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Saturday, December 12, 2009

Earning from rental

Effort, patience and research needed to achieve success

RENTING out real estate can be a lucrative source of income. Those who are already in the game know the rewards that it can reap. It offers stable returns compared with a lot of other forms of investments and is a great way to build wealth.

But just like any other investment, it requires a good deal of effort, patience and research to achieve success.

Location and money

These two factors are the essence of property investment. The investor needs to find properties in locations that are likely to generate great yields. To attract tenants, it is a good idea to own a place near a school or a college, with good access to public transportation.

Having money to spend is also very important. But what if you are a small-time investor and your financial resources are limited?

“There are many ways to find property. Look out for foreclosures or auctions. Get to know people on the inside who know about properties that are going under the hammer,” says Felix Wong, who has been a landlord for over 30 years.

“Keep an eye out for advertisements in the newspapers or speak to real estate agents who can let you know in advance about these sales.”

Alternatively, if one doesn’t have the money to buy property, one can always rent and subsequently sub-let at a profit. That was how Tan, now an accountant, financed his tuition fees when he was studying in college.

“I was renting a bungalow in Petaling Jaya and got a part-time job to pay the rent and tuition fees initially. I then sub-let the rooms in the house to other students. I was able to quit my part-time job and use the spare time to focus on my education,” he says.

It is important, though, to make sure that your tenancy agreement has no clause that forbids sub-letting.

If you are determined to own property, you should have a rough idea of how long you plan to hold on to it, says financial planner Alex Low.

“The longer you own the property, the more you’ll need to invest in maintenance, repairs and improvements. If you’re only planning to own the property for a short period, you should avoid making any major improvements unless you’re sure you can recoup the cost with a better re-sale price,” he adds.

You’ve invested in property. What now?

Once you have something to rent out, you need to let the world know you’re looking for tenants. But before you do so, there are a couple of things that needs sorting out first.

·Checking out the competition

“Check to see if there are other properties within the vicinity that are being rented out. Find out their rates and set your rates accordingly. If you charge too much, you’ll only chase tenants away,” says Timothy Arumugam, a Bangsar-based landlord.

“Of course, you still need to charge enough to pay for maintenance, insurance and utilities, and make a profit. Don’t forget that you may also need money for repairs and other emergencies.”

·Knowing your target market

Determine also the type of people you hope to attract. If you are targeting students, your rental rates would have to be more affordable than if you are hoping to have tenants who are, say, white-collar employees.

Property to let

Now it is time to tell everyone how attractive your rental offer is. If you have money to spare, the best way is to advertise in the newspapers. If you have a specific target group in mind, such as students or only women, you could try advertising in education or women’s magazines.

Alternatively, there are creative ways to advertise for free, says K. Marimuthu, a Klang-based landlord.

“You can always place ads on trees, street lights, walls, buildings or telephone booths. If you have permission, you can advertise in the colleges or universities,” he says.

Another idea is to to promote the property via a webpage or blog. “Don’t forget to put down your contact number or e-mail address, and if it’s an outdoor ad, the website or blog address, if there is one. It’s also helpful if you had pictures of your property on it. After all, a picture tells a thousand words,” adds Marimuthu.

Protecting your investment

Before letting a potential tenant into your home, it is best to run a background check. Doing a check on the person’s financial background helps if the tenant has a bad track record.

Marimuthu says it is also very important to lay down the “ground rules” before finalising the tenancy agreement. “Determine from the start what can and cannot be done. It’s your investment, so it’s your rules. It’s of course better if these rules could be laid down in black and white.”

He adds that it is also useful to set up an “emergency fund” for repairs to the property. “You never know. The toilet could get clogged or the water heater could go kaput. It’s your responsibility to make sure everything is in working order,” he points out.

“Just before the tenant rents the place, the landlord should take photos of the premises so that when the tenant leaves, any damage to the property can be assessed more clearly.”

By The Star (by Eugene Mahalingam)

Ireka, Aseana form partnership

PETALING JAYA: Ireka Corp Bhd is proposing to jointly develop with Aseana Properties Ltd (APL) a high-end residences tower at Jalan Kia Peng, Kuala Lumpur.

