Dubai rental rates will continue to decline in 2018 following a challenging few years, with yield compression expected across residential markets in particular, according to the latest report from the consultancy Core Savills.
“Further rental declines, the ongoing strength of the US dollar and the imminent, albeit probably limited, inflationary effects of the introduction of VAT in the emirates are all expected to compress investment yields,” the report said.
Real estate developers’ margins are “precariously shrinking to below viable levels” in the wake of intensified competition on sales prices, particularly in the affordable segment, Core Savills added.
Its report highlighted numerous challenges to Dubai’s real estate market as rental demand remains muted and prices continue to fall. The drivers for yield compression vary according to segment, it said.
Prime residential real estate saw a weakening of prices between 2014 and 2016 and an acceleration of yield compression representing a stark 11.2 per cent decline in 2017. However, comparatively stable rents encouraged tenants to shift towards ownership, driving down rental demand and causing prices to steady last year.
“In the near-term we expect prices to continue stabilising in the prime and upper mid-market segment while the current decline in rents is anticipated to decelerate, allowing yield compression to slow down,” said David Godchaux, the chief executive of Core Savills.
In the affordable and lower mid-market segment, a stronger decline in sale prices and comparatively minor weakness in rents over the same period allowed yields to rise and buyer demand to pick up.
Yields declined by 3.8 per cent from mid-2016 to the end of 2017 – only half of that witnessed in the prime segment.
However, unlike for prime real estate, demand was led by investors not end-users, due to affordability issues. With developers increasingly drawn to this affordable and lower mid-market segment, a bulging supply pipeline currently means high yields for investors are unlikely to be sustained through 2018.
“If rental demand of these projects is insufficient at handover, this supply surge is expected to exert considerable downward pressure on rents, leading to faster yield compression,” Mr Godchaux said.
“Eventually, this contraction in yields will reduce investor demand, in turn pulling sales prices down over the mid-term.”
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Dubai’s grade A commercial property market is sustaining steady yields due to strong demand from blue-chip occupiers, the report said. However, once again, a strong office pipeline over the next three years is expected to apply downward pressure on rents and yields.
The warehousing and logistics sector is also struggling to maintain rental levels. The segment has seen dampening levels of demand and rental softening across the board due to a slowdown in trade volumes and low oil prices.
Resulting consolidations among operators are creating an upsurge in supply of logistics units, which is expected to further drive down rents.
Despite ongoing market softening, investment opportunities exist in certain segments of the market, according to the report. International-grade commercial stock is witnessing higher levels of occupancy and steady yields in the range of 9 to 12 per cent, given the relative shortage of such assets, the report said.
Meanwhile, a general “commoditisation of the office investment market” is under way, with real estate investment trusts (Reits) becoming increasingly popular.
“Given that Reit’s represent a notably small share of the UAE’s listed real estate market compared to other global hubs, the sector is expected to continue expanding over the mid-term,” Mr Godchaux said.
“By further integrating real estate and capital markets, Reits will potentially increase funding avenues for developers as well as provide smaller investors access to diversified property investments.”
Dubai is expected to have one of the highest "generation Z to generation X" ratios among global cities in the next 10 years, which will provide a catalyst for migratory and social change and spur growth of the real estate market in future, the report said.