Once upon a time, an investor had an idea about allocating capital. He wrote it down. What happened next?
In America, prices of luxury real estate have started to get into negative territory after a dizzying bull run sparked by the post-Covid stimulus. On a national level, median prices have fallen by the most since the 2007 housing bust, indicating that higher mortgage rates are starting to bite the median household. This has been accompanied by the fact that M2 (a measure of money supply) contracted by 4 per cent - its first ever contraction since the number was measured.
This strengthens the belief that tighter monetary conditions are laying the ground for further asset price falls, and also raised hopes for interest rate reductions towards the end of the year as an economic slowdown finally starts to take hold and reverse inflationary pressures. In the UAE, no one has gotten the memo, as liquidity gushers continue unabated with record demand for IPOs as well as for real estate assets.
Despite broader market averages being slightly lower for the year, recent IPOs have performed exceptionally well. And transactions in the real estate market continue to scale new highs. What are investors to make of this?
There are three critical factors that explain the phenomena:
1. On a relative valuation basis, despite a re-rating, valuations remain lower than their global counterparts. The recent pricing of the ADNOC Logistics IPO indicates a near 25 per cent discount to its global peers, a trend that has been consistent through the recent UAE IPO momentum. Whilst the same applies for real estate to a lesser extent, it holds true especially in the ready market, where the gap between ready and offplan in areas like Dubai Marina and even JVC has widened to more than 150 per cent, indicating that value hunters are buying older buildings, even as more than 60 per cent of transactions tilt towards the offplan market.
2. Sales of assets have been driven by payment plans offered by developers who can afford to do so given the rising prices of new builds.
3. Most critically, the speculative forces that catapult themselves onto any momentum-based price action. This by definition augurs for moderation as prices move further and further away from their intrinsic value. Curiously, in many cases, prices that have risen remain attractive.
There is no guarantee for prices that are below replacement value to snap back via mean reversion, but as Japan illustrates, eventually markets are weighing machines, and as investors move away from highly priced assets, they gravitate to undervalued markets.
The UAE capital markets have been an example of a growing ecosystem that offers both growth and value, and the same is true for parts of the real estate market, as illustrated by recent price spikes in areas like international City, Motor City, Dubai Silicon Oasis and Dubai South. Commentary always tends to cluster around glitzy offerings, creating an impulse to churn portfolios - whether in capital or real estate markets.
But we know that momentum trading gets drowned by friction costs as investors chase performance. The long-term investor is characterized by inactivity, rather than ‘busyness’. But it is a hard mindset to adapt.
Frothy markets, but not a bubble
Emerging market institutional investors typically focus on companies with lower debt levels, yet prices in Dubai have in many cases outperformed, indicating an ability to not only service the debt but the core point of asset generation being offered at attractive levels. And those that generate strong cash flows (high dividend yields, and/or high rental yields), clearly illustrating the mindset of the long-term investor.
There will always be froth in rising markets. In Western markets, that froth trespassed into bubble territory, and its subsequent price correction signifies an end of an era of valuation premia. (Price bubbles in micro-markets like AI notwithstanding).
Swing towards local market dynamic
Local media continues to extensively cover international markets, more so than they do the extraordinary events that are transpiring at home. This trend is slowly changing, and we can see ‘home bias’ starting to seep through the real estate and capital markets. For the median investor, the answer to allocating capital is not to be distracted by the non-stop commentary on the ‘latest and the greatest’, but to focus on patience and value, boring as it may sound.
Can they? As Bob Dylan said, the answer is blowing in the wind.
