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Sector Review: Dubai's Cashed-Up Developers Are Prepared For A Cycle Reversal

Dubai's real estate sector continues to buck global trends. Since 2021, prices have risen at double-digit rates per year, nearing previous peaks, while pre-sales have also reached record highs (see chart 1). But we expect the momentum to slow over the next 12-18 months. In our view, stronger cash generation has strengthened developers' liquidity and credit metrics, creating headroom for them to withstand the turn in the cycle. A prolonged correction, however, could expose deeper strains.

Chart 1

image

Our ratings on the following Dubai-based developers already factor in the industry's cyclicality and the emirate's particularly volatile and sentiment-driven demand:

  • Emaar Properties PJSC (BBB/Stable/--);
  • Damac Real Estate Development Ltd. (BB-/Positive/--); and
  • PNC Investments LLC (Sobha; BB-/Positive/--).

Our assessment of the impact of a cyclical slowdown or potential reversal will vary by company.

Why The Dubai Market Has Boomed

High overseas demand:   Foreign investors, including high net worth individuals, have helped to sustain strong demand, particularly for prime properties. Strong pre-sales in 2023 contrast with our previous expectation that the market would stabilize. Dubai has remained relatively immune to external pressures from the sluggish global economy, echoing the strength it showed during the pandemic.

Economic dynamism:   Dubai benefits from a diversified economy. It has performed well since the pandemic despite higher funding costs for corporates and lingering inflation, which nevertheless remains below the global average. We expect economic growth in Dubai to average a relatively robust 3% over 2023-2024, following the post-pandemic recovery that led to average 5% growth in 2021-2022. Supported by the strong economic performance, the government's fiscal position is likely to strengthen and its debt burden will continue to decline as a share of GDP, in our view.

Conversely, we forecast a period of subpar global growth as more heavily indebted economies are hit by higher-for-longer interest rates.

Sector buoyancy:   We expect continued strong momentum in the hospitality, wholesale and retail, and financial services sectors to drive growth in 2024-2025. In contrast, real estate will likely slow down in the next 12-18 months after another strong year in 2023.

Population growth:   The population has grown by over 2% to 3.6 million according to the Dubai Statistics Center (data as of September 2023). And international visitor numbers are continuing to recover. Dubai International Airport handled over 41 million passengers in the first half of 2023, exceeding that of 2019. Dubai is on track to reach 17 million visitors per year, representing a full recovery in just three years.

The Contrast With Other Regions

Unfavorable economic headwinds have undermined developers in other markets.   The European real estate market has been marked by weakened purchasing power since 2022 due to high interest rates and relatively higher inflation. The China market also remains challenging for its leveraged developers, with margins tightening as prices drop--pressuring profitability. The picture has been a little brighter in the U.S., where demand picked up at the start of this year after a slowdown.

Negative rating actions persist in other markets.   S&P Global Ratings took several negative rating actions on Dubai developers in the early days of the pandemic. But we followed this with a series of upgrades from 2022 as positive sector trends improved the performances of all rated entities. Downgrades have persisted in other regions, however, even as the pandemic subsided. This reflects the markets' less-favorable macro and sector trends, their greater sensitivity to interest rates hikes, and higher inflation, which lowered consumers' purchasing power.

Chart 2

image

As real estate prices continue to rise in Dubai, the risk of a cyclical reversal is mounting.   We estimate prices will increase 15%-18% in 2023 and by another 5%-7% in 2024 as the Dubai market gradually slows down. The prices for villas have reportedly exceeded previous peak levels, but apartments are lagging at 10%-20% below previous peaks due to a historical oversupply.

We don't expect a profound market disruption. Instead, we think price increases could decelerate and potentially slightly reverse over the next 12-18 months, with price declines not exceeding 5%-10%.

At the same time, we expect pre-sales to also decelerate to a still-healthy level.  In our view, developers will adapt their offerings to demand. They will likely continue to launch prime properties--including branded residences--for which demand from high net worth individuals should be more resilient. They are also likely to launch smaller units since the price per square foot has become expensive and buyers are starting to downsize spaces. This contrasts with an earlier preference for larger properties following pandemic-related restrictions.

