Although real estate equities on the United Arab Emirates stock markets have rallied in the past weeks on the back of some good quarterly earnings by the sector, analysts are warning investors that the worst may not be over yet for the local property market as a supply overhang continues to depress prices.

Despite some signs of price recovery in select prime locations in Dubai, analysts say the real estate sector in Abu Dhabi, as well as in non-prime areas of Dubai, will continue to come under pressure this year as supply floods both markets.

Demand is also likely to shift to distressed eurozone countries as investors look to pick up bargains there, they said. Property stocks on both UAE bourses have outperformed the general indices since the beginning of July on good quarterly earnings.

The real estate and construction index for the Dubai Financial Market rose 17% while the sector index for Abu Dhabi Stock Exchange increased by more than 9% in the same period.

Jan Pawel Hasman, analyst at EFG Hermes, cautioned that the spate of strong real estate earnings from companies such as Abu Dhabi’s Aldar Properties and Dubai-based Emaar Properties aren’t indicative of a recovery in either market.

“The results are difficult to draw conclusions from, the underlying reasons are different for each company so we cannot say the market has improved based on the earnings we have seen. Aldar posted strong earnings mainly because of the government bailout execution and the results are not indicative of a recovery in the market,” Hasman said.

For Emaar, the strong rentals and hospitality revenues could be seen as an improvement in the Dubai market, but the revenues were boosted by deliveries in international markets such as Egypt and Saudi, he added.

Both Dubai and Abu Dhabi’s booming realty markets suffered in the aftermath of the global economic downturn when liquidity dried up and property prices declined by as much as 60%.

Analysts say any signs of recovery in Dubai now are restricted to the high-end areas of the market.

“For prime real estate in Dubai we are well past the bottom as there are not a lot of high-end properties coming online, but we are not expecting exponential growth going forward as a lot of investors were burnt during the pre-crisis when new projects were being launched at higher and higher prices,” said Matthew Green, head of research at commercial real estate services firm, CBRE.

CBRE’s latest Dubai property report shows newer less established districts — such as Jumeirah Village — are continuing to feel the pinch, witnessing a 5% drop during the quarter.

In Abu Dhabi, as new prime and non-prime supply comes online, the emirate will see more downward pressures on both market segments, Green added.

Real estate services firm Jones Lang LaSalle said due to competition Abu Dhabi’s real estate market is “moving further in favour of tenants and occupiers” after about 2,900 additional residential units were delivered in the second quarter, bringing the total stock to about 199,800 units at the end of 2Q12.

Another GCC-based stock analyst, who declined to be named, said although their firm wasn’t ruling out a recovery in prime Dubai realty prices, international investors are now seeing attractively priced investments in the troubled European markets, which may compete with Dubai going forward.

For Abu Dhabi, the analyst sees rents and sales falling between 10-15% across all real estate properties on oversupply in the coming year.

“In addition, a lot of nationals are expected to move into the newly-built government housing which will free up more space in central Abu Dhabi,” the analyst said.