Dubai property: Down but not out

There is nothing unique about Dubai property. Yes, the emirate experienced a property bubble, but so did more mature markets in the US, Europe and Asia. Dubai's property-related industries will smart over the short term, but in the long term, the market is likely to emerge leaner, meaner and stronger.

As if to spite the downturn, Dubai's skyline remains speckled with cranes. The slender Burj Dubai, rising at least 629 meters into the sky -- it will top out at around 818 metres when complete -- sits amid the construction site that is Emaar's Downtown Burj Dubai development. At other grade-A office centres throughout the emirate the noise of hammers still interrupts three-hour lunches.

Here's the catch. What was already under construction when the financial crisis hit is being completed but new projects have screeched to a halt. New commercial and residential property starts in Dubai are down by as much as 50%, according to Jones Lang LaSalle -- a drop equal to approximately 34.5 million square feet of office space and 100,000 residential units.

Zawya Project Tracker reported the value of cancelled or delayed projects in Dubai to be $263 billion in February. At the peak of the market in September 2008, developers had nearly $1.3 trillion worth of new properties in the pipeline.

"We have a real estate market that's under a contraction but what is important to note is that this is the first time there has been a contraction in the region," said Kamran Butt, director and head of Middle East equity research at Credit Suisse. "Dubai hasn't experienced a correction of any shape or form before. Since the freehold property laws were developed, it's been an absolute bull run where investors have experienced between 50% and 60% annual growth."

How foreigners got into the UAE property game

Dubai first opened its property market to foreigners in 2002. But it was Law Seven of 2006 that allowed for Dubai's property bubble. Otherwise known as the property ownership law, this seminal piece of legislation allowed foreigners the almost unlimited right to own real estate in the Emirate. Recognising an opportunity, investors descended on the emirate to buy properties off-plan, sparking the building boom.

"The government has [historically] owned a lot of the land and, particularly in Dubai, saw this as a great asset to leverage off," said Steven Henderson, a Dubai-based lawyer with the law firm Clifford Chance. "The only way they could do that, given the relatively smaller population of the UAE and in particular Dubai, was to offer some sort of ownership rights to foreign investors."

Since 2000, Dubai land values have risen four-fold to a market average of Dh13 million ($3.5 million) per plot -- the size of a master developed community, according to Morgan Stanley.

Under the new law, citizens of Gulf Cooperation Council (GCC) members -- Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates -- can own property anywhere in the Emirate. Non-GCC nationals were allowed the right to own property in designated areas, typically the large developments owned by Dubai's master developers, including Dubai Holding, Emaar and Nakheel. Outside these areas, non-GCC foreigners can enter long-term leases on land.

Abu Dhabi beat Dubai to the punch by passing its own free-hold property law in 2005. However, the Abu Dhabi law was more limited than Dubai's, creating a three-tier property ownership system. UAE nationals could own land anywhere in greater Abu Dhabi; GCC nationals in three designated "investment zones" and non-GCC citizens could only buy a building ownership (the underlying land would be leased) in the three investment zones.

Abu Dhabi and Dubai represent two poles on the urban growth spectrum. Further limiting real estate growth after its property law, Abu Dhabi took its time drafting an urban development plan, delaying the city's first major developments from entering the market until late 2007. By then, Dubai's land grab had long since taken off.

Dubai's bubble

"Foreign investors would sometimes invest in office and residential development projects off-plan without even visiting the country or ever seeing the properties," said Michael Atwell, head of Middle East operations for real estate consultancy Cushman & Wakefield.

Off-plan refers to units sold off of the developers' master plan, often before construction starts. Off-plan sales tend to go to investors intent on flipping the properties for a quick buck. It's impossible to know exactly how many off-plan buyers were speculators but industry experts agree to their culpability. "Off-plan sales absolutely fuelled the boom," said Henderson at Clifford Chance. "What added to the boom fire was that there were a lot of speculators entering the market."

Off-plan speculators were the driving force behind the astronomical real estate price increases for which Dubai became legendary. Morgan Stanley's property index recorded a 79% rise in prices during the 18 months to June 2008.

Investors are only partially to blame for fuelling Dubai's property bubble. Needing large amounts of up-front capital to build city-size master developments -- the tagline for Nakheel's Waterfront development exclaims: "Twice the size of Hong Kong [island]"-- developers sought large amounts of foreign investment through Dubai's nascent capital markets and off-plan sales.

Buoyed by the apparently sound fundamentals, investors flocked to Dubai. Other strong enticements included Dubai's 6.9% average annual population growth and the Emirate's plans to expand its traditional role as the Middle East's logistics hub into a global financial, logistics and leisure destination. Growth looked inevitable.

As much as two-thirds of foreign investment in Dubai went to the property market and developers owe the majority of the emirate's approximately $69 billion of non-bank debt. But the emirate had little hope when credit markets dried up and investor sentiment faltered. Property prices in Dubai have fallen over 30% since their peak in September and the Dubai Financial Market's real estate share performance index is off 77% since June.

"Off-plan sales dried up when Joe Public, who might have bought an apartment or a villa, stopped buying and the credit crunch has limited developers' ability to go to the banks to increase their level of borrowing," said Mark Blanksby, a Dubai-based construction and engineering partner at the law firm Clyde and Co. "It's a liquidity issue."