Table 1

Cyclical risks lie ahead for Dubai developers
Risk factors that could precipitate the cycle reversal Mitigating factors that could alleviate the risks
Global economic uncertainties, including subdued growth, could spill over to the region and affect the sentiment of international buyers. Our current expectations include steady albeit slower economic growth outlook for the GCC region.
Higher-for-longer interest rates. Limited sensitivity to interest rate given that mortgage transactions represented historically about 20%-25% of total real estate transactions and 16% over the first nine months of 2023, outpaced by faster cash transactions growth.
The cyclical nature of real estate development, and current close to peak conditions. Dubai's ability to attract people could prolong the cyclical highs, pushing out the market saturation. Positives include dynamic tourism, international events such as COP28, a strong investment story, a large share of foreign direct investments.
Large share of expat population (over 90%), inducing volatility in demand, particularly in cyclical troughs. Structural feature, but golden visas and other measures allow investors to become Dubai residents for longer, providing some relief. D33 economic program and 5.8 million population target by 2040 underpin the population growth outlook. Significant rental increases (over 20% up per year in 2021-2023) may accelerate buying decisions for the residents.
Sensitivity to oil prices that affects sentiment and regional demand from GCC buyers. S&P Global Ratings oil price assumption at $85/barrel supports our view of resilient demand.
Increased supply that will sustain annual unit deliveries at 30,000-40,000, and will extend the oversupply issue in two to four years upon delivery. We expect population growth at 2%-3%, partly absorbing the new supply. The supply from government-related developers has been regulated since 2019 by the higher committee for real estate. However, the bulk of the new supply is coming from private developers.
Speculative sell-off of properties by investors could accelerate the price drop and could trigger a more profound sector reversal. Compared with the previous cycle, the risk of speculative quick re-sale of off-plan properties is somewhat limited by requirements that developers impose in terms of minimum cash collections, generally around 30%-40%. Some developers limit bulk sales. Rental yield remains attractive, so the investors may hold on to their properties for longer.
Escalation of geopolitical conflicts in the Middle East and globally that could have a negative effect on Dubai. While the consequences for the region remain unclear, we note that Dubai benefits from a safe-haven reputation. As an example, it has seen an inflow of Russians/Ukrainians due to the recent conflict.
GCC—Gulf Cooperation Council. Source: S&P Global Ratings.

In the run-up to the next cyclical trough, developers will see strong cash generation and higher EBITDA.  This will support further deleveraging and build a buffer for the next cyclical correction. The balance of power has shifted in favor of developers over the past couple of years. Therefore, we believe their credit quality should be more resilient to a softer price environment or fewer transactions.

Developers have been able not only to pass on significant price increases but also to improve their cash collections. Post-handover plans have become rare in Dubai but were once the norm. Well-established developers are able to collect 100% of cash on the handover of units, as opposed to historical post-handover payments plans that extended up to five years. As a result, we expect cash collections will remain above historical levels due to:

  • Sustained flow of advance payments on new project pre-sales;
  • Faster collection on recent projects; and
  • Residual collections on older projects.

Altogether, developers are now able to reduce the risks in construction projects much faster, covering the construction costs within 18-24 months of collections, or even faster for some.

Chart 3

image

When the cycle shifts, we expect liquidity buffers and profitability to weaken.   We anticipate that developers will gradually give up their pricing power, leading EBITDA margins to correct from current highs. In addition, developers will be obliged to offer more favorable payment terms to buyers to keep delinquency rates low and assure maximum cash collections. In addition, funding needs will be high for our rated cohort of developers given the sizable pipeline of projects amid higher-for-longer interest rates. We therefore expect credit metrics to weaken in the next cyclical trough.

A significant shortfall in cash generation may occur from lengthier cash collections, reduced advanced payments on new projects as demand softens, and declining inflows from older post-payment plans as project completion progresses. Working capital requirements will increase significantly since construction costs of ongoing projects can't be slashed.

Record-high revenue backlogs are not indicative of future cash flow generation.   The large revenue backlogs of developers provide good visibility for the next couple of years, covering typically about 80% of revenue in the first year and 50% in the second year. However, delays are common in the construction sector and revenue recognition may lag on profit and loss statements, particularly for smaller developers with higher project concentration. Typically, developers' cash flow generation is decorrelated from revenue. In a severe scenario of a 10% revenue decline, the shortfall in cash flow could be disproportionately bigger.

Chart 4

image

The need to purchase new land will also weigh on cash flows.   Land banks shrank over several years for many developers in Dubai--including Damac and Sobha--as they launched new projects in response to strong demand. The remaining installment payments on earlier purchased plots, as well as the need to have a regular land acquisition strategy, will increase funding requirements amid less-favorable sector conditions. Emaar, by contrast, benefits from an ample land bank particularly after acquiring Creek Harbor from its partner in 2022.

