Consistently over the past 27 quarters we made it a standard practice to send a private investor’s letter to few of our investors holding sizable active portfolios.
The letter gave us a chance to take them through the general market conditions -in simple terms- as well as give them a personalized brief of the portfolios that have been presented by us and the performance for the quarter of their portfolio alongside the average of other portfolios. At the same time we provided a brief of where we see the market heading in the medium and long term.
This quarter we decided to make a brief of the letter publicly available to give the wider investor base the benefit of access to such analysis; and help every day investors by giving them an update on things that matter to them, rather than keeping such insights exclusive to few privileged clients.
The generic brief is a sample and does not represent the entire letter provided to portfolio holders investing through Arms &McGregor International Realty®.
Main elements – Investors letter Q4/2018- Q1/2019 :
- Current market state
- Portfolio analysis – Ultimate market positioning
- Market analysis- What’s coming
I. Current market state
The real-estate market is continuing its shift towards smaller more efficiently used space. This shift is usually driven by a market squeeze for developers to achieve an offering of smaller ticket properties.
As explained in previous investor letters the abuse of this phenomena gets developers to build minuscule properties in secondary none prime locations where space is plentiful as well as competition. Although this results in further attractiveness of property ticket prices it results in development of none attractive properties for inhabitants.
There is some supporting elements that may back this drive similar to a flood of buyers from certain markets where the standard of living space is smaller than what it is in Dubai Market. Unless users with a similar mindset drift towards the market similar consequences will be evident.
The luxury and Ultra luxury sectors stay under pressure while the mid-market segment sees good movement and the low end segment struggles.
An impacting contributor to asset valuations is revenues such assets generate.
Although asset values have dropped by around 20 to 50% since their highs late 2014 and rentals by around 40%; Cap rates are so attractive that it makes very little sense to dispose an asset unless to reposition a part of a portfolio. It also makes it attractive to grow or start building portfolios through a balanced systematic step approach that considers the perils going forward as well as the prospects. Offerings with long term payment plans have started taking center stage. More offerings expected with longer term payment plans and new to market schemes similar to real lease to own offerings will start evolving. In some instances calculating the present value of such offerings prove that some developers are offering properties at rates they should not be able to afford. The availability of low cost cash and sitting on land banks gives some developers such ability. This consists good quality opportunities for some end users who wish to make an entry to the housing market; as long as the property is looked at with consideration to all what makes a property valuable and usable thus right for the family planning to utilize the property.
II. Portfolio analysis – Ultimate market positioning
We have added properties to most of our residential diverse portfolios within the last quarter of the year, with a very descent CAP rate which in turn boosted the average rate of return of the whole portfolio. For repositioning purposes we have let go some of the assets linked to few portfolios which resulted in some small confirmed losses. This was mostly made up for by some new purchases that have great short and medium term prospects. We maintained our view of holding enough cash to fund entries when opportunities arise. Such entries proved worthy in the third quarter of 2018, as it resulted in 3 of the biggest active portfolios being boosted by a 6 to 9% growth in market value quarter on quarter. The average CAP rate among all (accounted for significant portfolios) sat at 7.1% during the 4th quarter while the highest ROE stood at 38.6% and the lowest was for a none ideal all cash portfolio of 8.9%.
Our middle end portfolios had a boost by two deals in the midmarket sector which represented a great opportunity. Shared among several portfolios those transaction came from developers at discounted rates and were mostly resold at a very healthy profit. End users were the major purchasers. This consisted the majority of the movement in those portfolios. As an over all we maintain a great 8.3% CAP rate and an Average ROE of 23%. Rentals in this segment (specifically in the top end of this segment) have a descent room to adjust although price corrections are not expected to be significant. We will capture opportunities in this segment with our appetite growing for villas and townhouses, not because they offer better prospects but because we would like to balance the portfolio’s composition which are currently dominated by apartments.
We continued replacing commercial assets with more prominent prime commercial assets during the last quarter. Our target is to end up with 80% of the total portfolios value repositioned to Grade A and prime commercial within the coming 10 months. Our Cap rates are still healthy and stand at 8.2% although the ROEs stand at 10.5% which is way lower than what we would hope for, as those portfolios are predominantly cash driven. There is a necessity to add a bigger leverage element to those portfolios which proved difficult in the past.
Although the market is providing great opportunities for aggressive and opportunistic investors in the mid-market commercial segment, we will stay away from in the near future until we get more clarity on the medium and long term prospects.
We are looking at starting new commercial portfolios to consist mainly of warehouses and industrial assets. Such a move may see some material steps forward within the coming 2 quarters.
III. Market analysis- What’s coming
We expect a continued flood of off-plan projects through out the first quarter and at least the first half of the second quarter of 2019. This said, it is expected that secondary market transaction volumes improve within the period and through out the year.
A general government and semi government sector boost in momentum is expected by the end of the year and towards 2020, which although may not be sustained alone may offer a good start to a renewed economical boost motivated and sustained by other market factors, of which the Chinese entry is one of and several others discussed already and highlighted multiple times in the previous private portfolio holder’s letters.
Vacancy rates are expected to rise slightly, eventually reaffirming that well positioned, well designed and well built property is up to the competition. Inter-Emirate migration is expected to continue specifically as more affordable housing in better built communities become ready for occupancy.
Institutional investors are expected to more aggressively consider our market although a scarcity of suitable assets is obvious. Built to fit assets will be predominantly looked at by local investors, attracting larger scale tenants with long term lease contracts, which by itself will offer an opportunity to far eastern and western institutional investors and family funds.
We have seen a move by the regulators, heading forward to align the regulations to meet but exceed in some instances international acceptable practices. The Introduction of blockchain powered transactions, long term visas, enhanced holiday home regulation, property marketing rules and processes, and last but not least the global initiatives that Dubai Land Department is heading are giving renewed trust to investors and boosting new market entries.
Other regulation similar to the time-share law that has been long awaited, and further development on PPPs will boost the momentum in a market tending to maturity, while still liquid and attractive compared to many frontier markets, and definitely outperforming mature markets.
Developments in lending and the valuations of assets will help the property market evolve an is expected to continue.
We are confident that, although the challenges, the Dubai property market will continue to represent a good opportunity in the long term. By Utilizing the right ratio of leverage and proper capital allocation, well built portfolios will make more sense than the most prominent investments offered globally. While we head in that direction the issue of how we think of real-estate and our expectation while investing persist.
Not all assets are right for every portfolio, similarly not all assets are right. It is imperative that we build our portfolios scientifically with minimum impact of market or performance pressure. We have always put an effort in doing so and we will maintain this approach although not fancied by some. We see any other approach a gamble rather than a step in the right direction.
Makram H. Hani
C.E.O. Arms &McGregor International Realty®
Prepared for Arms &McGregor International Realty’s clients
On the date of 11/ Feb./2019
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