In Dubai property market, rental yields only tell part of the story

By now, it’s self-evident to any student of financial history that mispricing is built into the system.

For the most part, they are generally fairly efficient in pricing between asset classes. But there has been a lot of silly stuff that has been written, and gets entrenched into the thinking and becomes very hard to dislodge.

One of these variables is the concept of rental yields where brokers and analysts have consistently touted the rankings of rental yields by markets and chosen that as a way to choose their investments. Any empirical evidence will reveal that the projected yields are nowhere as close as to what is actually realized.

Some investors confuse this further with a cash flow accounting model, where if the property is mortgaged, they do not see the benefits of the ‘passive income’. (Investors have come to realize that this is not so passive given the amount of time and effort that is required to upkeep and manage the property).

However, the old slogan of ‘offering one of the highest yields’ has stuck. Has anyone noticed that the so called rental yields on offer today are roughly the same as when they were at the start of the freehold boom, even though capital appreciation has been far greater than the change in rents?

Or for that matter that a weak dollar is as equally compelling a proposition to buy as a strong dollar was previously?.

Brokers retort by stating that they are obviously referring to gross yields, but the gap between gross and net yields has widened since the freehold phenomena. This partly explains the preference for offplan investing and why the gap between ready and offplan has increased given a market that is still tilted towards investors.

There are sensible ways to look at this calculation. And when markets do crazy things over time - bringing forward the returns of a typical market cycle post-pandemic - assets tend to get mispriced. When they do, that is the time to look at factors such as rental yields in addition to the replacement value of the asset.

It often boils down to really simple factors and can be compared to the capital markets: if a stock is selling at 110% of book value or less, it makes much more sense to buy it than when it is selling at 200% of book value.

Only if the first condition is met does one look at the dividend yield of the stock.

A similar prognosis applies to the real estate markets. It is only when the asset trades at slightly above replacement values does it make sense to look at factors such as rental yields. (Which investors know will be far less than what is shown on the tin).

The data obviously shows the reverse, where the more inflated the value of the asset, the higher the share buybacks and the higher the transaction volume. Happily, the gap between ready and offplan in some areas of the markets has meant that some investors have been able to make profitable investment decisions, but sadly none of this has to do with the rental yields of the investment. With increased turbulence - analysts keep referring to these events as 3-,4- or 5 sigma events, as if Gaussian distributions can predict human behavior - there will be more of such opportunities in the ready markets.

But investors need to keep in mind that capital allocation - when it’s not for end-user purposes - should have very little to do with projected rental yields that the seller proclaims it pays out. 

The writer is Managing Director at Global Capital Partners.