AsiaView: Room for a few

Though there are some obvious signs of distress in Dubai, there are not enough reasons to form an opportunistic investment strategy for the emirate. By Jonathan Brasse. PERE magazine, November 2009.

If you want to gauge the level of distress in Dubai at the moment, you could do worse than seek a room at the Burj Al Arab, the iconic hotel styled like a boat’s sail.

All the trimmings you would expect from a 7-star hotel are still there – complimentary Hermes bath products included. Yet the price of a suite has been slashed 35 percent in the past year alone.

Jonathan Brasse

There are some other obvious signs that Dubai is a distressed market right now. However, it is not yet a market ready for opportunity funds, even if it looks and smells like the kind of real estate play foreign investors crave at first glance.

The poster child of Dubai’s current woe is surely state-owned property company Nakheel Holdings which faces the unenviable task of repaying a $3.5 billion Islamic bond in December.
Things have gone so wrong at the company, famed for its Palm Jebel Ali and The World developments, that the salvation of its projects look increasingly likely to rely on financial aid from Dubai’s neighbours, according to reports. Perhaps the same could be said for the state too.

The answer at Nakheel appears to be that of a Dubai version of a bring-and-buy market as its owner Dubai World switches personnel and assets between it and its other investment company, Istithmar.

Dubai’s distress is backed up by conversations PERE has held with professionals on the ground. They immediately pointed to the fact real estate prices have plummeted 50 percent from their peak less than a year ago. They also said rents have nosedived between 25 to 50 percent and are not slated to return to growth anytime soon. Furthermore, they added that Dubai’s vacancy rate had already hit 25 percent.

So far so good, an opportunistic investor might say, and in other markets they might be right. But this place is far from being the next stop for opportunistic players looking to make 20 percent-plus returns from a developer’s dream playground gone wrong.

Sure some will have a reasonable go. Houston-based Hines, for example, is looking to raise $1 billion in equity and debt for a UAE-focused distressed asset fund. A call to the firm confirmed the fund would also take in Dubai. It obviously sees numerous opportunities across the emirate’s abandoned sites.

But while Dubai might represent an opportunity for an expert developer-cum-fund manager such as Hines – which already has experience of projects in the region – what does the state offer those with less international development expertise? The answer is very little. 

Dubai’s playground is now being labelled a laboratory experiment in overbuilding that has given rise to a Frankenstein. Despite the economic weakness, companies are persevering with delivering their outlandishly large commercial premises into a void. With an overbuild problem, Dubai is different to the established markets of the US and Western Europe where completed and leased buildings can be purchased. 

To compound matters, Dubai’s typically short lease system makes investment into buildings one for the more bullish of asset managers who think, despite evidence to the contrary, tenants will continue to roll in.

What’s more, there are anecdotes of developers resorting to supplementing tenant fit-out costs and offers of rent-free periods as well to further contend with.

Consider also that most of Dubai’s commercial real estate is traditionally sold on a strata basis. Then picture explaining to an investor that he now co-owns an office alongside 20 others of varying backgrounds. A can of worms surely?

When you think the Middle East market is said to lag Western economies by at least one year and that there have been reports of green shoots in mature real estate markets, such as the US and UK of late, then Dubai has at least 18 months to two years to go before the key drivers of occupational demand, and rent, will start to rise again. Considering that notion, PERE asked one international investment fund manager where the emirate sat on his investment schedule. He replied simply: “We don’t even consider investing in Dubai.” 

Unless you are a Hines with bags of development expertise, there will be few deals to be had in Dubai beyond its discounted luxury hotels.