise, auguring well for the future.

As a result, stock markets around the world have risen significantly in the second quarter of this year. The generally held view is that movements in the stock market pre-empt economic growth by six to nine months, and therein lies one foundation for hope for many observers.

If you look at US markets, the Dow Jones Industrial Average has gained 27% since its March low. In China, the story is similar, with the Shanghai Composite Index showing a 47% gain since March 2 and the London FTSE gaining 19% since March 3.

The local bourse was also performing extremely well during that period. The Dubai Financial Market had risen 40% since its March low; however, the first week of July saw a sharp drop to pull gains back to a disappointing 15%. Overall, despite the volatility, which will be a feature of markets for the ensuing quarter, the overall improvement in all these financial indices indicates an improvement in confidence of those who are looking for investment growth opportunities, suggesting that a bottom to the world economic woes is somewhere in sight.

Meanwhile, the rise in oil prices had definitely stirred the hopes of many in the region. With oil prices on the rise and reaching around $70, governments around the region were looking much better placed to implement infrastructural spending in order to fuel economic growth. Oil slipped to around $66 in early July, however. If this price level is sustained, the budgeted infrastructural spending proposed by the regions’ governments should continue unhindered.

Of course, the downside to excessively high oil prices is that they may hinder global recovery and drive energy costs onto those economies that are heavily reliant on imported oil.

When will we see real recovery, not just the “green shoots” that everybody is talking about?

This is very hard to predict. You would have heard about different types of recoveries, specifically, V, W, U, L and square-root-shaped recoveries.

In his article of June 2, Will Swarts of The Wall Street Journal provided an excellent explanation of the different types of recoveries, using examples from US and Japanese historical economic performance.

So, what type of recovery would be most likely for the world and Dubai economies?

I believe that either a W-shaped or square-root-shaped recovery is the most likely candidate, but I am leaning towards the latter.

If one considers that the current “green shoots” of the recovery are being fuelled by the enormous amounts of stimulus money that governments around the world have pumped into economies, and that the positive effects of the stimulus packages will naturally be exhausted, then there is a strong likelihood that underlying fundamentals of major global economies will not have improved enough to ensure that the growth fuelled by the stimulus packages can be maintained. Put simply, the effect of the stimulus packages, while effective in arresting the slide of world economies and sparking some “green shoots”, is not sustainable. The fundamentals of economies must provide the impetus for future growth.

An example of this would be the effect of US unemployment and its implications for domestic US consumption. With an unemployment rate rising to 9% or 10%, the US economy will be deprived of one of its principal drivers, which is domestic consumption. If the effect of the stimulus packages introduced by the government wears off while domestic consumption is low due to high unemployment, economic growth would stall, causing a square-root-shaped recovery or even decline, resulting in a W-shaped recovery. Of course, this is just one example of an economic fundamental being depressed, but there are many others.

In addition, the world is likely to be a different place even after the recovery begins in earnest. The attitude towards debt financing is likely to be far more conservative by both investors and lenders. This recession has taught many players in the investment and finance space a painful lesson with regards to risk management.

I believe that the square-root-shaped recovery is more likely given the extent of co-operation, sharing and commitment to address the recession on a global scale. Never before have major industrialised nations combined forces, ideas and stood resolute to address what, at one stage, was shaping up to be a depression. In consideration of this unprecedented co-operation, I have confidence that once the economy begins to recover, that same shared resolve will not allow it to deteriorate into a W-shaped recovery.

So, what does the recovery shape mean for the Dubai real estate industry?

Obviously, everybody wants to see a V-shaped recovery. For the real estate industry, that would result in a rapid increase in the demand for all types of property. But it’s not going to happen. The previous real estate boom in Dubai was driven to a large extent by a rapidly expanding population, made up of speculators, genuine long-term investors and owner-occupiers. Overseas investment, some of it speculative, which was fuelled by favourable exchange rates and changes to property ownership rights, fuelled the growth further. This activity was supported by unhealthy levels of credit availability.

The recovery phase will need to be driven by fundamental and solid economic drivers, not speculation. Population growth, driven by an increase in commercial activity, will be the primary determinant of a real estate recovery as Dubai attracts new business entities, investors and owner-occupiers who have a long-term outlook to their participation in Dubai’s economy. The days of growth driven by speculation supported by questionable levels of credit availability will not be repeated. We are witnessing a major and much-needed step in the maturation of Dubai’s real estate industry and economy as a whole.

