Downsizing Dubai: Will the Middle East's golden child ever be the same again?

It’s only 7pm on Tuesday night but it is already buzzing in Neo, the swanky cocktail bar at the top of The Address, a 63-storey hotel in Dubai. The view from the floor-to-ceiling window is stunning. We are immediately opposite the 818m Burj Dubai, the world’s tallest tower, which is due to open with one almighty party on 2 December, the UAE’s National Day. On the lake in front of it, the world’s largest fountain performs a mesmerising dance on the half hour. Beyond are the glittering lights of the city … including those of tower cranes, because like the nightlife, construction is moving again. The roads are clogged with traffic and the armies of labourers are back on the city’s sites.

In fact, six months after the global recession brought Dubai to a screeching halt, it does not feel like there is a recession here at all. Down the road, Abu Dhabi is busy again, too. But despite the evidence of recovery, nobody thinks the UAE is about to turn back into the rocket economy that exploded so spectacularly at the end of last year, and many British firms here are still struggling. So the question is, exactly what will the new UAE market look like?

Stop and start

The downturn in the UAE came suddenly, particularly in Dubai (see box), but the signs are that recovery will be more tentative. The Association of Consultants and Engineers (ACE) forecasts that, after the Emirates’ construction economy contracted 15% in 2009, it will grow 1% in 2010 and 3% in 2011. Not good, but still better than the UK, which also fell 15% this year and is expected to shrink 1% next.

UK Trade and Investment (UKTI), the arm of government that helps British firms to work abroad, certainly wants to encourage those in the UAE to stay there, and for others to join them. Phil Dowrick, a business specialist at UKTI, says: “Dubai is not as dead as people think and it’s hard to see how the emirate will not remain the regional hub for financial services, tourism, transport, trade and exhibitions.”

Some of the 500 or so projects that had been put on hold in the UAE in September are also restarting. These include a 9 million ft2 mixed-use project called Tameer Towers on Al Rheem island in Abu Dhabi, which has a project value of 7bn dirham (£1.2bn); a 400m dirham project to build a headquarters for the municipal government of Abu Dhabi’s western region; and a residential project of up to 1 million ft2 by developer Bloom Properties in Abu Dhabi.

New projects are getting under way as well. Arabtec, the UAE’s biggest contractor, which employs 42,000 people, has just won a number of deals. These include the 638m dirham Silverene Twin Towers, a residential scheme at Dubai Marina for Cayan Investment & Development; the Onyx development, a 686m dirham office scheme on Dubai’s Sheik Zayed Road; and the Nation Towers, a 1.6bn dirham mixed-use scheme on Abu Dhabi’s Corniche seafront.

Rival contractor Al Futtaim Carillion says it is also winning work. Richard Howson, the managing director at the firm, says: “Dubai is waking up. There are a number of hospitals, hotels and lots of infrastructure projects moving forward. There is also a lot to do in areas like Meydan [a 76 million ft2 “horse racing city” near the mouth of Dubai Creek].”

Lingering problems

It might not be surprising that Abu Dhabi is starting to pick up where it left off. After all, it has the world’s second largest combined reserves of oil and gas per head after Qatar, and the world’s biggest sovereign wealth fund – thought to be worth $400bn.

Unfortunately, it’s a different story for Dubai, which has no oil, relies on lending to fuel its development and is presently weighed down with debt. Its government-related entities (GREs), including top developers, collectively owe between $80bn and $90bn, of which $50bn is due by 2012, according to credit rating agency Standard & Poor’s.

The question commentators are asking is whether Abu Dhabi will bail out Dubai. One indication that it might is the $10bn (£6.1bn) lifeline it has thrown its neighbour. This came when Dubai issued the first half of a $20bn bond in February, which was bought by Abu Dhabi’s central bank. Dubai is expected to issue the remaining $10bn imminently and recent reports suggest it may seek a further $6.5bn of medium-term notes.

But Standard & Poor’s, which has downgraded its ratings for a number of Dubai’s GREs, warns that February’s deal, which amounts to a loan, is “insufficient to meet its debt”. More worryingly for the contractors and consultants that are owed so much, one senior industry source is concerned that the bond money has gone out of the country to pay debts owed to foreign banks rather than to firms working in the emirate.

So will Abu Dhabi take further steps to back up Dubai? The widely held view in the UAE is that it cannot afford to let Dubai fail: despite the rivalry between the two, Abu Dhabi’s reputation rests on the that of the region as a whole. That said, one expert warns that it could be some time before any deal to rescue to Dubai is struck. He says: “Behind the scenes there could be a bit of classic Arabian haggling going on. Abu Dhabi will want something in return for bailing out Dubai, be it land or a stake in key companies. But Dubai can see how embarrassing it is for Abu Dhabi to have it in a mess and it may be refusing to concede anything in return for being rescued.”

