Dubai real estate developers may issue bonds to fund a growing pipeline of new projects - and market movements suggest they would attract strong investor demand, despite the sector's crisis just a few years ago.

In the past, most property and construction firms in the emirate relied almost exclusively on bank finance. Although local banks are flush with cash, that strategy may not work as the next building cycle begins.

The partial pull-out of European banks from the region has reduced the number of lenders, while many banks want to diversify their exposure since the crisis. The United Arab Emirates central bank is drafting rules to limit banks' exposure to state-linked entities, and the state holds large stakes in most of Dubai's big real estate developers.

So the bond market is set to play a bigger role in the real estate sector in coming years, giving regional investors access to a wider range of credits after they were forced to focus largely on bank debt in the last several years.

"Property firms like Nakheel have already borrowed from local and international banks, and lenders may not be willing or allowed to lend any further to these companies and increase their exposure," said Ambereen Jiwani, senior analyst at Securities & Investment Co (SICO) in Bahrain.

"From an investor's point of view, debt instruments by government-linked property firms will be attractive based on the risk premium offered over sovereign bonds and so I think they will be taken up. The Dubai real estate market has staged a recovery and investor confidence has improved."

PROJECTS

A big question mark over the slew of real estate projects announced in Dubai over the last nine months has been their financing; even if only a fraction of the plans go ahead, they will require tens of billions of dollars.

Last month Emaar Properties said it would form a venture with Dubai Holding to build Dubai Creek Harbor, a 6.5 million square metre district including business, shopping, sporting and entertainment facilities. Separately, Emaar said it formed a venture with Meraas Holding to build a residential and commercial area near the city's downtown area.

Meydan Group and the Sobha Group have announced plans to develop a leisure, retail and residential complex, while Meraas hopes to complete the first part of a $2.7 billion complex of five theme parks by end-2014.

There are already signs that some companies are thinking of the bond market. Dubai construction firm Arabtec, which this month completed a $653 million equity rights issue, has said it might raise as much as $450 million from the bond market at the end of 2013 or in 2014. That would be its first bond issue.

Dubai Investments, which has interests in property and manufacturing, has hired banks for a $300 million Islamic bond sale, but has not issued yet. The company was given a BB rating by Standard & Poor's earlier this month.

The Gulf's bond market has deepened and become more liquid than it was during Dubai's last real estate boom in the middle of last decade; foreign investors are more familiar with it. This makes the use of bonds by real estate firms more feasible.

The dramatic recovery of investor confidence in Dubai since its 2009-2010 financial crisis also helps. After plunging more than 50 percent in the wake of the crisis, residential property prices in Dubai are on average up by around 16 percent year-on-year, analysts estimate.

Also, Dubai's real estate developers have been forced to reorganise and diversify themselves over the past few years in order to survive. The benefits of this may still be emerging.

For example Emaar, in which the state owns 31.2 percent through Investment Corp of Dubai, has moved to capitalise on Dubai's tourism boom by developing a hotels and malls business.

Early this month JP Morgan Chase & Co analyst Zafar Nazim upgraded Emaar's $500 million Islamic bond maturing in 2019 to "overweight", citing the company's recurring revenues from hotels and malls and a strong cash balance, last reported at $1.3 billion.

He recommended the real estate sector as offering the most value among Dubai corporate credits.

"We are constructive on all real estate-related credits in Dubai - each for idiosyncratic reasons not necessarily related to the city-state's recovering real estate market," he wrote.

PERFORMANCE

The recent performance of the few outstanding bonds issued by Dubai real estate developers suggests the market would absorb more supply. The bonds have held up well during volatility in global markets caused by the threat of rising U.S. interest rates.

The yield on Emaar's 2019 bond, rated BB+ by S&P, has risen about 100 basis points since May 15 to around 5.00 percent.

That has far outperformed most similarly rated emerging market corporate credits in other parts of the world; the yield on a $500 million bond maturing in 2020 issued by Turkish glass manufacturer Sisecam, also rated BB+, has jumped from 4.25 percent at issue in early May to 6.60 percent.

Emaar has performed about as well as the Dubai sovereign; the yield on the Dubai government's $750 million bond maturing in 2020 has also widened 100 bps since May 15, to 4.80 percent.

Fully state-owned Nakheel Properties, which agreed a $16 billion restructuring with banks and trade creditors in 2010, is also raising eyebrows with the strong secondary-market performance of its 4 billion dirham ($1.09 billion) sukuk maturing in 2016. It now yields 8.30 percent, up 80 bps since May 15.

Frontier markets investment bank Exotix moved the bond to "hold" from "sell" earlier this month, saying Dubai's real estate recovery had boosted Nakheel's liquidity position while the firm was likely to successfully extend bank debt maturities.

In June, company Chairman Ali Rashid Lootah said Nakheel was in talks with lenders to refinance loans worth $2.2 billion that are due to mature in 2015.

Regardless of the increased optimism towards their sector, Dubai's real estate developers would still have to pay more to issue bonds than firms in many other sectors such as banking. The cost for first-time issuers would be particularly high.

So a sudden flood of issues is unlikely, and some companies may wait for further positive news on Dubai before going to market.

One significant event will be the choice in November this year of the site of World Expo 2020; if Dubai wins the right to host the fair, it will be seen by some investors as positive for the emirate's economic development and real estate market.

Also, Dubai and its government-related entities face about $50 billion of debt obligations coming due between 2014 and 2016, including a $20 billion repayment of crisis aid to Abu Dhabi and the UAE federal government in November 2014. Much or all of this debt is expected to be rolled over; after the deadline passes, confidence in Dubai could rise further.

"Investors are waiting for the impending 2014 debt repayment of Dubai and state-linked entities...Once this is out of the way, it would be much more attractive for the companies to issue bonds or sukuk," said Jiwani. – Reuters