In a market where rental yields and sales prices are on the decline, the investor may not have much to cheer about. However, the transformation in the market brings along opportunities for the discerning investor. Given the emerging situation, looking long-term and making the best possible use of the existing market forces could make all the difference.

Decline in rents

According to the Dubai Chamber of Commerce's September report, both sales price and rents will continue trending downward for the near term. Asteco made a similar prediction in their Dubai Q3 Report 2010, noting that while transaction volume remained stable in Q3 over Q2, "additional price adjustments are expected in the near future," largely due to a steady stream of new inventory. Still, the report offered a positive perspective of Q3 transaction volumes in light of the season. "The number of transactions, which are generally at their lowest during the summer and Ramadan, has been surprisingly active with a number of people taking advantage of the quiet months to look for value for money accommodation. Therefore, the drop in rents has proved to be less significant than in Q2. Although further declines across the board cannot be ruled out, the drop in [Discovery Gardens and JLT] is expected to be less noteworthy due to the already lower rents."

In fact, the report cites greater stability in the emirate's "affordable apartment developments, such as Discovery Gardens and Jumeirah Lakes Towers (JLT), where the sales price remained at Dh500 and Dh750 per square feet respectively for the three months to the end of September."

At the other end of the spectrum, where prices are declining faster than rents, rental yields are actually on the rise where, in reaction to a relatively stagnant market, some sellers are reducing asking prices significantly. As a result, it would seem that a new pattern of investment could be emerging in Dubai, a pattern that begins with what Elaine Jones, CEO of Asteco Property Management, calls "… a change in focus in the real estate sector as maximising rental yields and long-term capital appreciation takes precedence over short-term sale profits, with pro-active property management being a key factor."

Quality of transactions

Speculators are long gone, inventory is ample, and renters continue to migrate to Dubai from both Sharjah and Abu Dhabi. While overall transactions are relatively low, especially when compared to historical peaks, it bears investigating not the quantity, but the quality of transactions in the market. In his August commentary in this magazine, Kosta Giannopoulos, manager for residential sales at Better Homes, describes a particular mode of investment that conforms to a longer term vision of Dubai property investment. "Many investors are looking for small purchases that can be rented out for marginal yields of 5 to 6 per cent which beats the returns that their deposits can generate in banks outside the UAE; as the property values are low, these acquisitions will appreciate overtime, making this an opportune time for your clients to get a great deal."

To get a sense of how this particular strategy might play out in the current investment climate, and how common it might be, we spoke to a number of real estate professionals.

Thomas Bunker, an investment sales consultant with Better Homes, correlated Gianoppoulos's comments with a trend towards a more patient style of investment. "We are seeing more and more investors in the market looking for rental properties rather than properties they can flip within 6-12 months. The investors believe that the properties should appreciate over the next two-three years, but for the time being are happy to earn an annual yield. The trend would seem to be focused more on the apartment market rather than the villa market, but transactions for both are occurring."

End-user market

Indeed, it seems unlikely that flipping a property in Dubai is likely, given the current conditions. Ahmad Saidali, vice president, investment and fund advisory for CB Richard Ellis Middle East, cautions that while investing in a rental property can work, it relies particularly on one finite resource: a supply of eligible and interested tenants. "The residential investment market in Dubai still remains very much driven by end-users rather than investors," explains Saidali. And while transactions of this type are occurring, their number may not be especially high in what is still a challenging market.

"Traded volumes are still low due to lack of credit and perceived market risk. As far as overseas investors are concerned, their number remains limited due to uncertainty over global economic recovery, perceived market risk, persistent transparency issues and uncertainty about suitable regulations."

In examining the issue of bank interest versus rental yields as an investment instrument, Bunker describes how, while Dubai investment properties have the potential to outperform bank interest abroad, factors like taxes and vacancy rates complicate the picture significantly.

Rental yields vs. bank instruments

"A typical rental property will achieve a gross yield of around 5 per cent to 6 per cent, with a net yield of 3 per cent to 4 per cent on average; of course, this will vary upon the purchase price of the property and how aggressive the buyer was during negotiation — some rental properties can achieve a yield as high as 8 to 9 per cent. Generally, investors are achieving a bank yield of anywhere between one per cent and 5 per cent, depending upon the bank and investment instrument. In most cases, the yields on these financial instruments are probably subject to income or withholding taxes, so it is difficult to draw an accurate comparison between rental yields down here and bank instruments around the world."

According to Ahmed Nawab of Trust City Real Estate, "This is a common strategy these days. The crisis hit the Middle East two years ago but smart investors see this as prime time to capitalise on cash that has been lying in their bank accounts." Nawab advises potential investors to negotiate from a position of strength, by focusing on distressed assets, noting recent successes among his client base. "The last three distress sales we did last month achieved 11 per cent RoI [return on investment] per annum, inclusive of service charges."

In Nawab's experience, "the criteria [for purchase] would be for the apartment to be in a prime location where expatriates live. Rental yield should not fall below 8 per cent per annum."

Better Homes has seen a similar emphasis on desirable locales, and Bunker comments, "Of late, I have seen properties sold for rental yields mostly in the Downtown area, but we're also seeing villas purchased in a variety of districts in the Marina, JLT and Palm. Investors are looking for the best deals available which can be easily rented out, so the activity is across the board and not isolated to one or two communities."

Investor pattern

In terms of the investors themselves, Bunker has yet to see any clear pattern in the nationalities of buyers. "I would have thought we would have had an increase in Europeans investing in the UAE," he adds, "but I haven't seen such an increase above any other group of countries."

While no data is available on the demographics of buyers making these types of purchases, one unifying factor is likely to be overall fiscal liquidity. Saidali cautions that "this strategy can work for cash-buyers but prove difficult for investors requiring a mortgage to fund their investment. In addition, I presume that the quoted returns are gross and one has to consider also the net yield on any property purchase. If we consider net yields, one has to pay attention to the property charges, which include service charges. On average, there are 200 basis points difference between gross and net yield on residential investments."

According to Saidali, current market conditions are changing not just investment strategies in Dubai, but the calibre of investor as well. "We see more sophisticated investors interested in the residential market in Dubai , but they ask for increasing discount rates in order to protect themselves against the perceived downside risk, with many expecting further decline in both rental and sales rates. Most of the international and institutional investors continue to wait for better market fundamentals and a less volatile market. Therefore, from my point of view, the increase in yields seen over the recent months is set to continue throughout 2010 and into 2011."

Landmark Advisory estimates that vacancy rates won't peak until 2012 and while pockets of stability are evident, as in Discovery Gardens and JLT, analysts predict continued pricing declines. As a result, both renters and investors continue to seek value for money as the property landscape continues to shift, both figuratively and literally.

With robust infrastructure surrounding the Dubai property market, the emirate seems uniquely positioned to service rental properties owned by foreign investors, or even residents that prefer not to play the role of landlord directly. What is difficult to know is how Dubai's population will grow to meet surplus inventory. Many of Dubai's former Abu Dhabi residents could be tempted to return to the capital if prices continue to fall there. The same could potentially be said of Sharjah, as traffic improves, but to a lesser extent, as many if not most Sharjah to Dubai transplants actually work in Dubai. And so, the most definite engine of population growth in Dubai will be its overall economic growth, an area in which there is more than ample precedent.

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