Various Rating Actions Taken On Dubai-Based Real Estate Firms On Economic Pressure And COVID-19 Uncertainty

  • In our view, based on publicly available information, the ability of the government of Dubai (not rated) to provide financial support to its government-related entities if needed may weaken over the next one or two years.
  • In addition, declining oil prices and uncertainty regarding the economic implications of the COVID-19 pandemic could hamper Dubai's real estate sector, which depends heavily on international investments and tourism.
  • These developments have led us to take various rating actions on four real estate companies we rate in Dubai.
DUBAI (S&P Global Ratings) March 26, 2020--S&P Global Ratings said today that it has taken various rating actions on four Dubai-based real estate companies and developers (see the ratings list for details).
  • We have lowered to 'B' from 'B+' our ratings on Damac Real Estate Development. The outlook remains negative.
  • At the same time, we have placed our 'BBB-' ratings on Emaar Properties and Emaar Malls on CreditWatch with negative implications.
  • We have also revised our outlook on DIFC Investments to negative outlook from stable and affirmed our 'BBB-' ratings.
Our rating actions follow weakening market trends.   The outbreak of COVID-19 is adding to the strain on Dubai's already weak real estate market. The emirate has been struggling with oversupply in most segments but notably in residential and hotel sectors for about three years. Property markets in the Gulf Cooperation Council, as in most of the world, are now hit by travel and other mobility restrictions imposed by governments to contain the spread of the new coronavirus, alongside low consumer and business sentiment. S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak between June and August, and we are using this assumption in assessing the economic and credit implications. We believe measures to contain COVID-19 have pushed the global economy into recession and could cause a surge of defaults among nonfinancial corporate borrowers (see our macroeconomic and credit updates here: As the situation evolves, we will update our assumptions and estimates accordingly. Oversupply across Dubai's real estate sector is amplified by tightening financial conditions, which significantly complicates our impact analysis.
We now expect the fall in residential prices will be steeper than we previously expected, with adverse trends lingering well into 2021.  The current supply-demand imbalance in Dubai's real estate market has been exacerbated by the effects of the COVID-19 pandemic. We also expect negative employment trends across some key sectors such as tourism and retail, as well as for certain small and midsize enterprises, which could weigh on demand for new properties. Given the global pressures, we also expect to see international demand for property in Dubai to be subdued. In 2019, more than 35,000 residential units were completed, the highest number delivered in a single year in Dubai. Based on developers' announced completion dates, 2020 is likely to be another record year for deliveries, adding to supply. We believe real estate prices are approaching levels seen at the bottom of the last cycle in 2010, and are even lower on an inflation-adjusted basis and considering sales incentives for off-plan property. While reported COVID-19 infection rates are not relatively high in United Arab Emirates (UAE), Dubai may at some stage see widespread temporary closures of business, similar to that in other regions, or work stoppages, including at construction sites, which could lead to delays in future residential property deliveries. This would increase working capital funding gaps for developers, including Emaar Properties and Damac Real Estate. We also expect developers' EBITDA margins to contract significantly given that prices may be lower on new sales and that companies may offer discounts to existing customers. However, given the negative macroeconomic backdrop, we might also see higher delinquencies in customer payments than observed historically.
Due to tightened travel restrictions, hotel occupancies will plummet for the next few months.   Some hotels have closed temporarily, and we think there may be more closures in due course. Malls have been mandated to close for two weeks for now, except supermarkets and pharmacies. Restaurants have been asked to cater only to home deliveries. This would significantly affect the variable portion of real estate landlords' revenues. Dubai-based government related real estate companies have announced a relief package designed to partly alleviate the burdens of businesses or individuals within their ecosystem that have been affected by the outbreak of the new coronavirus. We anticipate private retail real estate companies such as Majid Al Futtaim and Emaar Malls may also have to grant a rent freeze to allow tenants to manage their businesses, as is the case in other regions. Similar measures might also be extended by office real estate landlords, such as DIFC Investments, to supIs port businesses that aren't operating at their usual capacities.
Although the severity of the impact on Dubai's real estate sector depends on the duration of the COVID-19 outbreak and the extent of government measures, it's clear there will be some downside. This is mainly because of the emirate's reliance on travel and tourism activity, which provides thousands of jobs in the economy. What is also uncertain at the moment is whether the World Expo 2020, due to be hosted by Dubai later this year, can shore up market sentiment or lead to meaningful recovery.

