Brian Pepper is one of hundreds of property developers faced with the new realities of building in the Emirates. With no off-plan sales to help construction begin and little bank lending to sustain it, developers like him are being forced to work together and allow buyers to move their deposits while scaling back the ambitious plans of a year ago.
The Irishman launched three towers at the Marmooka City development, located off Emirates Road in Ajman. Now he can build only two, as the scheme that was slated for 204 towers looks more likely to actually have just 20 buildings. He says banks remain unwilling to fill the financing vacuum created by the demise of off-plan sales. "In Ajman there was never bank finance. But if Ajman Bank gave finance, the whole of Emirates Road would come out of the ground," he says.
When property prices started to tumble just over a year ago, thousands of investors started to miss their payments, putting many property developers out of business and forcing others to dramatically scale back their projects. About US$24 billion (Dh88.15bn) worth of residential projects have been cancelled across Dubai, according to Proleads, a market intelligence company. In Ajman, only one quarter of the proposed towers have been registered with the property regulator of the emirate.
"We are in for a dramatic change in how property financing will be done," says Michael von Uffelen, the head of corporate finance at Arqaam Capital, a regional investment bank. As banks seek to reduce their exposure to the property market, both private and commercial lending have been squeezed. That is causing problems for developers trying to raise funds to complete their projects and for end-users looking for mortgages to buy homes.
"Before, you could just build speculatively and they [investors] would come. But now? We need a new [financing] paradigm but we don't have it yet," says Simon Hersom, the regional managing director of property finance at Royal Bank of Scotland. Many analysts believe that until the balance between demand and supply is back and private buyers are again willing to commit funds, other players must step in to fill the gap. They are likely to include distress funds, private equity groups and sovereign wealth funds.
"Para-statal entities have to come in more strongly. So do alternative investment vehicles, private equity funds and investment companies," says Jamal al Kishi, the chief executive officer at Deutsche Securities in Saudi Arabia. Now that the speculators have retreated from the market, demand is being driven by end-users and long-term investors. While there is a general dearth of deals, some say that international private equity investors are becoming more open to the idea of investing in the region's property industry as valuations become more attractive.
"We're sourcing most of our finance for developers from America. Some banks and private equity funds in the US are prepared to consider funding projects in Dubai, but it is very hard work," says Jonathan Bridges, a mortgage consultant at Global Eye. Several private equity houses are considering property development funds in the Gulf. But for now, such structures remain undeveloped and funds in the region are mostly closed-ended with a relatively short duration of between three and five years. This compares with long-term vehicles out of the US or Singapore, which are often listed on stock exchanges and open-ended.
Rasmala Investments, a regional investment bank which is based in Dubai, is looking at several projects in Saudi Arabia, says Eric Swats, a partner at the firm. Rasmala is considering setting up funds with developers where it invests its own money plus that of third parties to help developers raise equity, or simply cash. The developer, who typically contributes the land, also ends up with shares in the fund.
Banks, however, might remain on the sidelines. While they were rarely the main financiers of property developments in Dubai, even during the boom years, they often provided short-term loans. Now, few of them are able to play even that marginal role because of a continuing liquidity squeeze. Bank lending in the Emirates fell by about 86 per cent in the first nine months of this year compared with the same period last year., the Central Bank has reported.
But given the importance of mortgage lending, banks will eventually come back to property financing, experts say. "The provision of land and building stock for mortgages is a core provision for banks," says Mr Hersom. "It makes sense to finance a block of apartments." Banks generally like mortgage financing because it spreads the risk. Mortgage financing is still a relatively young industry in the region and only one in five home purchases was financed by a mortgage last year. Nevertheless, analysts say it is crucial to revive the industry. For that to happen, lending rates must fall and major participants such as Amlak and Tamweel, which have not done any new lending since November, must get back to business.
Banks may also demand different types of collateral and more rigorous cash flow forecasts in the form of long-term leases. "Before, banks used projections, they did not care about the cash flow but only about assets. Now the developers must demonstrate an income stream," says Mr von Uffelen. But that is easier to achieve in the office market, where tenants are used to signing long leases than in the residential market where leases run a year or less.
"We are dealing with a number of clients in the real-estate space who are trying to generate a product which can generate long-term leases," says Mr von Uffelen. Central Park, the latest project by Deyaar, a developer based in Dubai, is a case in point. Instead of pre-selling offices in its 45-storey commercial tower located in the Dubai International Financial Centre, it is looking to commit clients to medium to long-term leases.
While local lenders may still be absorbing the impact of the unfolding crisis within the property industry, many international banks and investors have more experience of riding the peaks and troughs of the famously cyclical industry. As a result, they may be the first to return to the market. Some other sources of funding have emerged. "High-net worth individuals, many from abroad, are pitching in where developers need cash to finish projects," says Nicholas Maclean, the managing director at CB Richard Ellis, a property consultant.
That will help some projects reach completion, while the ongoing consolidation in the market may help other developers such as Mr Pepper finish their towers. "If nobody panics, the crisis can be worked through. Too much arrived in too short of a time, but the underlying demand is there," says Mr Hersom. @Email:firstname.lastname@example.org * additional reporting by Nathalie Gillet