The project is expected to generate a gross development value of RM272mil and a gross profit margin of RM58mil.

Ireka told Bursa Malaysia its wholly-owned unit World Trade Frontier Bhd had signed an agreement to buy a piece of freehold land there, measuring 4,047 sq m, for RM87.12mil cash.

Ireka yesterday also entered into a memorandum of understanding with APL on the joint venture for the ownership and development of the property, with APL to have a 70% stake.

Upon receipt of all relevant regulatory approvals, the project is expected to start within 18 months from the completion of the proposed acquisition.

The development cost will be funded by internal funds, bank borrowings and proceeds from sales of residential units.

By The Star

Sunrise confident of brisk sales for 28 Mont' Kiara condo

Property developer Sunrise Bhd is hoping to repeat the success of its 10 Mont' Kiara luxury condominium project in Kuala Lumpur with another similar project within the vicinity.

The 10 Mont' Kiara, featuring a 42-storey tower with 320 units, was sold out within months of launch.

Sunrise assistant general manager of projects department, Raymond H.C. Cheah (picture), said 28 Mont' Kiara is a 41-storey condo building, comprising 460 units with built-ups from 3,000 sq ft to 4,000 sq ft. Total gross development value of the project is RM800 million and is targeted to be completed in three years.

Cheah said 100 units of the condo had been taken up since its soft launch last Saturday.

"We are confident about sales (for 28 Mont' Kiara) due to its location and features of the property," Cheah said after the media walkabout of 10 Mont' Kiara in Kuala Lumpur yesterday.
He said the price of 10 Mont' Kiara condo units has appreciated by almost 30 per cent since it was launched three years ago.

"The units were sold at about RM500 per sq ft then and now they are fetching RM700 per sq ft.

"This track record has made our previous customers come back to buy more Sunrise properties, especially since second time Sunrise property buyers will get a 2 per cent discount (off total purchase price)," said Cheah.

Sunrise has completed the 10 Mont Kiara project and is in the midst of handing over the units to their owners.

By Business Times (by Zurinna Raja Adam)

More Sunrise high-end condos

KUALA LUMPUR: Sunrise Bhd will continue building high-end condominiums that give higher returns to its buyers, says projects department assistant general manager Raymond H.C. Cheah.

“Our previous developments are proof that Sunrise properties have given back much higher returns to the buyers and investors,” he told reporters yesterday during a media visit to 10 Mont’ Kiara.

As an example, he cited the just-completed 10 Mont’ Kiara. “When the project was launched four years ago, the unit price was RM500 to RM550 per sq ft. Now, the price has gone up to about RM700 per sq ft,” he said.

Cheah added that that rental rate at 10 Mont’ Kiara was now about RM12,000 to RM15,000.

By The Star

What’s the buzz on home loan refinancing?

Why would anyone want to refinance his home loan? The base lending rate (BLR) has been reducing over the past 10 years. From about 8% in early 1999, it has come down to about 5.5% currently (for most of the banks, as Bank Negara allows banks to determine their own BLRs).

Therefore, if you took a home financing package some time ago, you are paying more interest as compared with a person taking the same loan today.

That is only half of the story. Loans taken in early 2004, for example, came with a BLR + 0.25% rate. More recently, the rates are BLR minus 1.8 to 2.4%. To show the variance in the interest payments, let’s use an example with the recent average rate of BLR minus 2%.

We compare a loan signed in 2004, with an outstanding balance of RM100,000, against a new loan of RM100,000, with the following scenarios:

·BLR in 2004 : 6.75% (Therefore loan interest is 6.75% + 0.25% = 7%)

·BLR in 2009: 5.55% (Therefore loan interest is 5.55% - 2.0% = 3.55%)

So the loan taken in 2004 would result in an annual interest cost of RM7,000 (RM100,000 X 7%), whereas interest on the taken during recent times cost would be RM3,550 (RM100,000 X 3.55%).

The difference is a whopping 49%, and the annual saving is RM3,450. For loans of RM300,000 and RM500,000, the amounts saved work out to RM10,350 and RM17,250 respectively.

Therefore, looking squarely at interest cost, there is tremendous savings to be achieved by refinancing your home loans today.

