DUBAI, Oct 18 (Reuters) – Just a year ago, bonds issued by Dubai real estate firms held near-pariah status among investors. A compression of spreads against other bonds in the past several months underlines how the mood has changed – and the rally may have further to run.
The yield on the $500 million 2016 sukuk issued by Emaar Properties, Dubai’s flagship property developer, has tumbled from around 9.0 percent in October last year to about 4.45 percent.
Most of that drop is due to factors that have buoyed sukuk from Dubai and Gulf issuers in general this year: loose global liquidity, investors’ growing perception of the Gulf as a safe haven during the world’s financial crisis, and a supply-demand imbalance for sukuk among Islamic funds.
But in the last few months, Dubai real estate bonds have handily outperformed other local debt. Since the beginning of June, the Emaar sukuk’s yield has dived about 180 basis points; the yield on Dubai’s $600 million sovereign sukuk maturing in 2017 has dropped 110 bps in that period.
The outperformance against the rest of the region has accelerated in the last few weeks. Yields on the HSBC Nasdaq Dubai index for Gulf Cooperation Council corporate sukuk have tightened 15 bps since Oct. 1; the Emaar yield has dropped about 60 bps.
The trend has developed so much momentum that it is unlikely to end soon, traders and analysts said.
“Even after the recent rally, real estate bonds still offer better value than the financial and other corporate names in the region,” said Biswajit Dasgupta, head of trading at Abu Dhabi’s Invest AD.
One senior debt capital markets banker in the region said Gulf bonds, including Dubai real estate bonds, had been attracting considerable inflows of investment from international institutional investors since the summer.
“Dubai corporate names like Majid Al Futtaim (MAF), Emaar, Jebel Ali Free Zone Authority (JAFZA)…are in demand…Real estate is selling like hotcakes,” said a regional debt trader.
The outperformance of Dubai real estate bonds is based on two related factors: expectations for a continued recovery of the local property market, and the view that the bonds are still undervalued relative to other debt after their several years of pariah status.
While the property market’s recovery is tentative and incomplete, it appears to have accelerated in the last several months. Residential real estate prices plummeted some 60 percent between 2008 and 2011, but REIDIN Residential Sale Indices showed average prices increasing by 14 percent from a year earlier in August 2012, according to Jones Lang LaSalle.
Property developers still face pressures from high debt levels and unsold projects. But they have pleased bond holders by finding ways to reduce their direct dependence on residential developments.
Emaar, which is rated sub-investment grade but is 32 percent owned by the Dubai government, is expected next week to post a 27 percent increase in third-quarter profit, according to a Reuters poll of analysts. Part of the rise is likely to come from its hotel and hospitality business, as tourism in Dubai booms.
Emaar announced plans last month to build another new hotel in Dubai’s high-end Downtown area, its first major hotel project since the real estate crisis.
Meanwhile property developer MAF, builder of a chain of malls and sole franchisee of French hypermarket chain Carrefour in the Gulf, has been stressing its exposure to the retail sector. The company attracted strong demand for two issues this year, a conventional bond and a sukuk.
Because of factors such as Emaar’s implied government backing, MAF’s rarity value as the only Gulf issuer which is both investment-grade and completely privately owned, and the supply-demand imbalance in sukuk, calculating relative values is difficult. But two aspects of the calculations seem to favour Dubai real estate bonds.
One is international investors’ increasing perception of the Gulf, where most governments have low debt levels and comfortable budget surpluses, as a safe haven.
In the past, investors attached a “Gulf premium” to yields in the region to reflect geopolitical uncertainties, unpredictable policies and poor information disclosure; they are now willing to shrink this premium, and the effect may be largest among beaten-down real estate bonds.
“Dubai corporate bonds which are rated BBB+/- levels are trading like BB+/- bonds in the rest of the emerging markets space, so there is definitely room for tightening, if the macro environment remains neutral,” the regional trader said.
The other aspect is the historically ultra-low levels to which many bond yields around the world have dropped. With the 10-year U.S. Treasury yielding less than 2 percent, investors are desperate for yield, compressing spreads among many types of bond.
Nick Stadtmiller, head of fixed income research at Emirates NBD, said Dubai real estate bonds might tighten a further 40 bps or so against the sovereign. The spread between the Emaar 2016 and Dubai 2017 sukuk is now about 105 bps.
“Obviously, local real estate companies’ bonds can’t keep tightening versus Dubai sovereign forever. I would think the spread differential could come inside of 100 bps, but I doubt it would go much tighter than 60-70 bps.”