By Parag Deulgaonkar

Dubai is experiencing a sound and balanced cyclical economic upswing with the real estate growth not being reminiscent of 2008, according to a Citi report

In mid-2008, the Dubai economy was being increasingly driven by construction activity, with developers building projects based on off-plan sales model, the global bank said in a new report released on Sunday.

The bank said “it’s good news that we are probably quite far from that stage now”, stating that the drop in construction activity in the past few years had given the emirate economic revival time to reduce significantly residential supply overhang problem.

What’s different now? Here are the three primary differences that Citi refers to:

Growth in construction lower
The construction industry experienced a sharp contraction between 2009 and 2012, and re-emerged into positive growth territory in 2013. Despite the announcement of ever-grander projects in recent months, the reality is that construction remains relatively subdued.

Contribution to GDP lower

The subdued activity is reflected in the lower share that construction represents in overall gross domestic product (GDP). Currently, this stands at below 8 per cent of economic activity, but at the peak of the bubble construction represented nearly 14 per cent of GDP. The contribution to GDP growth also fell, from 2-3 percentage points to close to zero in 2013.

Reduced leverage

The real estate and construction sectors are much less highly geared than they were in 2008, reducing the sector’s vulnerability to exogenous shocks. This reduces the likelihood of a sudden stop in construction activity and its negative impact on the wider economy.
Citi, however, advices there is little room for complacency.

“The fact that we think things are different now does not mean that things cannot go back to the way they were,” the bank said.

“Indeed, Dubai’s dynamic economic and financial landscape are fast-moving and the circumstances of the real estate market and the wider economy could change in short order.”

Some key areas (listed below) will require close monitoring.

Return of flippers

It is impossible to say with confidence to what extent the recent surge in property prices is attributable to speculative activity, particularly to so-called flippers.
 
The magnitude of price increases, as well as anecdotal evidence, suggests that some level of speculative demand is likely back in the market. The risk here is that aggregate demand for property could once again far exceed the real underlying end-user demand.

The authorities have responded to this risk by raising the property registration fee from 2 per cent to 4 per cent, and developers have put their own restrictions on “flipping”. Whether this is effective in substantially reducing the practice remains to be seen.

There are two outcomes to rising speculation. The first is that real estate prices will rise beyond what is justified by fundamentals, resulting in a correction further down the line. The second outcome is that supply once again responds to the inflated demand, resulting in a renewed construction drive that increases the price interlinkages with the real economy.

New construction drive

In the past 18 months there have been a number of announcements regarding new projects, many have been revived after they were put on hold in 2009. Current growth rates would justify new supply in the residential market equivalent to around 25,000 units a year, on average. Indications in the retail and hospitality markets are also supportive of moderate construction growth in these sectors. However, the risk is that the surge in demand and prices could once again lead to exuberance in supply, which could have two detrimental effects on the emirate’s economic outlook.

The first is the risk that construction activity will once again take a prominent role in economic growth. In the event that the construction sector were to suffer another shock (e.g. large-scale off plan buyer defaults, as happened in 2008/2009), another sudden stop in activity could once again lead to the chain reaction and impact real economic activity. The second risk is that the financing of new projects becomes increasingly dependent on debt.

Leverage

Although the overall leverage in Dubai has not decreased substantially, the bank states the composition of the leverage and the smoothing of maturities have substantially reduced refinancing risk relative to 2008/2009, but have not altogether eliminated it. Going forward, there is a clear risk that renewed construction drive may be accompanied by heavier borrowing and increased leverage by developers. The domestic liquidity situation is supportive of such borrowing.

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