Fed rate raise could hit Dubai property buyers

The dirham’s peg to the US dollar is a double-edged sword. While useful in aiding international oil business and the UAE’s role as a global hub for trade and travel, it can be a curse for those seeking to buy property here, especially if the Fed gradually intends to raise borrowing rates in the US. Minutes from the last meeting of the Fed’s Open Markets Committee, which sets lending interest rates for US banks, released on November 18, indicate that it will bring the rate above zero (most likely 0.25 per cent) for the first time since 2008. This could happen in the first quarter, with a final decision expected to be made at the committee meeting on Tuesday.

The effects of this anticipation can already be felt. The US dollar has been strengthening across foreign exchange markets on grounds of regained confidence in the US economy, and this strength will be sustainable over the entire interest-raising cycle — unless there are other serious incidents impacting macroeconomic conditions. The main beneficiaries in terms of purchasing power will be countries with dollar-pegged currencies such as the dirham, but most others have to bear the brunt of seeing their currencies devalue. But how does this affect overseas UAE property buyers?

First, it will become more expensive for many important international buyer groups planning to pick up property here — namely Indians, Pakistanis, Britons and Eurozone nationals — when they convert their domestic currency into dirhams to acquire property. This adds to the financial woes caused by recently imposed regulations for higher down payments of a minimum of 25 per cent, or 35 per cent for homes in the UAE worth more than Dh5 million. Furthermore, the Dubai Land Department doubled transaction fees last year. All in all, a sizeable amount of additional cash will be needed by foreigners with non-dollar-linked funds to purchase the same property. And for Indians in particular, the implementation by the Modi government of a tax on overseas investments is another huge drag.

“Currency issues are hard to deal with in the cross-border property market,” said Craig Plumb, Middle East and North Africa Research Director for property consultancy JLL, while speaking to Bloomberg. “There isn’t much the government can do short of removing the currency peg or imposing restrictions on capital.”

Secondly, the delight of UAE residents enjoying higher purchasing power in their non-dollar-pegged home countries will be short-lived as they realise that the Fed’s hike will subsequently prompt UAE banks to raise their financing costs. That’s because changes in interest rates always lead to repricing of loans — even more so on the upside. Higher mortgaging costs can easily offset gains in currency conversions, especially in the case of mortgaged premium property.

So the question remains: What strategy can be deployed to avoid such an inherent price rise? Looking out for discounts is an option. The UAE property market has been weakening this year due to macroeconomic factors such as falling oil prices and a slowdown in the Russian and Chinese economies. Geopolitical tensions have taken their toll as well.

Plumb explains that these factors will result in a price decline at least on the Dubai property market at an average of 15 per cent this year. Put in relation with a slump of the euro versus the dollar of some 13 per cent this year, the two developments are actually compensating each other. The British pound was even more stable, dropping just 4 per cent to the dollar this year, while the Indian rupee depreciated 5.6 per cent relative to the dollar from the beginning of 2015.

One strategy would be to buy now at a discount before the impact of the Fed rate hike and an eventual rise in borrowing costs hits. This could make sense as a mid-term investment. “Prices are expected to continue softening into 2016, before they again rise ahead of Dubai hosting the Expo 2020 exhibition,” added Plumb.

Another strategy would be to borrow in the weaker currency to take advantage of continued lower borrowing costs. At least in the case of Europe, interbank interest rates are expected to remain close to zero for a longer period of time. That way, higher borrowing costs in the dirham could, at least partially, be made up for. Considering that — and healthy rental yields of up to over

7 per cent in Dubai — such a deal could eventually pay off even more so as rent is being paid in the stronger currency.

“With price falls continuing to outpace rental value declines, initial yields are rising,” said Diaa Noufal, Associate Partner at property consultancy Knight Frank while speaking to Gulf News in September this year. “Reaching more than 7 per cent in rental yields in the mainstream property segment, Dubai still stands tall among real estate capitals in the world for investors seeking income-generating properties.”