Dubai house prices to top UK property prices in 2008?

Indeed, the divergence in outlook between the UK and UAE property sectors for 2008 could hardly be more vivid. In the UAE, high economic growth rates fuelled by a five-year surge in oil and gas prices is being inflated further by a currency and interest rate regime pegged to the US dollar; and as the Fed cuts rates in the US home loans will also cost less in the emirates.

For local property this means cheap finance is available to buyers whose only alternative is to pay inflated annual rents. One study put the cost of renting a one-bedroom apartment at Dhs10,000 per month compared with Dhs7,500 to buy.

In this atmosphere further increases in house prices look inevitable, with 10-20% appearing a conservative estimate for 2008. And at the same time the UAE mortgage sector is only just really opening for business. EFG Hermes estimates the local mortgage market is presently worth a tiny Dhs16bn and could grow 10-fold over the next five years; and the availability of finance will definitely be a factor in local house prices.

Falling mortgage costs
There is indeed mounting pressure on Emirates mortgage providers to lower their interest rates. Currently market rates stand around 7.5% whereas the newest market entrant Commercial Bank of Dubai offers risk-assessed home loans from a little over 5% to customers with the best credit profiles.

Market competition among the 23 lenders should mean that local home loan rates go lower this year, with US interest rates set to fall further and the dirham's peg to the dollar still firmly in place.

By contrast in the UK a 10-year housing bubble has just burst courtesy of the credit crunch that started last August, and caused the first run on a UK bank for more than a century. Mortgage conditions are now tougher for borrowers, rates have risen and transactions have fallen steeply. House price have been falling for the past four months.

UK boom over
Many economists have pointed out that on any valuation technique UK house prices have become overvalued by anything from 20-50%. In a market correction it is normal for prices to move to an over-correction before reverting to the long term average.

This is the main reason for expecting the gap between UAE and UK house prices to close in 2008: prices stand to fall sharply in the UK while in the UAE house prices still have a lot of upside.

However, there is one final factor that will close the gap: currency devaluation in the UK. The pound sterling has been riding high against the US dollar - due to the well known problems of the US economy - and has therefore made dirham-denominated property cheap in the UK and UK property that much more valuable in dirham terms.

Now that the UK economy faces a series of challenges not unlike those in the US and the pound sterling has fallen in value below two dollars to the pound. HSBC predicts a decline to 1.75 over the next 15 months as the pound devalues to offset the impact of a UK slowdown or recession.

Devaluation bonus
For UK owners of UAE property that will provide a nice gain in value in sterling terms. But at the same time the price differential between UK and UAE real estate will be eroded in dirham terms.

For instance, take the Dhs5.7m price of a five-bedroom villa in New Dubai. To obtain a house of similar size in the UK Home Counties might cost around Dhs9m today. Now factor in a 10% rise in Dubai prices to Dhs6.3m and a 20% decline in UK house prices bringing the comparable home to Dhs7.2m. Then adjust for a fall in the value of the pound sterling and you have cheaper homes in the UK than the emirates.

This is a remarkable phenomenon: When Dubai house sales to foreigners first started in spring 2002 prices were at around a quarter of comparable UK prices in the Home Counties. A little more than five years later and the tables are set to turn.

Liquidity and supply issues drive Dubai prices higher

Waiting for a housing crash to buy a property is like hoping to win a raffle. The chances are it may never happen. And when it does you may not have the ticket to claim your raffle prize or the cash to put down on a deposit.

A word of caution to the many pundits who predict a housing crash in Dubai: one thing well known in the prediction business is that when so many people are predicting an event, it seldom happens, or it does so very much later than predicted.

Consider the UK housing market. How many people said the market was becoming overheated in 1999? And yet there was no sign of a downturn until the summer of 2004, and even now prices have barely moved from their peak levels, despite a series of interest rate rises.

The Dubai Marina factor
The same school of analysts now takes a long-look at the Dubai Marina apartment towers shooting up, and concludes that the end of the Dubai property boom is nigh, and that oversupply is clearly close. But this is not what we see in the marketplace.

It is presently very difficult to find a property to buy in Dubai, and even if you move fast the home that you like is likely to be snapped up from beneath your feet by somebody offering more money. This is an ongoing boom, though admittedly mainly for completed property.

The rental market in Dubai has soared so high this year, up 40% on some reckonings, that the Crown Prince General Sheikh Mohammed bin Rashid Al Maktoum has ordered a 15% rental rise cap until the end of 2006. This is hardly the stuff of a property market about to collapse.

Even the upcoming supply is contributing to the boom in prices and rentals by running later and later. For each month's more construction delay means higher rentals and prices in the completed housing market.

What is the base price?
With the huge liquidity in the region is it not more likely that house prices will go higher in the immediate future, before reaching a peak? It could well be that today's prices are therefore the new base price to which prices will fall in a 'housing crash', or the base price level may actually be higher than we see right now.

