Sunday, November 30, 2008

Dubai Real Estate- On The Ground Floor-Rental Edition

“Thus we have a housing bubble. It is a cascading tragedy of people using funds that are not theirs, to "purchase" real estate that they cannot afford, obligating themselves to make payments that will stretch their incomes and constrain their lives.”
-Byron King,, “free rent”

A recent conversation with a Dubai Property Agent

Me: Yes, good afternoon I am calling about the two bedroom listed in Barsha near the Mall of the Emirates.

Agent: Yes. 9,000 you want?

Me: Just to be clear you are talking about a two bedroom.

Agent: Yes. Yes. 2br 1300 square feet. Very close to Mall.

Me: Excellent. That’s a reasonable price. When can I come and see it; I live in Barsha.

Agent: Ok. Tomorrow at 2pm. Bring deposit.

Me: Ok, but I need to see it first.

Agent: Yes. Yes. No problem.

Me: Ok, tomorrow then.

Agent: Yes. But one thing.

Me: Yes?

Agent: Apartment has no electricity. You take chance. This your problem.

Me: Excuse me? No electricity. Are you kidding?

Agent: No. That is why only 9000 per month.

Me (in utter disbelief): Ok then. Good luck.

This conversation actually happened last week. Honestly, if I tried, I could not make up stuff like this. I have been spending an extensive amount of time over the past five weeks researching the residential rental market in Dubai as I am trying to move to a new apartment. As a result, I have learned quite a bit about how the participants in this market think and have gotten a very good peak at the underlying supply and demand situation.

It is at times completely mind boggling. For example, if you logged onto Dubizzle today you would see people asking for roughly the same amount for a 3br in Barsha, Dubai Marina, and Downtown Burj Dubai. There are 3br in Barsha going for 220-230. At the same time, I can get a 3br in southridge for 250 right now if I gave the landlord one check. Naturally, prime downtown space from a signature developer should be going for a lot more than some random residential tower in Barsha. Not in Dubai. All the landlords still think their properties are gold mines. Some are still actually kicking tenants out so that they can sell or raise rent. It is mind boggling as most of these landlords are ultimately going to be begging tenants to move in at some point in the not so distant future. And the price distortions don’t just exists between certain areas they also exist within the individual communities. I saw a 2br in the Burj Residences going for 195k. Two days later I saw an identical unit at 240k. The landlord would not budge as he is convinced that “rents are rising” and has in fact raised his rental demand twice over the past 4 weeks. I saw a 3br penthouse in Southridge 1 directly available under Emaar’s rent to own program. They are asking for 300k for a 3000 square foot unit. Two days later I called someone on Dubizzle that was also listing a 3br apartment penthouse in southrdige. Her asking price…400k. It turns out this unit is the one facing the unit I saw. So, rent directly from the developer at 300k(2checks) and get a free call option to purchase the property with your rent being converted into equity or rent from an agent representing a foreign investor asking for one check and the respective commission along with an asking price that is 33% higher than Emaar’s. Hmm, tough decision.

Sad thing is some of the agents don’t even get what is going on. Making money here was so easy that many of them can’t grasp the basic fundamentals of property rental marketing. I called one agent yesterday after walking by her advertised old town apartment facing the Dubai Mall. She is asking 285k for a 2br. Incomprehensible. I actually tried to explain to her that there are countless 2br being offered in the 180-220 range all over downtown burj Dubai. I even tried to explain the Emaar rent to own scheme to her. Her response was, “Fine go rent from them then if it’s a better deal, why call me.” I tried to explain that she would be giving me a better deal since she wasn’t the developer and wasn’t offering a free call option and was asking for 40% more than they were for comparable units. It was like talking to a wall. I almost felt bad for her. This can’t and won’t last. But the longer it does the worse it will be as buyers start hunkering down as they anticipate lower and lower prices once they notice that the unit they looked at 1 month ago is still available and has been joined by a few more units in the same building. The price discovery mechanism in the real estate market is completely broken right now.

Is there a solution?

It’s easy to comment on a situation and point out what’s wrong from the viewpoint of a bystander. It’s a lot harder to offer some sort of solution that might improve the situation. So here are some of my thoughts:

***Rent-to-Own- This marketing scheme launched by Emaar is brilliant. They are renting you properties in prime locations and offering you the option to buy this property 10months from now at a fixed price. Frankly, I think the scheme is ingenious, as it gives Dubai exactly what it needs which is swift kick in the behind on the way to an end user market in which buildings are lived in instead of traded. Furthermore, if the plan is aggressively executed it will accelerate the growth of the downtown area as warm bodies start to create the atmosphere of a community. Problem is while the deal being offered is brilliant from a marketing perspective, it lacks real teeth. If you sign up for a 2br in South Ridge with let’s say 1530 square feet of living space Emaar will quote you a sale price of 5.2million aed. That means they are still quoting you over 3400aed/ft for something that is being offered in the secondary market at less than 2000 aed and still not moving. So, there is a good reason you are getting a free call option, it’s because for all intensive purposes it’s not worth anything. The only way this option works out in your favor is if prices head north of 3400 aed/ft sometime in the next 10months. But wait, they will credit 100% of the rent, that’s got to be worth something. On this 2br they are asking for 200,000 aed in rent. That works out to a 3.8% yield. So, you basically get a 4% discount on a price that is already in some instances at a 50% discount in some highly distressed situations. Not exactly as good of a deal as you thought.

***If I was Emaar I would make it my mission to fill up downtown with renters as fast as possible. I would concede that I will not get optimal rents for the first year (heck my goal would just be to breakeven on the unsold units I own by covering my maintenance costs for the year), but the tradeoff will be that the market will become an end user market with people willing to contemplate permanently living there and the community becoming vibrant a lot faster than it would if they waited and waited to get the best price (which I believe is ultimately an exercise in futility). The idea is not about making money in the 1st year or two off of this renting but rather to add tremendous economic value that will make people want to buy once the correction has run its course. This means that developers and landlords(if I was emaar I’d offer to manage all owned and unoccupied properties in downtown for 2yrs at a very low mgmt fee cost..Again with the aim of jumpstarting the transition to lived in a community) need to come to terms with the fact that a sharp correction is unfolding and proactively respond with realistic proposals. Fully occupied buildings can go a long way to changing investor perception. Naturally, there will be losers, but you can’t recover until you bottom. Thus, I would recommend rejecting conventional wisdom which would say you need to toe a strong line about property prices and instead continue to focus on the vision of creating a vibrant metropolitan city in the middle of a desert in the Arab world.

There is of course an alternative course of action. We can continue to hope that the correction is not that severe and that property prices in Dubai will hold up while property prices everywhere on earth are under pressure. We could continue to believe that negative premiums(i.e reverting to 2006 prices or lower) are unimaginable in a world where most almost every asset class is trading at or has tested at least 2004 prices and in several cases are back to prices not seen since the 1990’s. A quick recovery is not impossible, it’s just highly unlikely. Oil prices could recover faster than expected. This would cushion the fall. Global markets could catch a whiff of dollar driven inflation. The fed is desperately trying to engineer this scenario. But odds are that a quick recovery in real estate prices when productive assets like corporate grade debt are so cheap will be hard argument to make. So, I think it couldn’t hurt to try something different for a change. Maybe…just maybe…it might work.