Dubai was in danger of becoming an unaffordable place to live for all but the highest earners in the summer of 2008. But the near collapse of the emirate's real estate sector since then has deflated property prices and rental costs, to the relief of many Dubai residents.

An exodus of expatriates following a wave of redundancies, coupled with new housing stock entering the market, has pushed rental prices in Dubai down by 20-40 per cent since the final quarter of 2008. Investment bank Deutsche Bank predicts Dubai's population will fall by a further 10 per cent by the end of this year, because of expatriates being made redundant and having to leave the emirate.

The effect of this population decline on property prices is not easy to calculate because of the lack of transparency in Dubai's real estate transactions. But according to US investment bank Morgan Stanley's Dubai price index, which was launched in August last year, rental rates in the emirate started to decline in December 2008. By February, apartment rents had dropped by 7 per cent from their peak in the summer of 2008, and villa prices by about 10 per cent.

Housing stock

Residential occupancy rates have fallen from 93 per cent in mid-2008 to about 74 per cent in March 2009. According to US real estate services company Jones Lang LaSalle, about 32,000 new housing units were completed in 2008, bringing the total in the emirate to 253,000. Even though half of all planned real estate projects in Dubai have been delayed or cancelled, a further 65,000-90,000 units are expected to enter the market by 2011.

Dubai's real estate sector faces a supply-demand imbalance over the next two to three years as the emirate's population is expected to continue to decline over the near term. But the oversupply is expected to shrink. With the drop in rental prices, there is growing interest among tenants in moving out of shared accommodation - which they have been forced to live in because of high rental costs - into single-occupancy units. At the same time, relocations within Dubai are rising. Increasingly, when their contracts expire, tenants are moving away from the outlying, low-cost developments such as International City and Discovery Gardens into more desirable, and now more affordable, locations such as Dubai Marina.

"There are a lot of relocations happening now, with people looking for better location and pricing," says Ian Ohan, head of investment transactions at Jones Lang LaSalle. "Rental prices for the good developments are bottoming out and it is the secondary and tertiary developments, in terms of location and quality, that will be the worst affected."

Dubai is also tempting people away from Abu Dhabi, where rents are much higher due to limited housing stock and the quality of available accommodation is inferior. Rather than pay higher rents, many prefer to take the 250 kilometre round trip each day.

Rental prices for villas and apartments have stabilised in Abu Dhabi, after soaring by up to 50 per cent between 2007 and 2008. Rents for villas on Abu Dhabi island have, since January, recorded an average 10 per cent fall. Rents on properties beyond Abu Dhabi's main island have gone down by 20 per cent since January. Villas in Al-Raha Gardens - not on Abu Dhabi island - were fetching AED250,000 for a four-bedroom property in April, down from highs of AED330,000 in the summer of 2008.

Further rent decreases are likely in Abu Dhabi as more projects reach completion. Villa prices have already dropped by 15-20 per cent since the economic crisis took hold. Some 14,500 new residential units are expected to be completed and on the market by the end of 2010, according to Dubai-based real estate consultant Landmark Advisory.

Nonetheless, with so many projects having been delayed in Abu Dhabi and population growth predicted to remain strong, housing is expected to remain in short supply. According to Landmark Advisory, residential developments on Reem Island, such as Al-Shams and Najmat, have been delayed. The company predicts the market will be undersupplied by 27,900 units if the population grows by 2 per cent a year in 2009 and 2010, and by 45,000 units if the population expands by 6 per cent a year, as forecast in the Abu Dhabi 2030 strategic plan. However, the shortage could become much more acute in the years beyond 2010 as the impact of the project delays take effect.

Occupancy rates

Office space is also in tight supply in Abu Dhabi, with about 1.4 square kilometres in total, according to UK real estate consultant Colliers International. Consequently, the occupancy rate is about 98 per cent.

Nonetheless, office rental prices have dropped by as much as 20 per cent since their peak in the summer of 2008, due to a combination of companies delaying their expansion plans and firms waiting for the arrival of higher-quality stock into the market over next couple of years.

"Currently, a lot of the office space is very poor quality - converted residential buildings or villas - it is not what you would call grade-A office stock," says David Dudley, Abu Dhabi branch manager of Jones Lang Lasalle. "When the new supply comes on stream, a lot of occupiers will relocate, but they will pay similar rent to now and will get much better space for it."

Colliers estimates that total office supply in Abu Dhabi will increase by 67 per cent over the next three years, which equates to about 938,000 square metres of new space. By comparison, only 50,000 sq m of space entered the market in the last six months of 2008. As a result, a short-term oversupply in the fourth quarter of 2010 is forecast to bring about a further price correction.

It has long been predicted that supply of office space in Abu Dhabi would exceed demand around this date because of the sheer number of projects under way. But the postponement of almost 60 per cent of office projects that had been planned for completion by 2011 means that the market imbalance will be much less severe.

Dubai has not been as fortunate. Vacancy rates in the Dubai office market are worsening as more projects are completed and demand continues to stagnate. According to Colliers, office supply in Dubai increased by 45 per cent between 2007 and 2008. In some new dev-el-op-ments the average occupancy rate is now just 40 per cent.

Rental prices have fallen by up to 45 per cent on the back of the oversupply. Even factoring in the project delays and cancellations, Colliers estimates that 3.1 sq km of new office space will be completed by 2011, doubling the existing stock, so empty office blocks are likely to be a common sight in Dubai for some time to come.

However, the collapse in rental and sales prices and new supply of both residential and office space in Dubai has improved the emirate's business competitiveness. The city is once again an attractive place for companies to set up and a much more affordable place in which to live, which will assist Dubai's recovery from the financial crisis in the near term.

One of the most significant improvements to come out of this crisis is the willingness of landlords to accept monthly rental payments instead of having to pay a year's rent in advance, which is the traditional practice in the UAE.

The recovery of the residential sales market is much less certain. Speculative investors who had fuelled the property boom in the UAE promptly left the market as the first signs of the global financial crisis began to emerge. Although some investors have since bought up the distressed assets in the market, residential sales volumes are low and developers now have to rely on homebuyers rather than speculators to buy property.

But would-be buyers are holding off until prices bottom out. Furthermore, many potential buyers will now be wary of acquiring property in the emirate, not just in reaction to the sharp price falls but because the crisis has highlighted the flaws in the real estate sector and the lack of protection for consumers.

"Developers should not assume a return to a highly speculative market," says Hani Shammah, chief executive officer of Abu Dhabi-based real estate developer Bloom. "It is important that developers do not assume there will be a quadrupling of the population in five years. Instead, we need to create solid demand fundamentals. We hope for continued government spending on social and economic infrastructure that will create its own real estate demand."

With the government's spending commitments to transform the emirate into a sophisticated, knowledge-based economy by 2030, demand in Abu Dhabi is much more assured. Furthermore, the under-lying tightness in supply in the emirate is expected to support the real estate sector in the short term and bring about a much faster recovery in the market.

But common to both emirates in the future will be a greater focus on the quality of property developments. Gone are the days of speculators buying and selling assets with no thought to the layout and finish. Private buyers and tenants are becoming more discerning and less accepting of substandard work, construction noise, lack of amenities and other inconveniences that damage the quality of life.

Developers whose projects are lacking in some way will struggle to close deals unless prices drop to levels that better reflect the quality of the property, and many will be left ruing the decisions made when the market was on the up.