Competition for land will stiffen.   We think that the availability of land reserves will increasingly become a differentiating factor to assess the competitive advantage of Dubai-based developers as sought-after waterfront premises and other prestigious locations become scarcer and more expensive. This will be even more so considering the entrance of new developers, including the large Abu Dhabi-based Aldar (not rated). In response to the sector's slower cash generation, we would expect developers to downsize their new project launches, land acquisitions, and cost structures. This, however, could affect their market position if the absence of new projects persisted.

Why Developers Should Hold Up

The ratings on Dubai developers are not likely to change rapidly since they already factor in some demand volatility. As cash-generation weakens and liquidity buffers reduce for developers, we think companies will increase debt. Some of them, including Emaar and Sobha, have taken measures to reduce their gross debt balances recently, using excess cash for debt repayments. Reduced debt balances will limit increases in leverages during the cyclical trough.

Conditions are currently close to that of a peak cycle, which is not sustainable in the long run for such a cyclical sector. That's why we factor sector volatility into the ratings even though leverage levels are relatively moderate. As sector trends decelerate, the deterioration in credit metrics will not immediately lead to ratings downside, given the existing headroom in leverage ratios.

We expect financial headroom to further improve in the next few months before the slowdown as cash flow generation will remain strong thanks to healthy pre-sales. Larger developers, such as Emaar, that have a more favorable business mix will benefit from their exposure to less-cyclical end-markets, including highly profitable and cash-generative mall leasing.

Our ratings on two developers, Damac and Sobha, remain on positive outlook despite rising risks. That's because we still expect them to demonstrate strong operating performances, steadily growing profits, and further deleveraging as they head toward the cyclical slowdown. These factors could even result in upgrades as headroom improves, primarily resulting from a continuation of the deleveraging trend, after factoring in the sector's volatility.

Table 2

S&P Global Rating's rated developers in Dubai
Rating Business risk profile Financial risk profile Downside trigger 1 Actual ratio Downside trigger 2 Actual ratio
Emaar Properties PJSC BBB/Stable Fair Modest Debt/EBITDA > 1.5x 0.3x FFO to debt < 60% 295%
Damac Real Estate Development Ltd.* BB-/Positive/-- Weak Significant Debt/EBITDA > 2x 1.9x EBITDA interest < 8x 9.4x
Sobha (PNC Investments)* BB-/Positive/-- Weak Significant Debt/EBITDA > 2x 1.1x EBITDA interest < 8x 10.6x
S&P Global Rating's-adjusted ratios are for the year to June 30, 2023, RTM for Emaar and Damac, annualized H1 for Sobha. *Damac and Sobha rating triggers are related to Positive outlook.

While developers are coping with sector cycles, they will also need to adjust to changing consumer expectations.   For the past few years, Dubai has offered a counter-narrative for real estate markets: Growing rapidly as others contract. As conditions are expected to soften, a key differentiator for developers in the emirate will be how well they adapt their strategies and build their defenses amid the shifting sands. And that may include adapting quickly to changing consumer preferences, tighter cost structures, and astute land procurement. The key will be to do all this without overburdening their balance sheets.

Dubai's developers are facing the need to adapt to demands for more sustainable housing and construction methods. Improving energy and water consumption to reduce high-carbon emissions, as well as achieving better waste management, are also part of the changing picture. Dubai's 2040 Urban Master Plan and the UAE's 2050 net zero objectives will spur greener homes and sustainable design, environmentally friendlier building methods and materials, and the increasing use of renewable energy sources. In 2022, the second phase of the urban master plan outlined key priorities for sustainable urban development, among others.

Sustainable housing in Dubai is becoming increasingly varied but is still just a small portion of the existing inventory. More and more developers are obtaining certifications for their new residential projects (such as LEED and BREEAM) as part of their commitment to higher sustainability standards. Some have also announced net zero targets. While industry-wide disclosure standards related to sustainable initiatives are still being developed, we expect developers will start providing more information about their quantitative targets and the means to achieve those. We also expect new regulation to support sustainable development and growth in Dubai, consistent with the urban master plan objectives. Adapting business models to sustainable development in Dubai's cyclical and competitive real estate sector, without compromising on profitability, could pose challenges for developers in the years to come.

Related Research

Editors: Alison Dunn and Julie Dillon

Digital Design: Joe Carrick-Varty

This report does not constitute a rating action.

Primary Credit Analyst:Tatjana Lescova, Dubai + 97143727151;
tatjana.lescova@spglobal.com
Secondary Contact:Sapna Jagtiani, Dubai + 97143727122;
sapna.jagtiani@spglobal.com

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