Back when the freehold phenomenon began in Dubai in June 2002, investors who bought and held initial offerings from master developers realized capital gains of between 3.5 and 5 times over a period six years when prices peaked in 2008.
This applied to Springs two-bedroom townhouses, Greens (one- and two-bedroom apartments), Meadows (three-bedroom villas), Palm Jumeriah (one- and two-bedroom Shoreline apartments), Jumeirah Islands (four-bedroom villas) rooms) and Cité Internationale (studios and one-bedroom apartments).
Since then, in two consecutive boom and bust cycles, these investors have seen between 80% and 100% of their returns through rental yields, a startling statistic whichever way you look at it. Remember that for most real estate assets in Dubai, 2008 levels have not yet been reached.
Solid rental returns
In other words, over the past decade, those who have made money in real estate have done so through rental yields and the capitalization principle (an annoying maxim, yes, but a truism nonetheless) . Despite a slew of new offerings and the exuberance of intermediaries that caused investors to time the markets, those initial gains were followed by more than a decade of rental returns.
As the market matured and end users dominated the landscape, investors began to have less impact on the overall direction of the market. Nevertheless, the structure of aggregate returns remained predominantly skewed in favor of cash-annuity-type flows. The results were compiled using data points from over 150 units, where returns were measured from selling prices; rents were measured in actual rents collected as opposed to contractual rents; and costs were measured as the sum of service charges plus actual maintenance performed in the units.
This kind of granularity is similar to the rigor of studies conducted in London, New York and Berlin over a 40-year period and published in various academic journals. What are we going to do with this?
The studies point to three fundamental conclusions:
* Residential real estate returns are highly volatile, where periods of capital gains are followed by periods of low or even negative returns.
• Capital gains are often exaggerated on average because they do not account for individualized quality differentials in a heterogeneous market (when examined closely, actual capital gains are up to 33% lower than reported statistics that feed the index data).
• Over time, rental yields are the dominant part of total returns for the buy-and-hold investor.
Whatever data we can get in any developed market leads to exactly the same result: rental returns are more than half of the overall returns achieved over a 10-15 year (and longer) period. Compare this to the prevailing zeitgeist, where the dominant paradigm is one of entry and exit trading, which essentially raises transaction costs (which over time devour up to half of returns of a portfolio renewed once every five years).
Wealth and excess have a blinding effect on psychology, and they certainly do so even more so in the age of social media where the latest record-breaking deal is reported with a sense of elated wonder. It is this churn mentality that has permeated the culture of investing, with most falling prey to this mental distortion.
However, it is prudent to remember that wealth accumulates over time and no matter how attractive market timing is, very few end up on the winning side. When the opportunity cost of capital is close to zero (a prolonged period of zero interest rates), asset values can be distorted and send the wrong signals. But gravity eventually exerts its influence, and when it does, it’s always the patient investor who stands out.
Dubai real estate data fundamentally testifies to this and is shaking up investment decision-making. Capital should be invested with caution and patience, keeping long-term horizons in mind.
In time, someone will develop a name for the era of zero interest rates and the greed that went with it. For now, all we can be sure of is something we’ve always known: in investments and capital allocation, the best form of work is to be a respirator (breathe) in order to to be away from the madding crowd.