Lehman Brothers’ death did not cause the great recession of 2008.
An extensive body of scholarly work has examined the choices made in an interconnected economy, and concluded that despite the fact that Lehman loved leverage, at heart was the fact that investors were simply unaware of the opaque nature of risk they had taken on in their pursuit of such effortless wealth. In an age of abundance, where ‘scarcity economics’ is rapidly losing its explanatory power, there is always the allure to slip into new modes of thinking, which somehow defy the economics of gravity. Whilst the latest issue of the ‘Economist’ has called the current real estate market a ‘super-cycle’, the reasons to explain this sound eerily familiar to when the same magazine famously claimed that oil would forever trade in the single digits in the late 1990s.
Hindsight is always a perfect science and it is easy to mock forecasters – Cassandra-like prophecies haven’t panned out for the most part - but we know that for the better part of this year, there has been a series of signals that indicate that frothiness in the Dubai real estate market has been in place. That even as primary offplan sales have continued to skyrocket, there has been a widening gap between primary prices and what these sold in the secondary offplan space.
Increasingly, that gap has not only widened in areas such as JLT, Dubai Harbor, Dubai Marina, Business Bay and Arjan, but the gap has equated to the amount of commissions that have been paid out by the developer (which also increased during the year).
This implies that the real ‘price discovery’ has been in secondary offplan sales, and the price incentives being offered by developers are passed on to secondary investors.
In areas such as JLT, Arjan and Business Bay, the gap has widened in excess of 20%, an astonishing number, especially when you consider that this might equal to the broker incentives. The other set of incentives has been the payment plans, which despite its generosity, has led to an even greater percentage of such units being offered (often under the description of distressed), as flippers try to off load their inventory.
More offplan launch price increases
Such payments plans by definition increase the amount of developer leverage with the consequence that the prices they offer continue to march higher, with the result that prices from Ras Al Khaimah to Business Bay are all being offered at a median price of Dh3,000-Dh3,500 per square foot, regardless of the discrepancy in land prices that exist in these developments.
Every area has its own dynamics, but the rush of offplan at similar prices indicate that in the background the dynamics in play are pointing to an increasing elastic set of payment plans.
There is a common thread that runs through this analysis, and that is one of the increasing beat of euphoria. Investors have learnt that it is often painful to bet against relentless march of Dubai and the UAE, but equally true is the fact that processes do often take a life of their own, and when they detach from economic fundamentals, there is a falling to earth - or ‘mean reversion’ - that inevitably occurs. This is something that we have yet to see in the current capital market cycle in the US as well, despite a higher number of flashing red indicators by way of valuation disparities. (In the real estate market, despite the reduction in interest rate, mortgage rates have yet to fall thus far).
At its core is the approach that investors should have a clear understanding of how much capital they are willing to put at risk, and that ‘effortless wealth generation’ is rarely effortless. It is clear that the only thing investors can learn is diagnosing vulnerabilities that exist in the system. And that ready sales continue to lag is the surest indicator of two probabilistic outcomes:
* It is inevitable that there will be a shift towards ready properties as investors seek to arbitrage; and
* The value and volume of offplan sales will fall to levels that imply a price correction.
By the time the media has caught on to this phenomena, the outcome will have already been played out.
