For two days in September, panic gripped the organisers of Cityscape Dubai, the emirate’s biggest annual property show. State-owned real estate giant Emaar Properties and Nakheel, developer of the Palm Jumeirah and The World islands, had announced within hours of each other that they would not be attending.

After much negotiation, both companies issued retractions. “Following discussions with various industry stakeholders,” Nakheel declared, it had decided to appear at the show after all. The statement came shortly after Emaar announced its own U-turn.

The peculiar turn of events gives some idea of how fraught Dubai’s real estate industry remains a year after the first ripples of global recession reached the Gulf and sent property prices tumbling from the speculative heights of 2008. Despite posting an annual drop of 47 per cent over the past 12 months, house prices in the emirate are likely to fall by a third again, Swiss bank UBS said on 17 September.

Of the many developers struggling to keep their heads above water, Emaar and Nakheel have come under particularly intense scrutiny. Not only are they the biggest real estate companies in town, but they are intimately tied to the government of Dubai and its ruler, Sheikh Mohammed bin Rashid al-Maktoum.

Financial challenges

Dubai has so far admitted to having debts of $80bn, the result of its rapid economic expansion over the past five years. Much of this can be traced to the real estate sector.

Dubai’s government is now attempting to get to grips with the problem. Its first task is to restructure its debts, which involves finding financial support for the likes of Nakheel.

Its second task is to restructure its property holdings. Under plans drawn up in July, Emaar is to be merged with several other government-owned property companies – Dubai Property, Sama Dubai and Tatweer – leading some analysts to predict a series of real estate mergers in Dubai. “With most property developers being cash-strapped, with banks restricting lending and homebuyers defaulting on payments, the primary aim of consolidation is to pool resources to enable firms to survive the downturn,” said Dirk Buchta, regional managing director of US consultant AT Kearney, in an August statement.

The consultant forecasts a wave of consolidations similar to those in Singapore and Hong Kong following past real estate bubbles, which left those markets dominated by two or three property giants.

Dubai has a particular interest in seeing Nakheel and Emaar prosper, not least because both firms are potent symbols of the financial strength of the emirate and its government.

Local bankers regard the fate of a $3.5bn sukuk (Islamic bond) held by Nakheel as a key test of the emirate’s sovereignty, as it approaches maturity at the end of the year.

Nakheel’s government-owned parent company, Dubai World, is already trying to persuade bank creditors to restructure up to $12bn of its loans. It reportedly hopes to use extra bailout cash from the UAE federal government for the $3.5bn principal repayment of its sukuk.

Nakheel has good cause for hope that the sukuk test will be passed. Dubai has already managed to cover its immediate liabilities with a $10bn bailout from the federal government in February. But it remains to be seen whether Abu Dhabi has the stomach for more of its neighbour’s debt.

Dubai hopes to launch the second phase of its $20bn bond programme by the end of the year, but has not yet said whether it will approach the UAE central bank for a second time or turn to the international financial markets. Abu Dhabi has managed to stimulate considerable appetite in its own international bond issues over the past year, but it is uncertain whether Dubai would get the same response.

With these financial challenges weighing on the minds of the emirate’s leaders, Dubai has moved to consolidate its real estate holdings. Dubai World has already restructured its property portfolio, putting the real estate holdings of the Dubai Multi Commodities Centre and Dubai Maritime City under the control of Nakheel. The holding company, Dubai World, is also thought to have approached local investors with a view to selling some of its property assets.

Of greater significance to the local real estate industry was the announcement in June that Dubai Holding, the investment group owned by Sheikh Mohammed, also intended to restructure its operations.

“The realities of the global economic climate have made it necessary for us to look at our portfolio in a different way,” said Ahmad bin Byat, chief executive officer of the company, which intends to create four divisions covering property, business parks, hospitality and investments (see diagram right).

Dubai Holding has already moved to consolidate its two investment arms: Dubai International Capital and Dubai Group. The next stage is to combine its property interests, which include Dubai Properties, Sama Dubai and Tatweer, and place them under the umbrella of Emaar. Following the completion of due diligence, finalisation of valuation reports, completion of legal documentation, and regulatory and shareholder approval, the transaction is expected to close by the end of October.