However, one must also be aware of the “lock-in” periods usually provided for in loan agreements, whereby banks specify minimum loan holding period (ranging from three to five years).

Therefore, an early settlement of the loan will result in a penalty payment, usually a percentage (ranging from 2% to 5%) of the loan amount.

Another element of refinancing is that the bank that provides the refinancing usually absorbs the transaction costs such as legal fees.

You can also turn to refinancing to lengthen or shorten your loan tenor, depending on your priorities. For example, you can increase your loan tenor so that your monthly loan repayment is lower. Others cut their repayment periods, therefore opting for higher instalments and less total interest cost.

Yet another reason for refinancing is to realise the cash value when the property that has appreciated significantly. Otherwise, the only way to benefit from the capital appreciation is by selling the property.

Refinancing makes it possible to realise up to 90% of the property’s current market value. Let’s assume a 100% home financing loan at RM100,000 as an example.

If the property has appreciated 20%, the value today would be RM120,000. As such, one can refinance at RM108,000 (90% of RM120,000).

If the RM100,000 loan was taken in 2004 on a tenor of about 15 years, the outstanding balance would be about RM77,000. The refinancing of RM108,000 will result in a cash-in value of RM31,000, which can be used to retire high-cost borrowings (such as credit card balances) or to invest for higher returns.

Here is the interesting part. For the higher new loan, the interest per annum works out to about RM3,800 (RM108,000 X 3.55% = RM3,834). This is still lower than the interest payable on the existing loan balance of RM77,000, which is about RM5,400 (RM77,000 X 7% = RM5,390).

With the refinancing, interest cost is slashed, instalment is lowered (assuming continued loan tenor with no increase), and you get RM31,000 cash in hand. Now, isn’t that just a clever idea!

A point to note is that while you qualified for the initial loan, refinancing is not an automatic option. The financial institutions will check your credit worthiness and will want supporting documents to show payment capabilities. Therefore do maintain a sound financial status. Never allow overdue payments to exceed two to three months and verify your credit status.

It pays for the borrower to walk up to his banker and request for a loan restructuring, especially when the loan is still within the lock-in period. Banks are known to be willing to listen and accede to restructuring requests, albeit resulting in a longer lock-in period.

This works out well as both parties’ interests are served. I propose this option first.

Financial institutions have been on the prowl for refinancing, with a foreign bank advertising with this tagline: “Refinance with us and earn a free flying lesson.”

Why not? Happy refinancing.

Raymond Roy Tiruchelvam is a former senior manager – economics and investment analysis at an oil and gas outfit.

By The Star (by Raymond Roy Tiruchelvam)

Ireka buys KL land, plans upmarket project

Builder Ireka Corp Bhd plans to build a block of high-end serviced residences worth RM272 million near the Kuala Lumpur Convention Centre in 2011.

This follows the signing of a sale and purchase agreement by its wholly-owned unit, World Trade Frontier Sdn Bhd, for 43,559 sq ft of prime land in Jalan Kia Peng, Kuala Lumpur, for RM87.12 million yesterday.

In a filing to Bursa Malaysia, Ireka said the project was expected to generate gross profit of RM58 million. It will have a net sellable area of 212,650 sq ft.

"The timing of this acquisition is opportune as we have begun to see confidence returning, albeit with a slower momentum, to the real estate sector," chairman Abdullah Yusof said in a separate statement yesterday.

Simultaneously, a non-binding memorandum of understanding was signed between Ireka and the London-listed Aseana Properties Ltd to co-develop the land on a 30:70 basis.

Abdullah said that having built its success in the upmarket Mont'Kiara area, Ireka believes that it fully understands the aspirations of today's discerning buyers.

"We believe that small- to medium-sized upmarket serviced residences will appeal to the growing cosmopolitan lifestyle of urban Malaysians and foreigners who desire to live in the heart of the city and near one of the most famous landmarks in the world, the Petronas Twin Towers."

The proposed project is expected to start within 18 months after the land acquisition is completed. Financing will come from internal funds, borrowings and proceeds from sales of residential units.

