After a tough 2020, this year looks brighter for the real estate sector in Dubai as it emerges from a very low point. The extent of the impetus, however, differs materially across real estate segments, with the residential segment gaining momentum and the hospitality sector lagging behind.

In residential real estate, bigger and well-established developers offering high-quality assets in prime locations are set to capture energized demand. However, secondary players will continue to struggle due to structural oversupply.

We foresee only gradual recovery for mall operators. They are regaining their footing now that COVID-19-related relief measures ended in the beginning of the year and the tenants have experienced some improvement in sales. Still, subdued footfall and the struggling tourism sector will constrain profitability, in our view, as new capacity ushers in sharp competition and continues to pressure rental rates.

The hospitality segment will continue to struggle since international travel to Dubai has been slow so far in 2021. We believe tourism may not recover to prepandemic levels until 2022 or later, despite the momentum we expect from the Expo 2020, which was delayed a year because of COVID-19. Importantly though, we believe that Dubai is well placed to capture resumed international air traffic.

We anticipate that office space will remain exposed to the risk of high vacancy rates and rental pressure. Tenants may reconsider their workspace needs, considering the pandemic-induced changes related to remote work arrangements, and the amount of office space available remains abundant.

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Because of the varying degrees of recovery across the real estate sector, our view of the creditworthiness of Dubai players varies from one company to another. We revised the outlook on Emaar Properties PJSC to stable from negative in June 2021. Emaar is the largest primary market developer, and we assume that the market's overarching recovery will benefit the group's development business. Our rating on Damac Real Estate Development Ltd. remains on a negative outlook. The company's EBITDA has contracted consistently over the past years, coming in negative over the first two quarters of 2021, leading to very high leverage, reflecting the completion and handover of projects, in the absence of launches. Although we think that Majid Al Futtaim Properties LLC will continue to benefit from greater geographic diversification outside of the United Arab Emirates (UAE) and its longstanding franchise relationship with Carrefour S.A., recovery will likely be moderate in 2021 before strengthening in 2022.

Gradual economic recovery, high vaccination rate, and government actions provide welcome support.

We expect a steady economic recovery in Dubai. The GDP is set to grow by 3.5% in 2021, followed by 2.5% in 2022, versus a 10.9% contraction in 2020. In addition, we estimate the population will grow by about 2% on average over 2021-2024, after a reduction in 2020. Other factors supportive of GDP growth include high COVID-19 inoculation rates, with reportedly about 80% of the population fully vaccinated, and the gradual easing of global travel restrictions. We believe the city will register stronger tourism inflows in 2021, from historical lows in 2020, and sustain demand momentum, partly thanks to the World Expo in Dubai over October 2021–March 2022. The introduction of new residence visas, including for remote work and for retirees, should further propel population and investment growth over the longer term.

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A sustained recovery in residential real estate remains fragile.

The lingering effects of the COVID-19 pandemic and potential new severe waves of infections in Dubai and globally might disrupt recovery, especially if developments prompt more travel restrictions. In particular, the evolution of the pandemic in India is important for Dubai. Indians represent one of the largest investor and visitor groups and were until recently unable to travel to Dubai. We note, however, that oversupply continues to represent the biggest structural risk. New project launches with several years lead time will extend the oversupply, thereby continuing to hamper the long-term outlook for price appreciation.

At this time, the rebound in demand for residential real estate has largely benefited premium developers with a surge in presales and price improvements. Prices have risen for the first time since the decline initiated in 2015. The reversal started at the beginning of 2021, mainly for villas, as the buyers' preferences shifted amid COVID-19-related confinement measures in 2020. The sale prices of premium properties in attractive locations have seen 10%-20% increases since the start of the year, while prices across the wider market increased by 23% year-on-year for the quarter ended June 2021 (source: Asteco). Recent market data suggests that apartments, which account for 85%-90% of total properties, also witnessed a price increase of about 6% in the second quarter. With regards to rents, the rates for villas have also accelerated, demonstrating year-on-year improvements, while rents for apartments are still lagging, albeit with some sequential pick-up in the second quarter.

