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Battening down

While Dubai’s real estate sector has taken a massive hit, the scale of construction activity has been such that even in these times, there are sufficient ongoing projects to keep contractors busy. In fact, some see the current downsizing as a chance to simply catch their breath, reports M Philip.

01 April 2009

THE question being posed recently in international circles, of whether Dubai will survive in the medium to long term, has much to do with the dominant image of the emirate’s construction sector.

Big infrastructure and giant real estate projects have for five years running pulled in investors and overawed the rest of the world. Within the Gulf, Dubai’s plans and practices have set the benchmark and provided the inspiration.
We know well that the runaway success of the property development, infrastructure and building services sector — until the last quarter of 2008 — had aroused both envy and admiration.
The refrain now is: Dubai has overextended itself and is now paying the price. Is that really so?
The answer depends on whether one’s focus is the construction and infrastructure sector, or Dubai’s approach to development. When it is the latter, then the answer is that a single sector has for several years overshadowed the economy, and that the rest of Dubai continues to have the skills, talent and community energy that have served the emirate well since the 1950s. The city-state’s core strengths have neither gone away nor have they been replaced entirely by the chromium glitter of 500 skyscrapers.
Dubai’s fundamentals as a regional hub of shipping, services, people, trade and capital have not changed. If one considers the construction sector as a corporate diversification that yielded high returns for five years – which helped buy new infrastructure, helped fund the acquisition of new talent, and which must now be scaled down – then the ‘Dubai question’ becomes easier to plot. As one phlegmatic Dubai banker has put it, Disneyland Dubai is being torn down financially, but the core business model of Dubai remains sound.
What the headline-grabbing dynamics of the real estate portion of construction have obscured is that a lot of this money has been used for much-needed infrastructure projects such as roads and ports, tourism developments that include vast hotels and shopping malls, and more down-to-earth residential and commercial properties.
Infrastructure, overall, had suffered from decades of under-investment. Government efforts concentrated on developing oil and gas, the power sector and transport infrastructure. The private sector concentrated on residential, commercial and tourism real estate projects.

Impact of crisis
Since October 2008, real estate projects have crunched to a halt as investors have stopped buying properties and developers have run out of funds. The impact of this on the construction market has been profound.
A Reuters poll forecast that the economy of Saudi Arabia would grow by 0.3 per cent this year, while the UAE would register zero per cent growth and Kuwait would shrink.
Meanwhile, according to a EFG Hermes report, the UAE’s population will contract by a marked 5.5 per cent in 2009, driven largely by Dubai, where the population is expected to decline 17.1 per cent this year.
“We believe the impact of the global financial crisis will be particularly harsh in Dubai, compared to the other emirates and the rest of the region. This is because of both the highly leveraged and externally facing nature of the Dubai economy. We will see a slowdown or contraction in a number of economic sectors, most notably in real estate and construction as projects are cancelled or put on hold. We are forecasting that the construction population of Dubai will fall 30 per cent in 2009. The fall in population will further result in weaker demand for housing,” the EFG Hermes report said.
A number of real estate developers have cancelled projects or scaled back their plans. In January, Nakheel said it was suspending preliminary work on the 1-km The Burj planned as the world’s tallest tower — pushing past the more-than-160 storeys at the nearly-completed Burj Dubai. At the end of last year, it had also laid off 500 staff and said it would scale back work on the archipelago of man-made islands for which it is best known. One of the projects on hold is the island of Ireland which, as part of The World development, was to feature Irish-themed homes and a hotel resort when finished.
Last month, Nakheel confirmed that it had delayed its $3-billion shopping mall expansion programme by 12 months. The ambitious mall development programme covering the UAE was unveiled last April.
Dozens of other iconic projects have been placed on the backburner, including the Dubai World Trade Centre District and Palm Trump International Hotel and Tower, which was planned by US real estate mogul Donald Trump. Construction work on the Dubai World Trade Centre District has been delayed by around nine months to enable the World Trade Centre to focus on expanding its exhibition centre.
Although developers are reluctant to admit it, of the projects that are continuing, many are progressing using extended schedules and minimal workforces.
But despite the suspensions and cancellations, projects are still moving ahead, and most Dubai-based contractors are confident that they have enough work to see them through the rest of this year.
According to a recent report, more than half of the construction projects in real estate, infrastructure, and leisure and entertainment in the UAE are now on hold. That still leaves construction projects worth almost $700 billion going ahead as planned.
In an in-depth investigation, Dubai-based analyst Proleads Global recently reported that 52.8 per cent of the total current civil construction project portfolio of the UAE, worth $582 billion, was now on hold while a further $698 billion remained in operation.
However, the analyst firm put it into perspective: the $698 billion of continuing work being reported is almost equivalent to the latest stimulus package proposed for the US.
What remains a problem is the banking sector crisis. Stock markets and bond markets in the region are still relatively underdeveloped compared to the leading global bourses and the private sector – particularly the real estate segment – relies heavily on bank credit. This has exposed the region’s banks to boom-bust cycles in assets like real estate. Islamic financial institutions also have high exposure to real estate and Dubai banks have financed much of the emirate’s construction boom.
Industry analysts predict that many real estate firms will go out of business this year with the firms most at risk being those that have not accessed the corporate bond markets over the past two years. The prospects for new bond issues are likely to remain limited until 2010, removing this as a financing option for the foreseeable future.
Contractors are also being squeezed by the lack of credit. The combination of high borrowing costs and falling prices is putting them in a tough position as clients demand lower prices be passed on to them.
Senior representatives of 30 leading Gulf construction companies were surveyed at the Arabian World Construction Summit held in Abu Dhabi in February. Of the sample, 87 per cent of companies have had one or more contracts cancelled or postponed in the last three months, 35 per cent have had five or more contracts cancelled or postponed, 61 per cent have seen their forward order book shrink compared to one year ago, and 44 per cent say forward orders have shrunk 10 per cent or more.
In response, construction sector companies that are not laying off staff are relocating them to more buoyant markets in the Middle East. Many are pinning their hopes on Abu Dhabi, Doha and Riyadh. However, there will not be enough employment for everyone and some will inevitably have to cut costs through redundancies.
Through the dust and haze of the massive restructuring this sector will see this year, there is one bottom line: even if a quarter of planned construction eventually goes ahead in Dubai, it will be a big driver of growth.