By Business Times (by Azlan Abu Bakar)

Building-for-land deal with a slightly different model

About three weeks ago, Naza TTDI Sdn Bhd surprised the market when it announced it was going to build a RM628mil expo centre for the Government in exchange for 65 acres of state land in Jalan Duta, Kuala Lumpur, in the vicinity of the Malaysia External Trade Development Corp (Matrade).

The total gross development value (GDV) of all the projects on that piece of land comes up to RM15bil. The announcement set tongues wagging among politicians, developers, analysts and property consultants. How did the Naza group land the deal? Did they get the 65 acres for a song? Shouldn’t there be an open tender for the project? Is the timing right, even amid the soft property market?

There are many questions and Naza TTDI group managing director SM Faliq SM Nasimuddin will attempt to answer them when he calls for a press conference, likely to be next week.

The Naza group is headed by Faliq and his brother, SM Nasarudin SM Nasimuddin. They have some very prominent projects, the KLCC Platinum Park being one of them.

They have other developments, residential and commercial, in Ampang, Shah Alam, Kajang and Taman Tun Dr Ismail. The group, however, is best known for its automotive business.

The Government has said that the Naza project is a public-private partnership (PPP). But what exactly constitutes a PPP?

A check on the Internet brings up this example – a PPP is a contract between a public sector authority and a private party where both parties enter into an agreement in which the private party provides public service and assumes substantial financial, technical and operational risks.

A PPP can be between the government and one or more private sector companies, which come together to form a consortium, according to Wikipedia. The consortium may have different functions, but they have one single objective.

In the case of the Naza project, that single objective should be to develop this 65 acres into the form, shape and function that will meet the criteria of the government, with the benefits to be accrued to the community at large.

A PPP takes into consideration the larger community and how a project can benefit them. It is not to the profit of a single entity or company.

Kumar Tharmalingam, chairman of Hall Chadwick Asia Sdn Bhd, says Naza’s building-for-land deal is a PPP, but with a slightly different model.

“The Government is not providing any financial undertaking other than that piece of land. All the expertise and financing is from the private sector,” he says.

“Instead, the Government acts as a facilitator or enabler by giving a list of approvals – from the master plan, to the building approvals to re-zoning.

“Naza will have to find people to develop and build the different components. They will have to sell the place, or find people to occupy all those projects around the convention centre. So in that context, all the Government does is give them planning approvals.”

As Matrade will get the expo centre, the Government will have to maintain it. Kumar says in some ways, the Government is turning away from the old style of doing things.

“It is not giving any guarantees,” he says. He cites the North-South Expressway concession, in which the Government had to provide a guarantee to Projek Lebuhraya Utara-Selatan (PLUS) on traffic volume in return for PLUS taking on the job.

“The Government does not need to guarantee that the buildings on that 65 acres will be filled, or how these buildings will come into existence. That is Naza’s responsibility. So in this sense, we are moving one big step forward,” says Kumar.

On the Government being handed a convention centre, Kumar says that should not be an issue as Matrade can give it to someone else to run and operate.

He does not share the view that such a development may be unnecessary. “There is something about convention centres. People will use it after it is built. The Kuala Lumpur Convention Centre is very popular because it is well located, managed and marketed,” he argues.

He says an important point that most observers have missed thus far is that the components that make up the master plan has to feed the expo centre. “All the components on that 65 acres have to complement the expo centre. So the onus is on Naza,” he adds.

A source, who declined to be named, says it will be a challenge for Naza to make a success of the huge project. “It will have to get the master plan right. If it pulls this one off, it will elevate the group to another level as a developer,” he says.

PPPs exist throughout the world in different forms. In some types of PPPs, the cost of using the service is borne exclusively by the users of the service and not by the taxpayer. A mass transport system is one example. In this case, the user may be a taxpayer also.

In other types of PPPs, the capital investment is borne by the private sector on the strength of a contract with the government to provide agreed services, and the cost of providing the service is borne wholly or in part by the government.

The government contributes to the contract by transferring certain existing assets into the partnership. In this particular case, that government asset would be the 65 acres of state land located behind Matrade.

Because the RM628mil expo centre will be turned over to Matrade on completion, this effectively means Matrade will be going into a new business.

