Wednesday, December 10, 2008

Regional Rental Inflation in a Global Deflationary World

On a side note, I’d like to throw in my two cents on the rental inflation argument made in the real estate report I referred to in my last post. According to the Khaleej Times (, the report stated that the “continued pick up in the rental market will prop up Dubai property prices with no signs of rental inflation slowing down with demand growing in outskirts like Jebal Ali and the Dubai-Abu Dhabi corridor”.

I do not buy this argument. To say the least the authors appear to be very static with respect to their assessment of the local market. I understand the tried and true argument of rents rising as end users switch from buying to renting in a typical real estate market. However, this argument does not strike me as very persuasive when it comes to Dubai properties. Why? Well, to put it simply this is not a true end user market, at least not yet. Most renters in Dubai were not choosing between owning a unit and renting one when the real estate market was booming. In fact, the actual demand/supply imbalance in Dubai and lack of available housing was largely being driven by hoarding of properties by investors parking money in local real estate with no intention of renting out the units. The incentive to rent a unit, floor, or recently completed building is not very high when you can sell it in a matter of months for a 30% premium or 150% realized gain if you were typically geared. Furthermore, rent controls in a booming real estate market provide a significant incentive for land lords looking to cash in on the boom to treat their properties like stocks and just hold them for capital appreciation, as an unrented unit is easier to sell in an economy with rampant inflation and negative real interest rates. So, if a 2000 sq ft 3br was renting for 350,000 aed a year in July when the prices in Downtown Burj Dubai were as high as 3500aed/sqft, I do not believe the rent on this unit is not going to come down significantly. Yes, the rental yield may rise, but the absolute rental price will fall as the selling price declines drastically from the July peak. There have been a few units in southridge listed for around 1600-1700 per square foot. Current rents being demanded for these units are between 180-210k per annum. This implies rental yields of over 7%. Personally, I believe yields will fall below 5% as rental supply starts to dwarf demand, but at even a 5% yield the asking price should be closer to 120-140k. Thus, the prospects for rental inflation in Dubai are in my view next to nil, particularly in the midst of a global deflationary shock.

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