Will villas or apartments be the best investment in 2008?

dubai real estate investors have found villas providing the greater capital appreciation over the past few years. but rental yields have fallen as a consequence, making apartments more attractive in certain locations. is this a trend likely to continue in 2008, or will villas emerge again as the better choice for investment?

this article is not concerned with establishing the merits or demerits of living in an apartment or villa from a personal point of view. that is very much a matter of individual taste and circumstances.

however, it is possible to be far more objective from a strictly investment perspective. both villas and apartments have gained strongly in capital values over the past five years in dubai, albeit from an artificially low base of zero foreign ownership.

to take two of the oldest developments, the greens apartments and the meadows villas, prices are up three-fold and four-fold respectively. but rental yields have diverged, and the greens offers a handsome 10 per cent yield while the meadows yields around six per cent.

it seems you cannot have both high capital appreciation and the top rental yield, as the rent is effectively capped by what people can afford to pay while capital values can be leveraged with bank loans. but is this status quo likely to continue?

logic would suggest not as the flow of apartments into the market is now growing while very few new villas are being delivered. the 950 new shoreline apartments on the palm, costing around $1m for three bedrooms, are presently yielding around five per cent in rent.

that is not to say that apartments as an asset class will not see a 10-20 per cent inflationary rise in rents and prices in 2008; the level of demand in relation to new supply is sufficient to drive both rents and prices higher.

but you could expect to see rental yields on apartments weakening, and that should give a further boost to the appeal of villas to investors.

how low rental yields could fall in dubai is another interesting question. real estate investors in london have been prepared to accept 2-3 per cent or half the base interest rate.

and if, as expected us interest rates head sharply lower in 2008 then local uae rates - which are pegged to the us dollar - will also fall in unison. that means that investors ought to be willing to accept a lower rental return on property in dubai.

in practice that means investors would likely be paying relatively more for a property unit and accepting a lower rental yield. this is what you would expect to see in a maturing real estate boom, not the high rental yields that are still seen in the market today.

these high rental yields are surely another reason to believe that dubai is someway from a top in the real estate cycle and that 2008 should be another profitable year for investors, albeit the top is naturally getting closer all the time.