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Dubai Oasis Drying Up as Property Rally Nears Edge: Arab Credit

The rally that sent real estate company bond yields in Dubai to record lows risks petering out because the emirate’s property recovery may not be broad enough to justify further price gains.

Dubai Holding Commercial Operations’ January 2014 and February 2017 bonds were cut to hold from buy at Exotix Ltd. after yields fell to the lowest since 2007 this month. Emaar Properties PJSC’s August 2016 note yields rose 10 basis points to 4.44 percent today since Oct. 23, when the company reported third-quarter profit that missed estimates. Property company Nakheel PJSC’s 10 percent sukuk, or Islamic bonds, due June 2016 have “little upside potential,” Exotix said.

A nascent real estate recovery in Dubai has been limited to a few areas in the emirate, which suffered a property slump in the past four years causing values to fall by as much as 65 percent. While the pick up is set to continue, opportunities in the bond market are limited at current prices, Exotix, National Bank of Abu Dhabi PJSC and Emirates Investment Bank PJSC say.

“The recovery has been in selective areas, not broad-based,” Gus Chehayeb, Dubai-based director for Middle East research at Exotix, said by phone Oct. 29. “I don’t think there’s substantial value remaining in the real estate credit space, especially compared to the bargains we saw over the past three years.”

Empty Units

Investor optimism in Dubai’s recovery gained ground this year as sale prices for villas and apartments jumped and retail and tourism industries extended their best year since the crash. The average price of a mid-range villa and high-end apartment in the city advanced 27 percent and 14 percent, respectively, in September, according to data from property broker Cluttons LLC.

The emirate’s property industry isn’t out of the woods. A quarter of residential units are empty and an additional 25,000 are due to be completed in 2013, Jones Lang LaSalle Inc. estimates show.

The number of property transactions jumped by 50 percent in the first half of 2012 from the year earlier, according to Dubai Land Department data. Even so, the value of the purchases is 74 percent less than the first half of 2008, prior to the crash that started later that year.

‘Highly Levered’

Government-owned Nakheel, developer of artificial islands shaped like the world map and fronds of a palm tree, has seen its bonds rally this year as profit at the company surged 83 percent in the first nine months. The yield on the debt maturing in August 2016 has tumbled 798 basis points, or 7.98 percentage points, this year to 10.33 percent today. That compares with the 295 basis-point drop to 2.62 percent in the yield on Dubai’s 6.396 percent sukuk due November 2014.

“I wouldn’t be accumulating large positions at these prices,” said Yaser Abushaban, director of asset management at Emirates Investment Bank. “Accumulation would have been advised when they were priced much lower, specifically when you look at higher-yielding names,” including Nakheel.

Exotix reiterated a hold recommendation on Nakheel’s August 2016 notes, saying the developer hasn’t released audited earnings since 2008 and “is still highly levered post restructuring.” The builder, which wrote down the value of its real estate by $21 billion from late 2008 through mid-2010, got an $8.6 billion bailout from the Dubai government in 2009 to help avoid default.

Trading at Premium

Emaar, developer of the world’s tallest skyscraper, posted a 5 percent decline in third-quarter profit as revenue fell 12 percent. The company’s 8.5 percent sukuk maturing in August 2016 yielded 4.44 percent today compared with 8.2 percent at the end of 2011 and the bonds trade at a Z-spread, a measure of credit risk, of 366 basis points, compared with about 443 for similarly rated companies tracked by Bank of America Merrill Lynch’s BB Global Emerging Markets Credit Index.

“I don’t think such a premium is warranted,” Chehayeb at Exotix said. “The market is now trading Emaar almost as if it’s a risk-free asset” and the sukuk “is trading very rich compared to equivalently rated emerging market peers.”

The economy of Dubai, one of seven emirates that comprise the United Arab Emirates, is making a comeback and its default risk tumbled as several state-linked companies restructured or paid debt this year. Economic growth will accelerate to 5 percent this year from 3 percent in 2011, according to government forecasts.

‘Selected Stability’

Dubai’s five-year credit default swaps fell 197 basis points this year to 248 yesterday, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market. That outpaced the 67 basis-point decline to 262 in the average for contracts in the Middle East and North Africa.

“There have been some signs of selected stability in the real estate market, and that has created a lot of investor optimism,” said Nick Stadtmiller, head of fixed income research at Emirates NBD PJSC.

Still, Dubai has more than $17 billion of bonds and loans maturing in 2013 and 2014, according to data compiled by Bloomberg. Emaar, which still generates most of its revenue domestically, is also vulnerable to political developments in countries including Syria, where it’s expanding, and Egypt, where it plans to invest more than 5 billion pounds ($819 million). The yield on Emaar’s 7.5 percent notes maturing in December 2015 rose nine basis points to 3.53 percent today since hitting a record low on Oct. 22.

“In terms of risk-reward, much of the juice has already been extracted on some of these names,” Chavan Bhogaita, head of the markets strategy group at National Bank of Abu Dhabi, the U.A.E.’s second-biggest bank, said by e-mail yesterday.

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