We think that real estate prices overall are at a low point in the cycle and improved consumer sentiment, reinforced by improved oil and gas prices, will continue to drive demand in the second half of 2021. Additionally, effective measures in response to COVID-19 and high vaccination rates in Dubai, teamed with momentum from the World Expo, should support visitor growth, stimulate foreign investments, and underpin residential real estate's rebound in 2021-2022. In the longer run, we believe that the demand for residential properties will depend, among other things, on the success of the recent government initiatives targeting population increase, such as new visas and more liberal social laws. Nevertheless, we believe that price increases will not endure over the long term due to the structural oversupply of residential real estate in Dubai.

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A strong rebound in presales and in operating cash flow benefits developers.

We assume developers will see continued strong presales in the second half of 2021 and announce launches in response to robust demand. This will yield higher revenue in the coming years as the new projects get recognized in the income statement on the basis of their percentage of completion. Emaar reported UAE dirham (AED) 16.8 billion in presales in the first half of 2021, representing a 229% jump year-on-year. Damac's presales soared by 147% to AED2.6 billion. Both companies reported much stronger operating cash flow over the same period: AED4.5 billion for Emaar (versus AED0.8 billion in the first half of 2020) and AED1.2 billion for Damac (versus AED18 million). So far this year, they have sold a large part of their existing inventory and therefore have seen higher collections as projects are finished and handed over. This contrasts sharply with their cash flow track record over the past five years; historically, high working capital requirement led to very limited operating cash flow. For instance, Emaar's cumulative reported EBITDA over 2016-2020 amounted to AED37.3 billion, while operating cash was only AED7.3 billion. Damac reported cumulative EBITDA of AED2.4 billion and a negative AED134 million of cash flow. We expect cash flow to remain strong in the second half of the year, on the back of strong demand and sustained cash collection on handed-over units, likely to outpace the requirements for new constructions.

Rents in the retail market remain under pressure amid ongoing new supply and subdued footfall.

Traffic at malls has yet to recover to prepandemic levels, while rental rates demonstrated persisting weakness with 10% and 5% year-on-year declines in first-quarter and second-quarter 2021, respectively (source: JLL). In the first half of 2021, Emaar Malls PJSC reported 43 million in footfall, a slight improvement from a depressed 39 million in the same period last year owing to the temporary closure of malls during COVID-19-related lockdowns. Still, the improvement is much weaker than the 68 million recorded in the first half of 2019. Low tourist volumes have driven the decline in footfall. The number of tourist visitors has remained quite low so far in Dubai; only 2.9 million visitors arrived between January and July, versus 16.7 million in 2019 (source: Dubai Statistics Center). We therefore think that footfall will remain subdued throughout 2021, except for an anticipated improvement in the fourth quarter when peak tourist season begins and the World Expo starts. In this regard, Majid Al Futtaim remains less affected since their malls cater to residents and are less reliant on tourists than Emaar Malls'. The Dubai Mall is Emaar's largest asset, and it is one of the key tourist destinations in the city. The sluggish foot traffic is partly mitigated by higher average spending by customers since non-discretionary spending curtailed sharply in 2020 has partly recovered. Luxury product sales have soared on the back of pent-up demand, but we expect this effect to be temporary.

The supply of new malls continued in Dubai even throughout a very challenging 2020, and capacity will be added in 2021. Dubai Hills Mall, for instance, is now scheduled to open in the first half of 2022 (initially end-2019). Although we think that new malls are notable revenue drivers for mall operators as they ramp-up and increase occupancy, we think that additions heighten the ever-increasing competition that continues to weigh on average rental rates as the mall operators strive to retain tenants. Likely tenant-friendly measures include lower rents on lease renewals, wider inclusion of turnover rents rather than fixed rents, and rent-free periods. Emaar Malls has about 10% of its leases due for renewal in the second half of 2021 and another 17% in 2022. Majid Al Futtaim renews on average 20%-25% of its leases every year. We see a risk of reduced rental rates upon renewals but expect relatively stable occupancy in return.

Positively, we understand that retailers in prime malls now operate at healthy sales level. Mall operators' profitability, however, is unlikely to rebound to previous levels in the short term due to the competitive pressure. That said, we expect the cost-reduction efforts completed during the pandemic will continue to support the margins in the near term.

