Analysis Property companies are under increasing pressure to change their business models.
Developers seek new business models
More than six months after the global financial crisis began having a serious effect on the country, property companies are under increasing pressure to change their business models and devise strategies to ensure they remain profitable. With prices falling across the Emirates, sales of homes from developers have slowed almost to a halt. Even those wishing to buy homes to live in are having trouble because they cannot get mortgage financing.
Property companies have separated into three groups: those that are introducing radical strategies to ensure they survive a potential sales drought; those that are taking cautious steps to change their businesses; and developers that are facing a severe cash shortage and are looking to sell off assets or obtain government support. The consequences of the slowdown were apparent in the earnings reports of the six publicly traded property companies for the first quarter.
Profit declines at the companies ranged from 35 per cent at Aldar Properties to 87.4 per cent at Union Properties, compared with the first quarter of last year. Even those profits are misleading because they are mostly made up of sales from last year that are only now appearing on income statements because of accounting methods. For example, while Aldar's net profit for the first quarter of this year was Dh888.6 million (US$241.9m), its net operating profit, which is made up of its cash-generating items for that period, was just Dh14.2m.
This is because Aldar included the transition of 3.5 million square metres of land into "investment property" and other revaluations of its assets as profit. The low net operating profit of a company such as Aldar is proof of the challenges companies across the sector face, analysts say. With low cash flow, they must rely on cash reserves and debt financing to make it through to a time when sales pick up or rental income starts kicking in.
"It's going to be a challenging year for most of these companies," says Bobby Sarkar, an analyst at Al Mal Capital. "There won't be many sales and the incidences of defaults will increase as the companies start to hand property over." But with some time having passed since the market took a turn for the worse, several companies have outlined strategies to adapt their businesses to the conditions. Deyaar Development in Dubai and Sorouh Real Estate in Abu Dhabi are pushing forward with plans to cut prices. They are also gaining regular income through, for example, renting properties and property management.
Deyaar has become a market leader in consolidating its projects and cutting costs, according to Chet Riley, an analyst at Nomura International in Dubai. Deyaar has sought to reduce the number of people defaulting on payment plans by offering them the opportunity to swap their purchases for buildings closer to completion, and cancelling some projects and refunding the investors completely. Deyaar reported last month that the initiatives had helped them reduce the default rate at Al Seef Tower 2 to less than 3 per cent.
Deyaar has also cut prices, extended payment plans and created a distressed asset fund, which will hold on to properties until it can resell them. "They are effectively providing the sector with leadership in a sector bereft of leadership," Mr Riley says. Sorouh Real Estate, meanwhile, has announced price cuts at its Al Ghadeer project and started to keep more of its property for rentals. Paul Warren, the company's chief strategy officer, said Sorouh had a five-year plan to ensure that between 30 per cent and 50 per cent of its income came from rentals of homes, offices and retail space, as well as facilities management. Mr Warren said the company would have about 1,000 rental units by the end of this year.
Sorouh said in its first-quarter earnings report that it had moved past the lowest point of its earnings cycle and would see greater profitability for the rest of the year. Ahmed Badr, an analyst at Credit Suisse, says Sorouh has enough cash to fund its projects for another two years and praised the company's attempts to diversify its income. The two largest property companies, Emaar Properties and Aldar Properties, have taken less proactive measures so far to change their business plans, but analysts say they will be under more pressure to change over the course of the year.
Emaar wrote off most of its major losses, such as the bankruptcy of its US subsidiary John Laing Homes, in the fourth quarter of last year. Mr Badr says the company will probably have to further "scale down its projects" in international markets this year. Its future income will come increasingly from its retail and hospitality businesses, he says. Just last week, Emaar announced it was hiring as many as 1,000 new employees for its hospitality arm.
It also announced a deal to operate a resort in the south of France called Domaine de Lavagnac under its brand, The Address Hotel and Resorts, although the development has yet to be built. Larger developers have been reluctant to cut prices even while small and medium-sized developers have reduced prices by as much as a third. While it has avoided this route so far by halting sales, Aldar Properties has sought a more subtle strategy of changing some of the units in its unsold projects into apartments more affordable to middle-income buyers.
This has been a strategy across the sector to take advantage of the population that is most likely to buy homes during a downturn. Aldar, like many of the developers, is also renegotiating construction contracts for any projects that have not progressed far to cut costs. Two of the smaller property developers, Union Properties and RAK Properties, appear to be having the most difficulties in the market, according to analysts.
Mr Badr downgraded Union Properties to "underperform" last month, saying the company was highly leveraged and threatened by rising defaults. The company's saving grace so far has been its contracting and ancillary businesses, which contributed most of its revenue in the first quarter. Executives at the company are trying to obtain financing through securitising its future rental income, striking a deal with Emirates National Bank of Dubai and selling its district cooling company.
There has also been discussion about whether Union Properties could receive some of the $10 billion the Dubai Government raised through a bond offering this year to assist companies in trouble. RAK Properties, the only public developer outside of Dubai and Abu Dhabi, is facing one of the most difficult cash squeezes, especially after its investors overruled a management decision recently not to pay dividends despite the company's low-cash position.
The Dh150m dividends burnt through about 25 per cent of the company's cash. Mohammed al Qadi, the chief executive of the company, said the only way the company would be able to continue projects would be to raise money through syndicated loans or sukuk. email@example.com