By The Star

Naza to hold PC soon over recent deal with Government

NAZA Group will call for a press conference soon to address the many questions that have arisen after the group recently signed a building-for-land deal with the Government.

Naza’s property arm, Naza TTDI Sdn Bhd, will receive 65 acres of prime land in the Jalan Duta area in Kuala Lumpur for building a RM628mil expo centre for Malaysia External Trade Development Corp (Matrade).

The centre and other projects planned on the land would have a combined estimated gross development value (GDV) of RM15bil over a 10-year period.

Observers have questioned whether Naza has landed a sweetheart deal and if the project will yield the best returns on a valuable government asset. Naza TTDI group managing director SM Faliq SM Nasimuddin is aware of the level of scepticism.

“There has been much talk about the deal since we announced it. We will be having a press conference, maybe early next week, hopefully, to talk about it. At this juncture, however, the master plan has not been approved,” he told StarBizWeek after a function on Thursday to mark the rebranding of the Naza Talyya hotel business.

He says phase one of the project comprises the expo centre, which will be on that 65 acres together with a hotel, a shopping mall and one office tower. This will be ready in four years.

He adds that the company is currently talking with investors in the hotel and retail sectors on their participation in the project.

“We would like their involvement and contribution. It is a big piece of land, and their experience and presence will help to ensure its success.”

On the possible strategy of carving out parcels of the project land to different parties, he says Naza “is looking to develop what we can, but will also enter into various joint ventures with foreign and local developers and contractors.”

An analyst, who declined to be named, says the deal lacks clarity. “On what basis was the land awarded to them? If private negotiations are the way to go, does this mean government land banks like the ones in Jalan Cochrane, Ampang and Sungai Buloh, will go the same way?” he asks.

“There are other government-linked companies that are in construction and property development. They could all be parties to a restricted tender if the Government does not want to have an open tender.

“This would at least give the whole deal a vague semblance of transparency, if not total transparency. Without calling for a tender, the Government may not be maximising returns on its assets.”

Another sticky point is the current soft climate. Property consultants have their reservations, given the scale of the development. It has everything – condominiums, hotel, expo centre and shopping malls.

“They have to get their master plan right. When MRCB (Malaysian Resources Corp Bhd) got the KL Sentral project, it did the right thing by anchoring the place as a transport hub and got two five-star hotels in to upgrade the image of Brickfields,” says the analyst.

The market value of the land is also a subject of debate. Says valuer Elvin Fernandez of Khong & Jaafar: “The straight analysis of this is that the price per square foot (per sq ft) is RM222. In order to equate the price to a current market value, one has to discount it at an acceptable rate of return.

“Based on a five-year period, we would arrive at a discounted per sq ft value of about RM150.”

Several land deals of between two and three acres were done in the Jalan Ipoh area at over RM600 psf this year. If the gross development value of all the projects totals RM15bil, that means it will be high-density development.

Another source values the land at between RM350 and RM500 per sq ft. In Malaysia, the land cost would make up between 10% to 20% of the total GDV of RM15bil. In Singapore, land cost could go up to 50% of GDV, while in Hong Kong, 65% of GDV.

A property consultant, who declined to be named, says Naza got a fair price for the land.

“They did not get it for a song. They are planning the convention centre for Matrade over a period of time. That means the land price is being paid for that period of time,” he says.

By The Star (by Thean Lee Cheng)

Dubai, or is it bye-bye?

The Gulf city state’s debt problems offer an important lesson – unpredictable, unsustainable and unclear policies are a no-no.

After two difficult years, most come away with the thought that financial markets the world over should have stabilised. Sure, the extraordinary steps taken to stop the panic resulted in flooding the global system with trillions of US dollar liquidity.

In all, governments have spent, lent or guaranteed close to US$12 trillion and central banks held interest rates to near zero to end the financial crisis. Even so, as to be expected, most of the previous excesses were never quite worked off.

They can’t just make all these excesses go away, no thanks to continuing flows of cheap money around the world. So, we should not be surprised to see over-leveraged Dubai stumble towards the end of November.

Inevitably, it had to cut its debt burden down to size. Around the world, financial markets quivered. Investors – mainly banks – found themselves in a flare-up they feared would happen, but had hoped would not.