Damac Real Estate Development

We estimate Damac's adjusted debt to EBITDA ratio at about 5.8x at year-end 2019, and we think that currently weakening market conditions will prevent any significant deleveraging in 2020-2021. Damac's estimated over $2 billion order book provides visibility on about two-thirds of its revenue for 2020. However, we still think the company's new sales may come under severe pricing pressure and hinder its EBITDA margin recovery from an estimated low 11% in 2019. We expect that under current stressed market conditions, Damac will not launch any new projects in 2020, and will concentrate its efforts on selling from inventory. We note that the company currently has more than 15,000 units under construction, of which 4,000-5,000 units are expected to be delivered in 2020 if not significantly delayed due to the pandemic. We think that cash collections on project handovers will increase, while remaining associated construction costs will gradually subside. This in turn will alleviate pressure on cash flows, since we expect working capital requirements to decrease in 2020-2021. We continue to see Damac's liquidity as adequate, with about $115 million in debt maturing in 2020 and no other major maturities before 2022 when a $500 million sukuk is due.
The negative outlook reflects our view that a lingering supply-demand imbalance in Dubai's residential real estate sector will be further exacerbated by increasing economic uncertainty induced by the COVID-19 pandemic, which we think may undermine consumer confidence and delay purchase decisions. For the current rating, we expect that Damac will improve or maintain cash flow generation, notably on the back of lower working capital outflows, leading to positive discretionary cash flow (DCF). We also anticipate that Damac will use its cash flow to repay debt, as per its commitment and supported by a positive track record of debt reduction. We estimate Damac's debt (after our adjustments) reduced to about $0.8 billion in 2019 from $1.3 billion in 2017.
Downside scenario:   We could lower the rating if Damac's DCF remained negative, for example due to large working capital outflows or further earnings contraction. In that case, we think EBITDA interest coverage could remain weak at below 2.0x, which would no longer be commensurate with the current rating. Weakening of liquidity could also prompt a downgrade.
Upside scenario:   We think that, under current market conditions, an upgrade is unlikely. We think that the residential real estate market in Dubai is oversupplied and absent a strong pickup in demand, it would take a few years to absorb the existing inventory. An upgrade could, however, materialize once the market starts showing steady positive momentum, with Damac's debt to EBITDA improving to below 5x and funds from operations to debt staying above 12%.

