Part 3: Why investing in Real Estate matters more than ever today

It took me some time to finish this - amidst closing our?Seed Round?:) - but here it is: my third and final piece to close off a three-part series on the timely and timeless reasons to invest in Real Estate.

To recap, in?Part 1?I attempted to highlight some basic investment principles that have benefited me and that I think are well worth taking stock of in today’s inflated and complacent-looking times. In?Part 2, I shared my version of a primer on the benefits of Real Estate as an investment asset class.?

Here I give my take as to why it makes sense to add a good chunk of Real Estate to your portfolio in the current low return/high volatility environment and why the case is especially compelling when looking at property in Dubai:

1.????Ultra low interest rates

You don’t have to look too far to see that interest rates are as low as can be across most of the world. Just check with your bank what they are paying you on your personal savings account or a fixed term deposit. In the UAE, most solid banks are not offering more than 0.1% per year.

This is largely a function of the Fed’s accommodative monetary policy which has led the US Central Bank to slash the Fed Funds Rate down to 0% last year to deal with the Covid crisis. When your cash is earning pretty much nothing at the bank, the incentive to hold that money idle is as low as it gets. In turn, what has transpired is a massive rush toward ‘risk assets’ (i.e. stocks, commodities, high yield bonds and real estate) in search for return. This is what classically happens when interest rates hit zero.

The result is a world where prices of most assets are “full”, with very little by way of bargains and values reflecting super low risk premia (i.e. the incremental return you can expect to make by taking more risk as opposed to keeping your money in US treasury bonds, the ‘risk-free’ asset). Looking at stocks, the average dividend yield across the S&P500 has tumbled down to less than 1.4%, whereas for non-investment grade bonds, the effective yield on the ICE BofA US High Yield Index has tightened to an all-time low of nearly 4%.

In this context, it is hard to contest that a historically safer and more stable asset class such as Real Estate is looking comparatively very attractive. For example, prime residential property in Dubai is at the moment generating an unlevered net yield of 4-5% per annum. With considerable upside in both rents and prices going forward (more on this to come later), it is no surprise why?real estate transactions?in Dubai are on fire.

2.????Inflation protection

As the global economy continues to recover from the shock of Covid-19, and vaccination is getting rapidly rolled out, market expectations for inflation have risen rapidly. Economies around the world are opening up and lots of money in the form of accumulated savings and stimulus checks is starting to be spent. This is expected to lead to an environment where growth and inflation come together, which is usually very positive for Real Estate. That’s because higher cost of construction and materials make it more expensive to build, which can constrain additional supply and provide a boost to real estate prices. Also, inflation typically passes through to rents so residential real estate can be an effective way to protect against inflation.

We’ve seen a recent spike in US CPI (Consumer Price Index) to 4.2% and 3.8% in April and May respectively, up from an average of less than 2% over the last 10 years. While this is not yet alarming, whether this inflation persists or will be transitory is a hotly debated topic among investors and economists. Either way, it has become a really meaningful risk and a prudent investor would argue that this risk alone should warrant increased allocation to Real Estate.

3.????Currency depreciation

Real Estate is a good tool against currencies that depreciate. This is because when a currency falls in value relative to others, assets denominated in that currency become more attractive for foreign buyers and the price of those assets tends to increase as expressed in local currency terms. In Dubai, where a huge part of the demand for property is driven by Foreign Direct Investment coming from non-resident investors, and where the UAE Dirham is firmly pegged to the US Dollar, the local real estate market stands to gain from a depreciating US Dollar.

At the same time, to deal with the worst economic downturn since the Great Depression, the US government is spending and printing unprecedented amounts of money to fund its fiscal deficit. That is expected to lead to significant pressure on the value of the USD, as the government starts to max out foreign demand for its USD denominated debt. This could lead to a gradual depreciation in the USD over time. The more the US government spends and prints money, the more it is indirectly devaluing its currency and the higher the price of USD-denominated assets will have to adjust to.

4.????Where we are in the Dubai property market cycle

The Dubai Real Estate sector has been going through a bear market for the past 6-7 years. In Q4 2019, we were already starting to see signs that the market would soon find a bottom as volumes of secondary homes started picking up and property prices were nearing ‘replacement cost’. Replacement cost, or the cost of buying the land and constructing a property (at current prices) from scratch, is typically a leading indicator of intrinsic value when it comes to Real Estate i.e. properties being sold at below replacement cost typically indicate an oversold market, presenting an opportunity to capitalize on this short term price dislocation. When the pandemic hit, we saw even further downside in response to the immediate shock to the business environment that ensued. Yet the way the Dubai leadership handled the pandemic was so impressive that it feels like the city is, on a relative and absolute basis, in a stronger position now than pre-Covid.

It is worthwhile noting that across the world, the pandemic also highlighted the resilience and strong performance of residential real estate, as home prices largely held their values in recognition that people always need a place to live. In Dubai, many residents have had to leave but also so many have moved to the city. Work From Home and Work From Anywhere have really benefited Dubai, reinforcing its position on the global map as an attractive base for remote working. What followed is a massive spark in real estate buying activity, coming from a healthy demand from both end users and investors alike. In April 2021 the overall Dubai real estate market recorded a sixth consecutive month of positive performance and saw property prices rise at the fastest monthly rate in 7 years. With the value of transactions in the first 4 months of 2021 having crossed $25bn, a 72% jump from last year, and most of these transactions happening in the secondary market as opposed to off-plan (whereas historically in Dubai the split was the other way around), the signs are there that we are at a turning point in the cycle. Add to that a flurry of new reforms enacted by the Dubai government, from issuing long term visas to allowing 100% foreign business ownership to creating retirement incentives (to name a few), and in parallel, widespread increased taxation expected across developed markets, the city’s economic prospects are bright. As?Morgan Stanley?and?HSBC?have recently reported, the recovery and bullish sentiment in Dubai’s property market is likely to continue on for some time.

So to sum it all up, in light of the above timely considerations, together with the unique attributes of private Real Estate as an asset class for long term investment, as well as the current macro context of financial markets, consider adding to your portfolio's exposure to Real Estate, especially in Dubai, as both a hedge and growth play.