This article was originally published in propertyfinder Trends Report 2017 – click here to read online (Adobe Flash required) or click here to download PDF instead. To request a printed Report, please email us on firstname.lastname@example.org
This has been an interesting decade, from the cruelty of the global financial crisis where property prices nearly halved, to the 2013 surge of investment activity that made Dubai the best performing property market worldwide and back to the mild slowdown we are currently experiencing.
However, that is a typical cycle that every market participant should accept before and after entering into it. There are fundamental reasons driving the property market that are nearly always correlated with the economy and overall visibility of what the future may hold for the subject market.
In the Dubai market, the drop we have seen in the aftermath of the global financial crisis was mainly attributed to overall global slowdown, as well as the fact that property prices were significantly overvalued at the time.
How do we know it was overvalued? Well, it’s simple–look at the cap rates. The cap rate is the rate of return on a real estate investment property based on the income that the property is expected to generate. This is calculated by dividing the investment’s net operating income (NOI) by the current market value of the property.
Here’s an example. Take the largest, full sea view two bedroom property on Shoreline, Palm Jumeirah and compare that property to pre and post crash:
Then it’s a perception of risk. What is the right cap rate for Dubai prime property? Let’s consider the following 5 factors:
- The risk-free rate (Look at EIBOR from time to time to determine the number
- Age of the property
- Credit-worthiness of the tenant
- Demand vs. supply dynamics
- Economic fundamentals (Population growth, employment growth, etc.)
Taking all of the above into account, and taking into consideration that the risk-free 2008 rate was significantly higher than today, it is intuitive to see how the property was overvalued back then. If we assume that Dubai prime property should have a cap rate of 5%, then one can argue that property prices are undervalued today.
5 WAYS INVESTORS CAN OPTIMISE THEIR RETURNS:
Intuitive judgments using the following tools can make the difference between smart, calculated decisions and rash, quick decisions.
1. Short-term model
Using it to generate higher yields where short-term rental investors gain four-fold through the following:
2. Invest in off-plan
In uncertain times, developers, big and small come up with very attractive payment and pricing plans for new schemes. If you believe in the supply/demand dynamics and the fact that there will continue to be pent-up demand for the city as population growth is on the rise, then making smart off-plan property investments in neighbourhoods that are already in demand and have limited supply (e.g. Dubai Marina, Downtown, Palm Jumeirah) is a good way to optimise property returns. This is because property prices under construction are normally at a 15-20% discount to similar ready properties in the same location. You can bene t from the immediate upside at completion, as well as higher yields.
3. Keep your property available
Short-term rentals ensure that your property is available and liquidity is certain. Ensure you have a good relationship with your tenant so you do not face difficulties with them in the future.
4. Use the low interest rate environment to increase IRR
As long as the interest rate that your bank is charging you on your mortgage is less than the cap rate you are getting on your property, then you are “in the money” and your internal rate of return (IRR) will be relatively high. The higher the spread between the interest rate and the cap rate, the better off you are and subsequently the higher your IRR.
5. Seek the right advice
Brokers will talk to you about capital appreciation and sell you the future and will sometimes hide the cap rate. You need to have a “margin of safety” today so that you can beat the market in case of a downturn. Thus, always ensure you talk to the right industry professionals and ensure that the cap rate of the property you are buying is above market cap rate for the subject location, and that your purchase price is at, or lower than, the last transaction price.