Dubai Property - Investment Risks

How to Be Sure You'll Get Those Headline Returns

If you're investing in property in Dubai, you'll clearly be focused on getting the best return on that investment. But what kind of returns can you expect? And how can you make sure you actually get the advertised returns?

Right now, Dubai offers a splendid rental yield. Invest in London and you'll be lucky to get a 4% annual rental return on your investment; in the best areas of Paris, or in New York, you'll get 3%. Dubai can give you 6-7% on average, pretty much double what you'd get elsewhere.

Exactly what you'll get, though, depends on what kind of property you buy, and where. Downtown Dubai, for instance, is highly sought after and offers only 4% yields, whereas areas like International City, Jumeirah Village Triangle offer between 8 and 10%. Villas in Town Square will return 7%, but in Palm Jumeirah you'd be lucky to get half that.

Villas and townhouses tend to have lower rental yields than apartments; 7% is pretty good for a villa, but you can get up to 12% on apartments. And smaller apartments can offer better yields than larger ones.

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How to make sure you get maximum rental return?

Larger units tend to have significantly higher service charges, as well as a higher initial cost. They also have a smaller addressable market, with fewer tenants able to afford them; many of those who could will probably have opted to buy their own homes.

Newer communities offer higher yields, but may have higher vacancy rates - and you're taking more risk on the development of the community over time.

Suggestions from broker Michael Burke include studios in Discovery Gardens, which could yield 11-12% gross on an outlay under $100,000; or 7% on one-bed apartments in Jumeirah Lake Towers.

He also suggests going for 3 bedroom townhouses rather than the four to six bedroom villas that developers preferred to build. These smaller houses let both to tenants with young families moving up from smaller properties, and to those downsizing from bigger properties. A 6% yield is par for the course here - not the best you can get in Dubai, but still twice what you'd make in other major cities around the world.

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What about capital returns?

Of course, rental return is only one aspect of the return on property investment - you also need to think about capital returns. For instance, very roughly, a property that has a 7% yield and increases in value by 3% has an annual return on investment of 10%. But to calculate ROI properly, you'd need to look at it over the whole period of holding the property, and then annualise the number.

Capital gains are less easy to assess - particularly in the long term. At the moment, Dubai is seeing prices in a slight downwards trend, with a large amount of new supply coming on the market. Most estate agents are looking for 2019 to be flat to modestly down; fortunately, high rental returns provide a buffer against soft pricing. But few agents are willing to venture a longer term forecast. (By the way, prices for villas have fallen more than those of apartments - buying apartments has delivered better capital, as well as rental, returns.)

Current soft pricing appears to be due to a glut of supply; demand isn't lacking. Increased demand from China, together with Expo 2020, should help the demand side of the equation, and excess supply will be gradually taken up. With GDP expected to grow by around 3% a year over the medium term, economic conditions will have a positive impact on the real estate market. That suggests mid-2019 could prove an inflection point, after which buyers should enjoy modest annual gains on their investment. Add, say, 3% a year in capital return to 7% yield, and you're getting around 10% ROI.

Because Dubai is still cheap compared to other big city markets like Shanghai, San Francisco or London, international comparisons aren't a constraint on price growth. Dubai property could go up 50% in price and still be pretty competitive.

Some pitfalls to consider

If you're buying direct from a developer, one way to boost your cash returns is to use a post-handover payment plan. This isn't easy for foreign buyers - you'll need a Dubai bank account - but it allows you to reduce your initial outlay significantly. For instance, a 3 year post-handover plan could let you defer nearly a quarter of your payment. If you're getting an 8% yield, that would pay off 24% of your total price over the first three years. (Another way to secure a saving and boost your returns could be to ask for a compensatory discount rather than a post-handover payment plan.)

The numbers look pretty good. But there are a few pitfalls. For instance, when you're looking at rental yield, always look at the net figure. Most rental yields are quoted gross, but you need to consider service charges, which can add up to a significant percentage. For instance, 11-12% gross yield at Discovery Gardens equates to 8% net - Nakheel's service charges are above the average for Dubai - though that's still a good return. Make sure you've also allowed for any property management costs when you do your calculations.

You should also allow for vacancies. With smaller apartments you're unlikely to have much gap between tenants, but with larger properties vacancy can make a big bite into your rental returns. When you're looking for a property, choose developments with strong rental markets, or where you can see a strong tenant selling proposition (such as good mid-market space close to a new business development).

Above all, don't expect to make a massive return overnight. Dubai right now isn't a market where you can 'flip' an apartment or aim to double your money in a couple of years. It's a steady-as-she-goes investment market, where you need to invest for long term returns. That said, do your homework properly, and you'll be getting returns well above what other major city real estate markets can deliver.