Meanwhile, those potential buyers who choose to carry on renting have to pay the very high current rental prices; and while the 15% rent cap protects existing tenants, it probably will not help new tenants avoiding a rent rise. Besides which, do not higher rental prices in themselves have an impact on property values?

Surely higher rents make properties worth more, not less? Around the world rental yields are often presently around 50% lower than in Dubai, and why should property investors expect to earn more in a booming city like Dubai? Yet rents have risen by more than house prices this year, can this go on much longer?

No, the immediate pressure on Dubai house prices is all upwards. No doubt supply issues will kick in later on, but this may not be for two or even three more years, assuming that oil prices do eventually come down. But will this happen? Oil supply issues suggest a different market dynamic may be in place.

If oil is now permanently higher in price then Dubai property will settle at a permanently higher level of value as Dubai will become one of the richest cities in the world, and in rich cities property is not as cheap as it currently is in Dubai.

Dubai Property: The brow of the hill

Concerns about property bubbles abound around the world. Dubai is no exception. In recent years, we have seen a dramatic price appreciation. By the end of 2005, we estimate that property prices had doubled in the previous 3 years. There have been several causes of the boom. First, the dramatic expansion in non-oil activity led to an increased demand for housing as more and more people relocate to the city. Second, high rental yields (estimated at around 8-10% for the apartment sector and 6-8% for the villa segment) have attracted investors into the market.

Third, the excess liquidity generated by the region's petrodollars has led to a sharp increase in speculation in asset prices around the region. We have already seen the bursting of the stock market bubble, which resulted in the Dubai financial market index losing over 65% from its peak a little over a year ago.

Finally, we have identified a fourth category of buyers - insurance buyers. There are indications that many buyers are actually buying a property in Dubai - which brings with it the right to reside in Dubai - in order to have somewhere to go should the situation deteriorate in their own countries. This buying, we believe, is particularly prevalent from South Asia, Russia and Iran.

Given these sources of demand, there is still currently a shortage of supply.

This demand-supply imbalance has led to a significant rise in valuations and rents. We have argued before that residential property prices are likely to come down around 20-30% in the next 2-3 years. And we believe that we are getting close to the peak in residential property prices. While demand is likely to remain strong in the coming years, as Dubai continues to focus on diversifying its economy away from oil, the key is supply.

The good news, for those who have had to stomach sharp increases in rents in recent years, is that supply is set to grow rapidly in 2007, outstripping demand growth. Prime Group has estimated that, taking into account delays in the delivery of properties, 52,000 and 63,000 properties will be delivered in 2007 and 2008, respectively. Given a reasonable assumption of 7% population growth for the emirate, it suggests this will lead to an excess supply of around 6,000 units in 2007 and 33,000 units in 2008. This is likely to mean that we will see property prices and rents falling in the coming 24 months.

There are scant signs of this happening in the immediate future. Our updated residential property market index suggests prices have risen an average 18.8% so far this year. However, what is extraordinary is the 12.9% jump we saw in October after weakness between July and September, when we saw prices fall over 1.0%. The data is fairly volatile (for notes on how the index is constructed, please see the Appendix). What is interesting is the fact that the overall property price index has fallen in five out of the last eight months, but two of the rises, in July and October, were dramatic. The first can be explained by the announcement by the government that foreigners would be able to buy freehold properties.

The jump in October may have come from a realisation that estimates for the release of properties reported for the second half of the year are unlikely to be attained. Indeed, one developer at one point suggested it would be releasing 60,000 units onto the market in the second half of 2006 and Prime Group now estimates the full year market figure will only be 40,000. There may also be a seasonal effect at play here.

We break down our property index by type (apartment and villa) and by geography. On the former, it is conventional wisdom that the villa segment is unlikely to be affected significantly by any downturn in the property market as most of the supply coming onto the market is in the apartment sector. Our property indices indicate that villas (up over 30% year-to-date) have indeed outperformed apartments (10%) by a significant margin. However, we continue to argue that the two segments are not totally isolated from each other. While a family may have a preference for living in a villa, should the relative pricing change significantly (as apartment prices fall, say) we would expect some to migrate to the apartment segment. That said, we do agree the apartment sector is likely to lead any weakness and this is reaffirmed by the fact that villa prices have risen over 20% in the past three months while apartments have risen by just over 3%.

In terms of geographies, we have highlighted three main areas: Offshore Dubai, New Dubai and South West Dubai (see Appendix for more details on the developments included). The best performing have been the most developed; that is, those that have more of the projects completed. South West Dubai prices have risen 34.1% year-to-date. This was by far the top performer. While part of this out-performance is due to the fact that 86% of this sub-index is made up of the outperforming villa segment, it is still worth noting that this district outperformed the overall villa index in the first ten months of the year.