We think that brick-and-mortar commerce will remain essential in Dubai, where in-person shopping forms a part of the lifestyle. That said, we anticipate that e-commerce will continue to demonstrate solid growth albeit below the exceptional performance seen in 2020 due to the pandemic-related mobility restrictions. We anticipate that the e-commerce platform Namshi, owned by Emaar Malls, will expand 5%-10% in 2021-2022. Nevertheless, given the division's limited contribution to Emaar's profits, Namshi would continue to be margin dilutive for the group overall. We think that operators such as Majid al Futtaim and Emaar Malls will maintain their malls' appeal by focusing on stronger customer experiences and invest more in entertainment venues, among other leisure options.

Hospitality recovery is likely to be lengthy due to a slow rebound in international travel.

Dubai's overcrowded hospitality sector continues to struggle as the excess inventory built up over the past years has been exacerbated by the COVID-19-induced stop in international travel in 2020 and subsequent border closures. Under our base case, we don't expect international travel to rebound to prepandemic level before 2022 or later. As such, we think that the occupancy and average daily rates will remain subdued until then.

The oversupply will continue to cramp hotel operators and their profitability despite slower-than-expected capacity additions. New keys ahead of the World Expo were scaled back from the initial plans, with a mere 5.5% growth between end-2019 and end-June 2021. This brought the total keys number to 134 thousand (source: JLL). Even though occupancy rates have improved steadily from a very weak 2020, levels remain rather low, with average daily rates lingering below 2019. Hotel occupancy rate reached 58.4% this August versus 67.9% in August 2019 (source: STR Global). We anticipate that hotel operators will continue to offer staycation deals to domestic tourists to compensate for the absence of international travelers.

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Importantly, the evolution of the pandemic in India will be critical for Dubai, since Indians are the largest visitor group. The flights from India resumed in August after several months of restrictions. We think that some upside will stem from the World Expo and expect stronger visitor inflows in the second half of 2021, relative to 2020. Furthermore, Qatar's hosting of the World Cup in 2022 may also usher tourists into the Gulf Cooperation Council (GCC) region, particularly Dubai. We believe that Dubai is well positioned to capture early resumption of international air traffic. In addition to being the main vacation hub in the region, Dubai is one of the world's leading travel destinations. This is underpinned by Dubai being perceived as a generally safe destination amid the current unfavorable health environment, thanks to its efficient management of COVID-19 and high vaccination rates. Nevertheless, we think that catching up to the levels seen in 2019 will likely take at least two more years.

The office market will continue to face high vacancy rates and rental pressure.

Because high vaccination rates in Dubai support a return to the office, we believe that Dubai remains an attractive place for businesses, especially considering the minimal COVID-19-related disruptions. In addition, recent relaxation in rules regarding foreign ownership is a stimulus, in our view. At the same time, corporates are likely to revisit their real estate needs over the coming years, since COVID-19 triggered changes in work patterns and normalized remote work.

Despite an expected limited new supply (about 70,000 square meters in the second half of 2021), occupancy rates could continue to decline. Rents would remain strained as the tenants seek to reduce costs amid numerous offers available, even in prime locations. Since end-2019, total stock of office spaces increased by less than 2%, but this did not help reabsorb the existing overcapacity as business growth was stunted by the pandemic. In the second quarter of 2021, vacancy rates rose to 20%, a notable deterioration from 13% in second-quarter 2019 (source: JLL). At the same time, rental declines for premium assets in the central business district slowed to -1% (JLL: June 2021 report). We don't see the ongoing structural shift to remote work as an immediate threat, but in the longer run tenants are likely to downsize their offices. We also think that the demand will lean toward higher-quality offices and create polarization. This once again better positions more premium assets in prime locations, such as the districts DIFC and Downtown.

Related Research

• Airports Face A Long Delay To Global Air Traffic Recovery, Sept. 24, 2021
• Dubai-Based Real Estate Developer Emaar Properties Outlook Revised To Stable From Negative On Stronger Demand, June 27, 2021
• Full Analysis: Majid Al Futtaim Holding LLC, March 29, 2021
• Bulletin: Emaar Properties' Pending Noncash Acquisition Of Emaar Malls Is Credit Neutral For Both Companies, March 3, 2021
• Damac Real Estate Development Ratings Affirmed At 'B' Despite Weak Operating Performance; Outlook Negative, Feb. 24, 2021