Falling costs
An immediate impact of the crisis has been the falling cost of construction as all cost elements have been scaled down.
Land has contributed almost 25 per cent to the total cost of construction, and the decline in land prices has also pulled down construction costs.
At the end of last December, contractors were reporting a fall in materials costs of up to 15 per cent. This was the start of a series of price falls that are expected to include diesel, steel, cement and labour, all of which will continue to drop over the course of this year.
Quantity surveyors in the Gulf are welcoming the fall in costs, which have been most dramatic in the metals markets.
Data shows that steel rebar was priced at Dh6,500 ($1,769) per tonne in July 2008 before falling to Dh3,000 ($815) per tonne by the end of the year. Steel rebar is now at around Dh1,850 ($503) per tonne – back to 2003 levels.
Declining aluminium and copper prices are also expected to have a big impact on overall costs. Copper hit a record of $9,000 a tonne in December, but this had dropped to less than $3,000 a tonne by early January.
An industry source reported that his firm currently pays Dh18 ($4.9) for a 50-kg bag of cement or Dh360 ($98) per tonne.

Response
Faced with a major crisis, the state has responded with aid to the construction sector through a $20 billion bond programme, the first instalment of $10 billion of which was fully subscribed by the UAE’s central bank.
The bond issuance is expected to “secure the necessary funding for Dubai to meet its financial obligations and continue its development programme.”
Nasser Al Shaikh, the head of Dubai’s Department of Finance, said the property sector could be among the main beneficiaries. He said the $10 billion Dubai received from selling bonds to the UAE Central Bank would be enough for now to help local companies pay off debts and restructure themselves to deal with a real estate slump.
Dubai’s Real Estate Regulatory Agency (Rera) is also overseeing Dh8 billion ($2.17 billion) in escrow accounts after it supervised and agreed to issue payments from these accounts to cover construction works. The agency has said that availability of the funds is linked to the ratio of project completion, with commitments for finishing current projects being a condition.
The agency believes that Dubai’s real estate developers can weather the downturn without drawing on the central government’s $20 billion bond programme.
These measures will be sorely needed in 2009 as, according to the International Monetary Fund’s (IMF) most recent forecast, the GCC economy is expected to expand by no more than 3.5 per cent compared to 6.8 per cent last year. That difference emphasises the importance of the construction and real estate sectors to the Gulf economies.
The Frankfurt-based Deutsche Gesellschaft für Immobilienfonds (DEGI), an institutional real estate investment firm, points out that construction contributes almost 15 per cent to GDP in the UAE, for example.
Building spurs growth in other non-oil sectors, too, including transport, financial services and more. “A reduction in construction could stop the self-supporting upswing, with negative consequences for other industries and the whole region,” said the firm.
Conclusion
No doubt the region’s countries are better equipped to weather a low-revenue scenario due to their huge foreign asset positions and low public debt. The extent of spending in each country will be dependent on oil prices. What is important is the shift in emphasis – from real estate to investment in human capital and infrastructure to improve non-oil sector growth over the long term, including technological universities, mass rapid transport systems and value-added industries.
Even so, policy makers for the emirate of Dubai and in the UAE will need to pay closer attention to the concerns of foreign investors, who have consistently asked for more transparency. The creation of regulatory bodies to oversee developers, brokers and financiers, to train and certify real estate brokers, and to provide sector-wide data on property sales and rentals, may help address these issues. The creation of Rera has been a very important step in that direction – the decline in land prices has led to a fall in construction costs but speculators have not invested in plots due to Rera’s new regulations. Now, a developer has to pay 100 per cent of the land price if he wants to sell units off-plan. Besides, master developers are also strictly enforcing regulations that tend to discourage speculators.
The city-state will survive because of its commercial geography. With or without a booming real estate sector, it is a commercial and tourism hub for a region that encompasses the markets of emerging Africa, South Asia, Russia, Central Asia and Iran, and of course, the Gulf region. It will continue to work largely because of the heavy infrastructure investment made by Dubai’s rulers and the expatriate traders, service professionals, construction workers, bankers and techies who make up the bulk of the population.