Recent commentary on the health of the real estate industry has been conflicting for investors.
Amidst some cautious optimism being espoused in certain circles, there has been talk of unsubstantiated optimism expressed as well, with forecasts of further declines as the effects of low oil prices reverberate throughout the economy and affect the pace of investment flows.
In order to make sense of such conflicting claims, it is worthwhile to parse through the data of real estate cycles of the past in order to determine the likely course of price trajectory in the medium term.
To be sure, oil prices exert a considerable amount of influence on the role of economic activity for the region. That being said, it is surprising to note that over the long term, there is surprisingly little correlation between oil and real estate prices over a 20-year period.
Although the data points available are not complete, what emerges is a surprisingly low correlation of between 0.1 and 0.17 when different countries in the region are examined. Why would this be the case, and, more importantly, why does the fallacy exist in the zeitgeist?
There are a number of factors for this: Firstly, oil price levels have been largely used as a proxy for fiscal spending. Increasingly, however countries in the region have begun to retool their fiscal policies to make them more independent of “exogenous oil price shocks”.
Secondly, when Dubai and the UAE are examined, more than 48 per cent of foreign inflows into real estate sectors are from countries that actually benefit from the decline in oil prices. Lastly, but perhaps most significantly, the decline in oil prices benefits consumers, in the form of lower price levels in the economy.
With the current liberalisation of oil prices in the region, this sets the stage for higher discretionary consumer spending that most often manifests itself in the form of higher housing demand in the medium term. The low correlation between oil and real estate prices is perhaps the greatest example of the fallacy of “post hoc ergo propter hoc” (after, therefore because of it).
It is a myth that has had remarkable staying power in the discourse of domestic economic analysis, whereas the data indicates that real estate prices, especially in the UAE, have long divorced themselves from the effects of oil price volatility.
Moves announced by Saudi Arabia to overhaul their budgetary spending through fiscal policy moves and liberalise their economy not only validates the moves taken by Dubai over the past year, but also gives a fillip to investor confidence. This is by way of the reaffirmation of continued spending on infrastructure in the economy.
It is this circulation of money that gives investors visibility into economic projections that were earlier considered overtly optimistic. Of course in the UAE, and in Dubai, budgetary spending allocated for 2016 envisages a sustained and double-digit increase in spending, and equity markets have started to respond with share prices of contracting companies leading the rise.
Given that the region is pegged to the US dollar, the strength of the latter is also used as a factor in predicting price weakness of the real estate sector. When looked at the data, it is clear that the US dollar exerts a much higher correlation than that of oil (between 0.24 and 0.39).
What this data set ignores, however, is the rising influence that the end-user has begun to exert on the markets. The recent rise in transactional activity has been almost entirely led by end-users and not investors (thus explaining the dichotomy of rising prices in some areas with continuing reports of some brokerage houses closing down), and have two common themes.
First, they have been led in the relatively affordable areas and, second, they have risen in areas where price declines have been the steepest and where price levels have come closest to replacement value levels.
Moreover, the recent decline in the US dollar against all currencies, if sustained, foretells a period of gradually rising prices, a phenomena that is already started to be selectively observed.
What is imperative to note is that in every real estate cycle in history, equity prices have led the rebound in real estate prices. The current rebound in capital markets (25 per cent from the bottom) may yet falter for a number of reasons, and faces headwinds to be sure.
But it is equally imperative to note that capital markets provide the very source of liquidity that is the source of a lot of the concern that is being expressed currently. This is not to say that the nature of the rebound will be the same as has been witnessed in earlier periods.
The nature of the rebound is likely to be gradual and thematic, and it is the examination of this very nature that will determine the path of capital formation in the years ahead.
The writer is Managing Director of Global Capital Partners.