New Dubai prices were up 23.7% over the course of the year, a very strong performance given that it is comprised of 76% of apartments. However, it is important to note that prices rose a whopping 31% in October and before this increase prices were down over 5% year-to-date. This huge volatility, together with the large supply due to come onstream in the coming months in the form of the Jumeirah Beach Residences, may suggest this is a last hurrah for this district.

Finally, Offshore Dubai, which includes the Palms, has seen prices remain relatively lacklustre so far, up a relatively meagre 3.3% year-to-date, all of which can be accounted for by the rise in October. Therefore, we expect property prices, particularly in New Dubai, to peak in the coming months.

However, we believe the impact on the economy will be limited for several reasons. First, we expect the property price correction to be gradual as the developers avoid releasing properties too quickly into a declining market. Second, the Abu Dhabi property market is heading in a different direction with a supply shortage likely to be seen well into 2008. Third, we expect oil prices to remain firm, ensuring that liquidity in the region remains ample. And fourth, the diversification and investment drive is likely to remain very strong. Therefore, while the property sector may start to weaken from here, we expect economic growth to remain firm.

Appendix
The data used to build Standard Chartered Bank's residential property index is taken from betterhomes Property Listings magazine and the indices are are based on AED per sq foot. A note on the data This data is not a comprehensive data source of all Dubai properties. It focuses largely on the new buildings still under onstruction or recently completed. The three zones covered in depth are 1) Offshore Dubai (the Palms, the World and Maritime City), 2) New Dubai (Dubai Marina, Springs, Meadows, Gardens, Lakes, Jumeirah Islands etc) and 3) South West Dubai (Arabian Ranches, the Investment Park, Sports City, Green Community).

The composition of the properties changes from month to month, with some properties not being present for a few months and then returning. Therefore, there are two sources of changes in prices. First is the fact that different properties are covered from month to month. And second, the price of the properties can be revised, as perceived market conditions change. As an example of the breakdown of properties, the October index is based on 956 properties. Of these, 370 properties were new additions to the spreadsheet, 391 were updating September data and the remaining 195 were updates of previous monthly data.

It is also important to note that the prices are those at which the seller is offering the property to the market while the actual transacted prices may be very significant. There are two implications of this. First, it may increase the volatility of the data. Second, it may provide a delayed response to actual market conditions. Generally, when the market turns down in property markets, it takes some time for ellers to wake up to the fact that the cycle has turned and their perspective of market conditions is out of date. However, in the absence of a better methodology, we comfort ourselves with the fact that over time they should give us an nidication of where the market is heading.

Please note the May and August data were interpolated.

EFG Hermes points to 2008 as crunch time for Dubai realty

In 2008 some 139,000 units are due to be handed over. However, delivery dates in 2008 are even more likely to slip than in 2007. For in 2008 only 14 per cent of these units will be completed by large developers, compared with 75 per cent in 2007.

All the same this study highlights a fear prevalent in the local market that while the outlook for 2007 is sound enough, it looks as though supply and demand will be getting seriously out of kilter by 2008. Thus in 2008 EFG Hermes predicts that rents and prices will begin falling.

The exact extent of price falls in 2008 will depend on how much of this additional supply actually hits the market, note the authors. But they see an oversupply of units starting in 2008 when the bulk of current construction is due for delivery with the number of residential units doubling to 530,000 by 2010.

2007 a stable year
For 2007 this investment bank suggests that apartments are overpriced but that villas have not yet peaked in price. It points to the building of 10 apartments for every villa while the demand for villas remains high among families.

Without any historical precedent to guide to property cycles in Dubai, EFG Hermes turns to the last cycle in Singapore for a pointer to the future pattern. Singapore went through a boom in 1998-2000 with prices up 37 per cent and then a short period of stability before a sharp drop of 30 per cent.

This matches with EFG Hermes' main scenario for Dubai with a period of stability in 2007 followed by a cumulative 25-30 per cent fall in property values by 2010, albeit 'the range of potential price decline outcomes is very wide'.

EFG Hermes says that demand is the most difficult part of the supply and demand equation to work out. In short: whether or not Dubai can really absorb this huge supply of property over the next four years.

Economic conditions
The major caveat is that this analysis is predicated on there not being any significant slowdown in the economy which would weaken the flow of expatriates into Dubai. So if oil prices came unstuck in the forecast period the outlook would be very different.

On the other hand, instability in many regional countries and a continued high oil price would have the reverse effect, bringing more people, more money and higher housing demand.

For while it may look as though Dubai is building far too much real estate, the supply could still be too slow to keep up with a surge of demand under some scenarios, and who can really predict what is going to happen in the Middle East over the next four years? Analysts do not have an easy task.