So, what type of recovery will the Dubai real estate industry see?

Well, once again, it is likely to be a W or a square root type of recovery. A lot depends on the recovery of the economy as a whole, but there are some factors within the industry itself which may inhibit its recovery regardless of the economy.

The issue of oversupply has received a lot of attention, with some commentators suggesting that property vacancy rates, currently estimated to be around 15%, could double in the industry by the end of 2010. While I don’t subscribe to that view, there is no doubt that the number of properties predicted to be released into the market over the next two years is a concern, as there are an estimated 70,000 new units being released in 2009 and 2010. If demand cannot be generated quickly enough as part of an overall stimulus strategy, then a W-shaped recovery becomes more likely.

We need to look at the supply situation in tandem with demand. It’s impossible to comment on one without considering the other.

The effect and magnitude of the oversupply issue on the performance of the market will be determined by a number of factors which will help generate demand for property going forward. These factors are as follows:

1. Population Growth Derived From Commerce

As stated above, Dubai’s population growth rate needs to increase. Estimates of population decline due to the recession have ranged from 8% to 20% spanning the years 2009 and 2010. Needless to say, whichever prediction proves to be the most accurate, the slide in population must be arrested.

The prime driver of population growth going forward will be commercial activity. Dubai needs to ensure that as the world economy starts to recover, it has positioned itself competitively as a place to do business. It is encouraging to see the government implement a number of initiatives to achieve this end. The first set of initiatives involves the freeze or reduction in the cost of fees and charges on business entities in Dubai. This is a positive step in ensuring that Dubai is a cost-competitive place to conduct business when compared to other regional centres.

The second initiative involves the Dubai Chamber of Commerce proposing an end to the current sponsorship system for foreign companies wishing to set up business in Dubai. The vision of having free entry for companies with few or no barriers is a grand one and, if approved by the Executive Council, will provide a major boost towards establishing Dubai as an accessible and cost-competitive place to do business.

2. Lifestyle Values

The cost of living in Dubai has been a concern for some time. With double-digit inflation in the period leading up to the recession along with spiralling rent costs, many expatriates or companies importing talent from overseas found living costs prohibitive.

While real estate sales prices and rents have fallen, much to the chagrin of investors, and inflation is less than half of what it was eight months ago, this phenomenon will be important in attracting renewed interest in the emirate and stimulating a higher level of activity in the real estate market. Already we are seeing people from neighbouring Sharjah and Abu Dhabi taking advantage of the current low prices to move to Dubai.

3. Real Estate Industry Management and Regulation

Dubai has come a long way with regards to regulating the real estate industry. While the efforts to protect rights, lift standards of professionalism and establish a transparent, credible and functional framework are to be applauded, there is still a long way to go before the industry can be said to be in the final stages of maturation. The Real Estate Regulatory Authority has been considering the viability of a number of projects and reports state that at least 27 projects will be cancelled. This form of oversight is a positive sign, as any rationalisation of developments which are currently being planned can only help alleviate any oversupply situation. It is hoped that a full, robust and decisive review will be completed and the necessary actions continue to be taken, as marginal or non-viable projects can only be considered as “toxic assets” to the industry and the overall economy.

In addition, the ongoing pursuit of transparency is paramount. One of the reasons for such diverse opinions regarding the true state of the industry is the dearth of reliable information and data. While some progress has been made, the industry is a long way from having centrally stored, accessible, reliable, upto- date and relevant information on which to base decisions.

4. Liquidity and Exchange Rates

Liquidity is starting to flow back into the market, but it needs to flow faster. With the Eibor at around 2.4% and many banks successfully increasing deposits, lenders are now in the best position in over eight months to start lending again. There has been some easing of LTV ratios by some banks and the longawaited Amlak/Tamweel merger is reportedly just around the corner. The resumption of business by this entity will help alleviate the shortage of credit available to many potential buyers who are in the market now. While many have focused on liquidity in the local market, Dubai can benefit greatly as the credit markets overseas also start to loosen up.

During times of economic hardship, investors typically seek shelter in a select number of commodities or currencies. The US dollar, despite the US economic financial meltdown, is one such currency. During the early part of the recession, this phenomenon drove the value of the US dollar, and therefore the UAE dirham, higher versus other global currencies. This made foreign investment in Dubai more expensive.