Dubai’s caustic lesson

The problems of Dubai are already well known. It is a property play that turned into a bubble that burst. The boom was fuelled by easy credit and a poorly regulated market overrun by speculators, and it was cheered on by a go-go Dubai during the heyday of the pre-financial crisis. Since then, residential real estate prices have slumped by nearly 50%. Across the United Arab Emirates (UAE), it has been reported that some US$450bil of construction work had been scrapped.

It all culminated in the recent announcement by Dubai World, the UAE’s largest state-owned conglomerate, that it wanted to impose a six-month standstill on debt repayments.

Because Dubai is not rich in oil, it borrowed heavily to fund its grand ambitions. Nakheel, a government-sponsored developer, used part of these funds to develop the Palm Islands and other spectacular land reclamation projects.

On Monday (Dec 14), Nakheel is due to repay US$3.52bil to holders of its Islamic sukuk bonds. This is part of the US$26bil debt that its parent, Dubai World, is seeking to restructure.

In all, Dubai’s sovereign and its state-controlled companies’ debts could reach US$80bil, in excess of the size of its gross domestic product (GDP) (nobody knows for sure).

Viewed in perspective, Dubai makes up less than 0.1% of the global economy and the UAE, just 0.4% of outstanding global cross-border lending.

What caught investors “feeling wrong and wrong-footed” were reports that Dubai’s ruler had only weeks earlier assured investors that enough funds would be raised to meet “current and future obligations”, the emirate had only hours earlier raised US$5bil from two state-controlled banks in Abu Dhabi, having raised US$10bil from this neighbour in February, and banks in particular felt sure that the emirate would make good on publicly traded papers (particularly Nakheel’s sukuk) rather than lose face and damage the reputation of the Gulf as a business and financial hub.

So, investors can no longer take the “UAE umbrella” for granted. In the end, there are hints that it may still “pick and choose when and whom to assist.”

Over the past year, moral hazard appears to be firmly embedded throughout the global financial system. So for bankers, Dubai offers an expensive lesson. Most had expected the government to stand behind its “ward” (Dubai World).

In the wake of the Dubai debacle, it looks like Dubai is set to make investors share the pain, rather than foster moral hazard. Indeed, lenders are still reeling from the spectacular Saudi defaults not so very long ago.

Fair enough, Dubai World was technically not government-backed. But investors had perceived it to be so and acted accordingly. Dubai’s repudiation of such an implicit guarantee leaves a bitter taste in the mouth of most investors, something they are unlikely to forget anytime soon.

Tail risk resurfaces

Credit worries are back. Two years ago, few investors would worry about “fat-tail” risk. This refers to the occurrence of seemingly remote risky events, carrying with it blotted (hence, fat) devastation. The rest is history.

But the lesson is not easily unlearnt. Indeed, the mere sound of a crack can get everyone running for cover. Little wonder for the knee-jerk reactions to recent developments – from the sharp rise in risk premium for Greek bonds and Turkish as well as Hungarian credit default swaps (following their profound budget mess) to the Dubai debacle when investors fled from risks.

Wall Street tells us government debt is “risk-free.” Don’t you believe it. History is littered with sovereign defaults.

The charade continues. Early this week, reality came home to roost. Greece’s and Spain’s sovereign credit rating were downgraded. Even Britain and the US are not spared.

Moody’s rating for them were set apart from other top-rated sovereigns, calling them “resilient” and not “resistant” (a label kept for Germany, France and Canada).

In Dubai, lack of confidence continued to spread. Tuesday’s tumble in Dubai’s stocks wiped out its whole year’s gain; Moody’s downgraded six Dubai government-controlled companies, citing lack of government support. The carnage goes on.

The moral of the Dubai saga is clear: nasty fiscal shocks are not confined to just emerging nations. Markets soon realised that debt fundamentals in Dubai are no different from those in developed nations, even Britain and the US. Indeed, the line between emerging and developed gets more blurred; the rush to judgement that stability has returned is premature; fundamental imbalances created during the crises (for example, excess leverage) have yet to disappear. Beneath it all, huge vulnerabilities remain. The Dubai saga is a welcome wake-up call.