Whatever deals are being done in the UAE’s power centres, the longer it continues, the longer contractors and consultants must go without their fees. The ACE now estimates that UK engineers are owed £500m in the UAE as a whole, and Dubai’s main arbitration body is struggling to process almost £3bn of disputes. Some consultants say privately that they are being forced to accept discounts on their fees of up to 50%, and what money is handed over is arriving late. Mario Pishiri, managing director of property at Hyder, says payment periods are double what they were a year ago. “We’re looking at 140-160 days now, which does put a strain on your business.”

Contractors, meanwhile, tend to say that for their much larger fees they are accepting deferred payments. Tom Barry, chief executive of Arabtec, says: “We’ve not agreed to any discounts, just rescheduled payments.”

New reality

As with any post-apocalyptical landscape, the future UAE is going to be a place of scavenging, making do and getting by. Chris Johnson, managing principal at architect Gensler, says: “Things will start moving again but there will not be rich pickings for anyone. It will be about grafting hard and earning little.”

Margins will be lower for everyone. Contractors say those they are making on new contracts have fallen from 15-20% 18 months ago to 5-10% now. Agreed payment periods are 60 to 90 days. As for payment up front, this is either a low percentage of the price or zero. Indeed, many deals being signed presently allow the client to make no payment at all for the first 120 days of the job, which will make it particularly tough to buy resources at the start of a project, especially given the dearth of bank loans.

Clients are also keen to go down the design-and-build route, which puts most of the risk on the contractor, rather than spread it over the project team. Contractors are coming under pressure to agree to higher performance bonds, too. Whereas these used to be about 10% of the contract value, some clients are asking for 40%.

The new market will be equally tough for consultants. The regional boss of a one firm says: “Fees have gone down to 2005 levels – that is, about 20% lower than 18 months ago – and I think that could reach 25% in the coming months.”

He also questions whether, once current projects are finished, the pipeline coming through will be enough to pick up the slack.

And the projects that do come through will be a good deal more prosaic than those of the boom years. John Oliver, who heads consulting engineer WSP’s UAE operation, says the ostentatious hotels and theme parks so characteristic of Dubai will become “rare, one-off projects, rather than the bread and butter of the market”.

It could be argued that all the tourist attractions the UAE needs are probably either built or at least under way. Now, Oliver says, the UAE will focus more on transport and the industrialisation of the country, including oil and gas development and factories. This means the work coming through will be in the slightly less glamorous sectors of industrial sheds and energy plants.

In the residential market, the emphasis will shift from new build to refurbishment and asset management. Oliver says: “We’re no longer going to see 10-year-old buildings being knocked down. Instead, it will be about getting better value from existing stock, so I’m expecting to see a rise in asset management services.” Jumeira Gardens, the 110 million m2 region of Dubai being developed by Meraas, is likely to be a case in point. The developer is understood to be swapping its plan to build a neighbourhood from scratch for a development based on a mix of new build and refurbishment.

Whatever you are building, it will take longer. One contractor says that projects that would have typically taken 18 months are now being programmed to take two-and-a-half years, because of the lack of liquidity in the market and the fact that clients are seeking to reduce risk.

One consultant says an added difficulty will be deciding which clients are safe to work for. He says: “We’ve all become very nervous over whether we’ll get paid and the rule is, the closer the client is to the state, the more secure you are. People are very wary of pseudo-government-linked companies. Government entities may be more bureaucratic but we’ll favour them.” He adds that contractors may seek guarantees from developers in future, rather than vice versa.

As firms grapple with their slump in income, more pain awaits their employees. WSP’s Oliver reckons that up to 20% of those working in the UAE’s construction industry could be laid off. He says: “You have to question whether there is sufficient work here. While we are well diversified, we expect to see others, who are not so well positioned, cutting staff by 10-20% as workloads fall further.”

How far the UAE will recover is open to debate, but it seems unlikely that demand for property will ever hit 2007 levels again. Last month a report from real estate agent Colliers CRE said 25% of Dubai’s properties were empty. The report added that about 340,000 units would be on the market in Dubai by the end of 2009 and another 34,300 would be completed over the next two years. One senior source believes that the construction market will never return to even 50% of what it was.

Whatever happens, it seems hard to disagree with Tom Barry at Arabtec when he says, “things in the UAE will never be the same again”.