Based on figures for Dubai Holding from the end of 2008 and March valuations for Emaar, the combined asset base of the new entity is worth about $53bn, while its combined external debt is about $3.7bn.

Diluted stake

According to ratings agency Moody’s Investor Services, Dubai Holding, which is majority owned by Sheikh Mohammed, will merge some of its real estate assets with Emaar, resulting in a dilution of the government’s own 32 per cent stake in Emaar, held via Investment Corporation of Dubai.

The eventual size of Dubai Holding’s stake in Emaar will depend on a valuation of the various assets. Local investment bank Shuaa Capital predicts that by the end of the year, house prices in Dubai could have fallen by 60 per cent from their mid 2008 peak.

So what sort of landscape will emerge from this period of consolidation? Much depends on how Emaar and Nakheel fare in the coming months, although the Dubai government has said it is determined to meet its debt obligations on time and, where possible, pay them off in full. This was underscored on 27 September when Dubai Holding paid off a $300m loan owed by Sama Dubai.

One of the results of the past few months is the creation of a single dominant entity, Emaar, which in theory will have unrivalled access to a large bank of land, as well as the benefits of economies of scale and stronger bargaining power with local contractors. Yet this new entity will be dealing with a very different landscape from just a year ago, says Oliver Laroche, senior manager for AT Kearney Middle East.

“The time of endless growth for opportun-istic projects driven solely by land and cash availability is over,” he says. “Developers will compete for buyers, and they need to define a convincing strategy.”

With oversupply in both the commercial and residential property markets, Dubai is witnessing a marked swing away from new building activity. Nakheel, like many developers attending Citiscape, says it intends to focus on “exhibiting communal properties in several of its developments that are close to completion”.

Despite the rapid softening of prices, there is some hope for property companies looking to market existing developments. The fall in residential property prices and rents in Dubai slowed in the second quarter of 2009, according to research from US-based property consultant Jones Lang LaSalle. Transaction volumes also show signs of stabilisation, falling by 13.5 per cent to 845 in the second quarter, compared with a 26 per cent drop in the previous quarter.

“The primary aim of consolidation is to pool resources to enable firms to survive the downturn”

Dirk Buchta, regional director, AT Kearney

Supply is expected to outstrip demand for some time. Jones Lang LaSalle expects 22,400 residential units to be delivered this year, despite more than $24bn worth of residential projects being put on hold or cancelled.

Yet Emaar will be well placed to take advantage of changes in the make-up of the Dubai property market in the coming year. These include the recent opening of the Dubai Metro, which has already led to the firming up of prices in residential areas close to the train stations, and the opening of Burj Dubai, the world’s tallest tower.

Not only is Emaar the developer of the tower, but Dubai Holding has several large projects in the area such as Business Bay, a mixed-use development. “These projects are very close to completion and handover, which will result in booking revenues and profits,” says Moody’s in a report on the sector published in July.

Finances will remain strained, however, with Emaar unlikely to derive much income from land sales in the near term. Residential and commercial property sales are also expected to remain weak. UK real estate consultant Colliers International predicts the balance of supply and demand will take until at least mid 2010 to even out.

With Dubai struggling to regain lost ground, a consolidated Emaar is particularly vulnerable to local market risks. International expansion is one option. “Emaar has started following this path with the acquisition of Singapore-based Raffles for its education business and joint ventures in the construction, brokerage and facilities management segments,” said AT Kearney in its August statement. 

Yet Emaar has not always benefited from its foreign ventures. It posted a loss of $350m for the second quarter of this year, mainly down to a decision to write down losses made by its US subsidiary John Laing Homes. Any plans for the future still await the conclusion of its merger, which is by no means a certainty.

Emaar shareholders initially reacted coolly to the proposal, as Moody’s points out in its July report: “In 2007, they were also the primary force behind the abandonment of the then-proposed land-for-equity transaction between Emaar and Dubai Holding.”

The outcome of the Emaar merger with Dubai Property, Sama Dubai and Tatweer will decide whether a second and third wave of smaller real estate mergers takes place in the emirate. The developer will need to show investors how the merger will benefit them, and the battle-scarred real estate sector in Dubai.