Sukuk’s dilemma

No doubt, the problems of Dubai will have a chilling impact on the market for sukuk bonds.

These are a class of financial instruments that complies with Islamic investment principles, which prohibit the payment of interest (ironically, bonds theoretically are associated with interest payments).

In the past decade, the market for such US dollar denominated debt-like instruments has gained popularity. This year, US$19bil was raised in the international sukuk market; it peaked in 2007 with US$25bil.

The range of issuers, investors and instruments has since widened and deepened. About a month ago, General Electric’s financing arm became the first western industrial company to issue a sukuk bond for US$500mil. It attracted a new source of investors.

The debt standstill sought by Nakheel has thrown a spanner in the works and so close to the repayment date of Dec 14. In the past week, activity in sukuk bonds came to a virtual standstill in the face of its potentially biggest default.

By any standard, sukuks are small potatoes in the bond world. Less than US$1 trillion of such debt is outstanding – smaller than the amount of new bonds sold by non-financial institutions this year alone.

Nevertheless, it’s a big deal since it is now unclear how sukuks can be restructured. It will be a test case for how well investors are protected because these are viewed as quasi-sovereign credit, i.e. akin to government debt.

There have been at least two defaults so far – one in Kuwait and the other in the US by a small oil and gas company. At issue is whether investors can take possession of the underlying assets or are simply entitled to the assets’ cash flow.

There are no precedents in the Dubai courts. Further, sukuks are structured to comply with Islamic law but are created under English law. Further complications can arise since Nakheel’s assets are situated in the UAE. Moreover, investors have the benefit of Dubai World’s guarantee whose enforcement is subject to some local law issues.

Be that as it may, the episode looks likely to be long drawn out. Bankruptcy in UAE do allow for a protective monitorium, which can be a double-edged sword. Whatever the outcome, Dubai’s action has done the sukuk market a great disservice.

While Islamic finance wasn’t at the root of Dubai World’s problems, investor reaction so far in the face of delicate markets and an uncertain global recovery make people nervous about the future.

At the very least, short-term activity in sukuk will remain stalled. Credibility in the manner restructuring is being handled will determine the future. Indeed, investors are fast learning that no matter how buoyant potentials look, resources are not limitless.

Looking past the sandstorm

As it now stands, the Gulf markets are soft and under continuing pressure. To be fair, the structural underpinnings of these markets need to be viewed in perspective over the longer term.

Lest it’s forgotten, Dubai’s hydrocarbon-rich neighbours – Saudi Arabia, Kuwait, Qatar and Abu Dhabi – command two thirds of the world’s oil and 45% of gas reserves.

Debt levels are very low and high oil prices have enabled them to accumulate more than US$1 trillion in reserves. A few key elements set the stage.

These Gulf nations need some US$2 trillion in infrastructure spending to diversify from oil. This fiscal spending can be financed out of current reserves (viable even at US$40 oil price); offer strong benefits viz no taxation, cheap feedstock, and virtually free land; give rates of return on equity hovering historically around 25%, as against 10%-15% in other emerging markets; and provide access to low-cost funds made possible by accommodative monetary policy, with Gulf currencies pegged to the US dollar.

As with any market, risks loom large. It is always possible for oil prices to fall below US$40 per barrel; geopolitical risks don’t lend readily to being well managed; and opaque family groups dominate markets that are not really transparent.

But these oil-rich nations are known to be basically conservative. No doubt the Dubai excesses present lessons to be learnt. Throughout history, nations have defaulted and live to fight again, and succeed, even prosper.

To regain confidence, a number of things need fixing: call for fiscal transparency, opaque family business groups need to heed the lessons of Korean chaebols, and clarity on the road-map to government prudence over the longer term. This includes a credible plan on debt management once global recovery becomes sustainable.

Dubai teaches an important lesson. Unpredictable, unsustainable, unclear and uncertain policies are a no-no.

Former banker, Dr Lin is a Harvard-educated economist and a British chartered scientist who now spends time promoting the public interest. Feedback is most welcome at

By The Star (by TAN SRI LIN SEE -YAN)