As the global economies gradually show signs of improvement, investors will convert their US dollars into other currencies to avail themselves of investment opportunities around the world. The resulting devaluation of the US dollar and, by association, the UAE dirham, increases the value available to investors from investing in the Dubai real estate scene.

5. Confidence

It was not long ago that Dubai was capturing the admiration and awe of the world. Unfortunately, the world view on Dubai has taken a turn for the worse and needs to be rebuilt.

There has been a disproportionate amount of negative press regarding Dubai since the economic crisis began and this will have damaged investor confidence in the emirate. The recent initiative to address the issue of “Brand Dubai” through the development and implementation of a global communications strategy to address incorrect or misleading assertions regarding Dubai is tremendously important. The success of this initiative will play a major role in accelerating the pace of Dubai’s recovery.

However, confidence needs to be developed in other areas as well. The visa issue is one that has placed a lot of pressure on recently retrenched expatriates when trying to find alternative employment or heading home. This will not be forgotten quickly and will certainly be a consideration of those who might consider making Dubai their long-term home.

From an investor point of view, the Department of Naturalization and Residency has implemented a law which will grant a six-month renewable visa to those who invest in freehold property in the UAE. While this is a positive move to instil confidence in potential investors, the six-month period is considered to be too limited in duration to be meaningful to many investors. It is thought that the federal law should match the Dubai law whereby investors were eligible for a three-year residency visa, provided they visited the emirate at least once every six months. This approach would appear to be far more appealing and enticing.

6. Tourism

A large part of Dubai’s success has been driven by an incredibly successful tourism industry. If one considers Dubai to be primarily a trade/commerce, services and tourism hub, the influx of tourists is vital to the overall health of the economy.

The tourism industry has been a beacon of success in the Dubai economy and plays an important role in introducing the emirate to potential investors and entrepreneurs as well as sun seekers.

7. Oil Prices

It will come as no surprise that the price of oil will help determine the health of the Gulf economies. Despite not being reliant on oil as such, Dubai, being part of the UAE federation, has and will continue to benefit from the massive revenues derived from oil. With oil prices expected to fluctuate in the range of $70 to $75 a barrel going forward, the Gulf economies can continue to acquire healthy levels of revenues to enable government investment in infrastructure without generating huge budgets deficits or accumulating debt. Also, at this level, it is not expected that oil would place undue pressure on recovering economies.

However, there is a catch. It would be disastrous if the price of oil should reach the unimaginable levels of 2008. If this were to happen, those economies which are reliant upon imported oil for their energy requirements would find economic recovery difficult to sustain. This could result in a W-shaped recovery for some of the largest economies in the world and likely effect the recovery of the world economy as a whole.

Dubai would suffer as a result of this, as its reliance on the economic activity of other economies would make it vulnerable to any downturns in trade or global commercial activity and, as we have already discussed, the Dubai real estate industry recovery would stall.

So, in summary, you are predicting a square-root-shaped recovery?

Yes. I believe that the world economy is on the road to a square-root-shaped recovery. I also believe that Dubai has the potential to benefit handsomely from that recovery.

The IMF has stated that the Gulf economies are best placed to surface from this recession. This should come as no surprise, as one thing the Gulf economies have done successfully over the last decade is to accumulate huge reserves of wealth which would serve them well during a recession. This has proven to be the case, as evidenced from the continued infrastructure spending by government authorities.

With regards to the Dubai real estate industry, there is lots of work to be done. In all likelihood, its recovery will lag the recovery of the overall economy; however, in consideration of the rampant, unsustainable growth which was being witnessed in 2008, this should come as no surprise.

It’s important to understand that the industry is not terminally ill. The industry is experiencing some serious growth pains, but will recover. I believe we will see a much improved level of activity in the later part of this year as the world economy strengthens, credit becomes more accessible and Dubai relaunches itself as a preferred place to do commerce and trade.

The current pent-up demand will flow into the market once lending starts again. Many people want to take the opportunity to own a family home or take advantage of the investment opportunities in the market today. The demand is there; it just needs some liquidity to enable the conversion of intention into transaction.

However, a word of caution. While I believe now is a good time to buy into Dubai, we cannot expect the monumental premiums of the past. Real estate is for the long-term thinker and, despite being subject to economic cycles, will always generate wealth as long as it’s considered and managed as a long-term investment.

To think any other way would be to ignore the hard lessons of the last 10 months.

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