Is it time UAE investors switched action to secondary markets?

When the supply of credit increases to a particular asset class, there is little doubt that the price of the asset increases. This is true of housing prices as well as those in the capital markets.

In the case of the former, there has been a noticeable bias of increased loans extended to new buildings, which accentuates the belief that new builds - and even as insofar the loans extend to offplan projects in certain cases - will trade at higher levels than in existing ones. Regardless of pricing…

Expectations shift, and data reveals the increased flow of credit skews the pricing of new builds even further in the case of mid-income communities. Which, over time, reverts as investment related credit (as distinct from end-user/owner occupier credit) is unable to extract higher levels of income from newer builds in the form of higher yields.

Data from the banking sector indicates that credit extended over the last two years on new builds has exceeded those of existing buildings by more than 30 per cent. The same effect can be seen in the capital markets where the IPO phenomena has resulted in gigantic levels of oversubscription. Yet, in 1 out of 3 cases, the subsequent secondary market price action determines that the majority of the returns that are accrued do so in the form of dividends rather than in the form of capital gains. (Fertiglobe, DEWA, Bourouge, Tecom, Al Ansari and even Yahsat).

Not following through into secondary action

This partly accounts for the puzzling disconnect between the levels of oversubscription in the primary market and the subsequent lack of follow through in the secondary markets. Of course, in both real estate as well as capital market assets, the key variable over the longer term has to do with valuations. And the higher the price is in the primary market (on a valuation level), the lower is the subsequent performance in the secondary markets.

This is ominous given the current gap between the offplan and the ready market in the mid-market segment of Dubai real estate, even normalized for the amenities that are now being offered by developers.

At base here, there is the effect of the supply of credit, which distorts asset price signaling in the markets, as well as the preference for the ‘new new thing’. Invariably, this has the effect of price overheating, which in the real estate markets is marked by an increased offering of incentives via commissions and/or other handouts.

And in the capital markets, is signaled by ever greater announcements of corporate activity. Investors need to remain cognizant of the fact that total returns is the prize they are after. Even though the approach to investing in real estate markets have a different dynamic than that to capital markets, the base remains the same - a price where the present value of discounted future earnings is greater.

Of course, the predictive value of such an analysis is extremely difficult to map out. More so when the market is in a frenzied state of activity. Yet, that is not the skill set that is required from most investors.

Not get caught in investor hype

Rather it is the ability to understand what first principles are in both asset investments. Plus, the foresight to stay away from much of the hullabaloo that surrounds the hype machine often built up in bull markets.

Investors should welcome asset price declines, for it allows to increase exposure. In the real estate markets, that relative decline is seen most in the ready space. In the capital markets, the same can be said of the secondary markets, where activity should now come to the fore, even as the hype of every new IPO is being met with the cheerleader approach necessary for raising capital.

Undoubtedly, there will be great offerings in both real estate and the capital markets in the primary level that will be eye watering. For the most part, the shift to the secondary markets is a healthy one, and the supply of credit is expected to adjust accordingly (as they have already in Western real estate markets).

In investing, just as in cricket, to put runs on the scoreboard, you must watch the playing field, not the score.