Bubbly can be tasty. Bubbly stock markets are less so as those who have been caught in the implosion phase of market bubbles are known to share. The problem with market bubbles is not really that only very few people can detect them; the problem is that it is very tricky to avoid being hit when they burst.
For the past year, economists have been divided over the future course of the UAE real estate market, arguing when a correction will set in. The debate was quite intense in the immediate aftermath of the GCC stock markets correction, driven by the painful experiences of billions of dollars in market caps that were wiped out in the first half of 2006. Additionally, as analysts pointed out in autumn of last year, stock market corrections often are followed by downturns in real estate prices — and that with considerable lag time.
On the other side were experts who diagnosed the UAE as having continued severe housing shortages that in the short term would not likely be answered by home construction, despite the immense number of project announcements that flooded the emirate at the center of attention, Dubai, throughout 2006. In short, market liberalization, foreign property ownership, sector volatility, outstanding economic growth — both in the UAE and the GCC — has created two camps: One camp believes that Dubai’s property bubble has reached a head and will soon burst, while the other camp believes the sector will continue to experience growth at least until 2010 and the bubble will remain intact.
Diversifying economic programs
As part of its strategic diversification plan to rely less on oil revenues, Dubai has been for the past seven years spearheading an ambitious economic program with real estate, trade and tourism being the main drivers. The government invested directly into these sectors through the creation of the country’s top real estate development and operating companies. Consequently, Dubai’s measures designed to build a state-of-the-art, modern infrastructure, with the aim to attract millions of tourists and international firms has spawned massive construction projects in the emirate, which, in turn, has created a substantial and a buoyant real estate stock market. Real estate and construction accounted for 15% of UAE’s $164 billion GDP.
Not to be left behind, Abu Dhabi has also earmarked the real estate, business and tourism sectors as key drivers of growth and now engaged in a frenzy of construction activities unmatched in the world. The government of Abu Dhabi announced in mid-September its “Abu Dhabi 2030: Urban Structure Framework Plan,” which lays out a vision that would make the UAE’s capital a global city equal to its European peers. The plan estimates the city’s population to grow to over three million people by 2030 and calls for the spending of over $165 billion on real estate sector and infrastructure projects.
Due to the high speed of economic expansion, the real estate sector was marked by a speculative streak in both property deals and trading in the shares of sector companies on the two stock exchanges of the UAE, the Dubai Financial Market (DFM) and the Abu Dhabi Stock Exchange (ADSM). Equity prices have returned to levels that reflect more reasonable valuations but recent turmoil in international markets raised new questions if equities in the property development and real estate sector have fortified themselves by improving their corporate governance and sensitizing their expansion strategies.
The property sector’s volatility on the Dubai Financial Market was demonstrated in August by very strong, sudden fluctuations of leading property stock, Emaar, which swung within 48 hours from a 3.5% drop to a gain of 5.6% on poorly communicated information, fears, and speculative pressures. Emaar’s fluctuation impacted local and regional market indices but only on a very short term. Calm was restored in September and the following weeks demonstrated that UAE investors have considerable trust in the value propositions of listed real estate stocks.
One testimony to this optimism on the real estate sector was the trading start of Deyaar on the DFM on September 5. Strengthened by an IPO with high demand, the company — a real estate subsidiary of Dubai Islamic Bank — rocked up 100% on its first day of trading, achieving market capitalization equal to the fair value assessments the scrip had been given in recent weeks. The first month of trading saw Deyaar retaining comparatively high price levels of 80 to 90% above its issue price.
Notably, however, the two UAE bourses diverged in September as far as their real estate stocks. The key sector companies on the DFM, Emaar and Union Properties, were rather listless in their share prices. On the ADSM, however, key players ALDAR and Sorouh recorded substantial gains in the latter part of September. Up until the summer, Emaar (and the DFM real estate sub-index that is heavily under its influence) stuck out as subdued performer while Union Properties moved more similarly to its ADSM peers. If real estate sub-indices on the two bourses maintain divergent trajectories over prolonged future periods, it could imply that investors perceive the Abu Dhabi property market as promising but have doubts about the sustainability of Dubai real estate prices.
Supply still has to catch up with demand
However, until now, “the supply of properties, whether in the residential, commercial, hospitality or retail segments of Dubai and Abu Dhabi alike, has yet to catch up with the ever increasing demand,” a report by Dubai-based Shuaa Capital said. “The result has been spiraling prices and rental rates for properties on the market and those in the pipeline,” it added, noting that prices have increased by 13.9% in the eight months leading up to August 2007.
Freehold house prices had more than doubled in the last two years because a fraction of homes under development had been completed, creating a short-term supply crunch. Yet, with many set for completion from 2008 to 2010, experts say the market is set to experience a “declining price” phase and that prices may drop 20% by 2010.
But market observers told Executive that the current market conditions for real estate in the UAE will not turn to the worse in the foreseeable future, that balance on the demand curve has definitely shifted, and greater hunger for residential and commercial property is predicted. “The extent of a correction is difficult to quantify since the economic business cycle does not appear to be at risk of suffering a decline over the forecast period,” Shuaa said in its report.
However, one thing is certain: the price rise can’t go on forever. If the real estate bubble bursts, the pattern will be different from that of a correction in equity markets. While the latter is characterized by huge trade volumes at lowered values, a collapse in real estate markets shows through illiquidity. The prices may not go down but transaction numbers melt away and distressed sellers have a hard time finding buyers. This is bad news for people who bought a home at a price they considered excessive on a rationale that the value of the property will still go up. After a property market correction, these people may have to wait for years for a buyer.
Possible correction in 2009
While international markets carry the memories of burst real estate cycles in the 70s, 80s, and 90s of the last century, opinions on the GCC market see the two possibilities of a sharp sudden drop or a soft landing. Prices will not go up indefinitely but a gradual slowing is a plausible scenario for many in the current positive economic environment of much of the region.
In its latest sector view, investment bank EFG-Hermes expects a UAE price correction in 2009, following upon “a rise in average prices of 10-15% in 2007 and a rise of 5-10% in 2008, with the peak being reached in 2H2008.”
Earnings of listed real estate companies in the UAE, so far, have been no cause of concern and it makes no sense to speculate on short-term weaknesses of publicly traded sector heavyweights, however disappointingly some companies may have treated their stakeholders.
Historic causes of real estate bubbles were in relation to the economy’s expansion low interest rates, scarcity of land, rapid accumulation of people in an area, and speculative pressures. Experts say if investors are concerned about real estate values and feel that the bubble might burst, than they must keep a close eye on long-term interest rates and the unemployment rate. If both of these rates start creeping up, it might be time to reconsider investment in real estate market.
Currently, the unemployment rate of locals in the UAE remains high and given that the emirates has its national currency tied to the US dollar creates a potential recipe for a bubble burst. Add to this the fact that that real estate companies in Dubai are already overvalued the chances for a burst become more acute.
But much can be done to reduce the risk of a stock market decline. For example, housing prices simply can’t continue to rise faster than wages do and wage increases must catch up to housing price increases. Furthermore, speculative excesses in markets will trigger downturns in real property valuations. As such, the government must take steps to end the speculative winds. Proper valuations of real estate firms are also in order. “Proper handling of the real estate market dynamics by the authorities will prevent a potential meltdown,” Samer Shaheen, a senior analyst at Zawya told Executive. “The UAE’s young markets lack a form of information sophistication. In-depth research on the property market to forecast trends are rare and much more on this level is needed.”