Emaar Properties PJSC And Emaar Malls PJSC

We placed our ratings on Emaar Properties and its core subsidiary Emaar Malls on CreditWatch negative because we foresee the COVID-19 pandemic and general macroeconomic situation in Dubai will lead to notable weakening of Emaar Properties' credit metrics in 2020-2021. We now anticipate funds from operations (FFO) to debt will decline to 30%-35% in the absence of mitigating actions by the company's management, as opposed to our expectation of FFO to debt remaining above 45% for the 'BBB-' rating level. We estimate our adjusted FFO to debt ratio for Emaar at the end of 2019 was below 40%.
We anticipate additional pressure on the group's revenue and margins across all of its businesses in the next few months. We think that real estate development operations in Dubai will continue to experience heightened pricing pressure that could reduce margins, and we see a risk of handover delays and more difficult collections due to oversupply and weakening economic conditions. We also think the hospitality business will be hurt, since three hotels were already temporarily shut down in an effort to reduce costs. The temporary closure of entertainment venues and recently announced shutdown of malls due to the threat of COVID-19 will undermine the group's more stable and profitable operations from these businesses, in our view. We think the group's international operations will be subject to the same economic uncertainty that may dent Dubai's growth prospects. We, nevertheless, think that Emaar's solid market position, strong brand value, high asset quality, experienced management team, and focus on cost management will allow it to navigate through the current challenges visibly better than its peers.
At the same time, we take into account Emaar's stated commitment to an investment-grade rating and measures management plans to take to mitigate the current weak market environment. We understand these potentially include paring down uncommitted capital expenditure (capex), or asset disposals, although the latter might become more difficult given financial market volatility. Over the past four years, Emaar Properties witnessed a significant increase in working capital outflows--reporting about UAE dirham (AED) 27 billion (about $7.4 billion) owing to new project launches. Under the current weak market conditions, Emaar properties plans to gradually reverse these in the coming years as it continues to build and hand over units. The cash collection at handover could lead to deleveraging over 2020-2021.
We expect that Emaar Malls' operations may feel the effects of Dubai's weakening retail sector since the economic outlook has softened significantly. Should Emaar Malls have to lower rental income or offer rent-free periods, discounts, and other forms of support could be provided to tenants, in our view, and this would likely translate into lower revenue and margins. The delivery of the Dubai Hills Mall planned for the fourth quarter of 2020 will come at a difficult time.
We align our rating on Emaar Malls with that on its parent, Emaar Properties, since we view Emaar Malls as a core subsidiary, integral to the group's current identity and future strategy. On a stand-alone basis, we foresee stronger credit metrics for Emaar Malls. We anticipate, however, limited free operating cash flow in 2020-2021 since we estimate that the company will have to upstream a significant amount of capex as a payment for Dubai Hills Mall to Emaar Properties, based on a third-party valuation.
The CreditWatch indicates the potential for a downgrade for Emaar Properties and Emaar Malls over the next three to six months, depending on the impact of COVID-19 pandemic and the weaker economic environment on Emaar Properties' operations and management's mitigating action s.
Downside scenario:   We could lower the ratings by one notch if we believe that management's actions are not sufficient to offset the weakening operations and that FFO to debt is unlikely to improve to above 45% in 2020-2021. In addition, we could downgrade both companies if credit conditions in Dubai weaken further as a result of deteriorating macroeconomic conditions.
Upside scenario:   We could affirm the ratings on both entities, if Emaar Properties took meaningful action that allows it to restore FFO to debt above 45% and debt to EBITDA declines below 2.0x in 2020-2021. However, such a rating action also depends on conditions in Dubai's real estate market and implications of the COVID-19 pandemic on the domestic economy.

DIFC Investments (DIFCI)

Over the past four years, DIFC Investments Ltd. (DIFCI) showed strong operating performance in a very weak market. With its distinct jurisdiction, strategic location at the center of Dubai's diversified economy, and its high quality assets, DIFCI has long established itself as a premier global financial services hub. Given the significant negative impact of COVID-19 on the business environment globally and regionally, we now expect further pressures on the Dubai office market in 2020-2021.
Despite the weaker macroeconomic environment, DIFCI performed well in 2019, with strong occupancy of 95% and higher rental income than the market average. In our view, the company's current credit metrics represent a meaningful buffer against the expected visible deterioration of operating conditions. We consider DIFCI to be a government-related entity that has a very high likelihood of receiving timely and sufficient extraordinary support from the Dubai government if it faced financial distress. We therefore continue to include one notch of uplift into our rating on DIFCI for extraordinary government support.
The negative outlook reflects the possibility that our expectation of the Dubai government's ability to provide extraordinary financial support to DIFCI, if needed, could weaken in the coming one to two years. This could be the case if a prolonged downturn in the real estate market and COVID-19 significantly weighed on macroeconomic conditions and increased pressure on government finances. Risks to growth and the government's revenue generation capacity could also arise from a slowdown in foreign trade. Low oil prices, accompanied by weaker regional demand could further slow Dubai's transshipment trade flows, which have been sluggish since 2016. We also consider that Dubai's creditworthiness might deteriorate to an extent that could materially affect DIFCI's creditworthiness.
Downside scenario:  If credit conditions in Dubai deteriorate further, this could affect the government's ability to support DIFCI or lead to weakening of DIFCI's credit metrics, either of which could result in a one-notch downgrade.

Upside scenario:   An upgrade is highly unlikely over the next 12 months, since this would require an improvement in DIFCI's stand-alone credit profile, in addition to a substantial change of our view in the Dubai's creditworthiness.
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