Why Dubai's Construction Boom Continues

Construction sites are buzzing with work across the Persian Gulf sheikdom of Dubai more than two years after the financial crisis set off a real estate slump that caused values to fall by more than 60 percent. In the next two years, tens of thousands of new properties will come onto a market where about 40 percent of homes and offices are already empty.

Some developers have chosen to complete projects started before Dubai's property market collapsed instead of canceling them and facing a legal obligation to return all advance payments to customers. Falling construction costs and low interest rates also provide an incentive to build now rather than wait for property values to increase. As many as 48,000 homes will be completed in the next two years, increasing supply by 12 percent, real estate broker Landmark Advisory estimates. "The cost of walking away from these projects is much higher than completing them," says Ahmed Badr, head of Middle East real estate research at Credit Suisse (CS).

Home buyers in Dubai, part of the United Arab Emirates, typically put down 10 percent upfront and pay further installments based on how much work is completed. That means a developer that sold a home before the crash in 2008 and collected 50 percent of the price so far would have to pay back more than the property's current market value if the project were canceled. Average prices in the emirate have dropped 62 percent since the peak, Deutsche Bank (DB) said in February. Buyers are obligated to adhere to their contracts, even though values have fallen.

New buyers are scarce. Residential transactions declined 53 percent in volume and 65 percent in value in the first nine months of 2010, according to real estate consultant and broker Jones Lang LaSalle (JLL).

Demand may increase as political turmoil in Mideastern and North African countries, including Tunisia, Egypt, Libya, and Bahrain, prompts companies to move staff to more stable places such as Dubai, says Matthew Green, head of United Arab Emirates research at CB Richard Ellis, a commercial real estate firm. That could boost housing demand in the sheikdom, where citizens are relatively prosperous and receive many benefits from the state. "The longer the instability in the region goes on, the more attractive Dubai will be for companies," he says. About 12 million square feet of commercial space may be completed in Dubai this year, says Jones Lang. Office vacancy rates stood at 41 percent in the fourth quarter and may exceed 45 percent this year, the broker said on Jan. 23. Average rents fell by 30 percent during the fourth quarter.

The backlog of unfinished projects is a legacy of Dubai's rapid rise and fall. The sheikdom had the world's fastest- growing property market from 2006 to mid-2008 because of rising demand from a growing expatriate workforce and speculation fueled by borrowing. Prices quadrupled in the six years following the 2002 decision to allow foreign ownership of property in designated areas. Soon after Lehman Brothers collapsed in September 2008, banks across the UAE stopped lending, and two months later trading in the stock of the country's two biggest mortgage lenders, Amlak Finance and Tamweel, was suspended. About 50 percent of Dubai real estate projects were canceled or halted.

Developer Nakheel, which along with Emaar spearheaded the building boom, says it will restart work on seven projects, including the construction of hundreds of homes in places such as Al Furjan and Jumeirah Park. "There is a reputation factor here," says Mala Pancholia, a Dubai-based analyst at NBK Capital. "If you finish a project in a down market, there is a trust factor that you can build with customers, and that can have a cash impact when a developer decides to work in other countries."

The bottom line: The cost of canceling projects in Dubai has builders continuing to work even in the face of a residential and commercial property glut.

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