At the beginning of 2014, it was surprising to note that amid the euphoria surrounding real estate markets, there were hardly any calls for concern among the analyst community, though it was obvious red flags had been raised throughout the preceding six months.
Transaction volumes were surging, and asset prices had moved substantially above their replacement value. There was a shortage in the now popular term “affordable segment” and this structural maladjustment had occurred principally because global monetary policy (in the form of quantitative easing) was the only game in town.
It was apparent that this was a market that had ignored fundamental realities of the asset price mismatch; yet market participants and analysts remained “irrationally exuberant” about the prospects of further asset price appreciation. What has subsequently been revealed has been an asset correction, not only in Dubai, but throughout the global markets.
It is the nature of this slowdown that needs to be scrutinised to ascertain clues about where markets are heading.
Academic literature in finance defines a crisis using variables that include a cumulative decline in equity values of 25 per cent and a depreciation of the currency against the dollar of more than 10 per cent.
If these criteria are met, the resultant growth in asset values in subsequent periods is below average for the ensuing decade. However, it is the examination of asset price trends that reveal interesting underlying results.
In a survey of more than 80 developed and developing markets, what was witnessed was an increasing concentration of real estate and financial assets. And wherever this concentration increased, subsequent asset performance underperformed relative to other markets.
By way of illustration, after the 2007-08 crash in America, the subsequent monetary incentives led to a rebound in asset prices across the country. However, what is of note is that prices in Tier 2 areas such as Philadelphia and Arizona outperformed Tier 1 cities such as Manhattan and Miami, in some cases by as much as 30 per cent.
Interestingly enough, the same results were witnessed within city areas as well. When looking at Los Angeles, for example, the rebound in asset prices in areas such as Orange County and Malibu Beach underperformed mid-tier areas such as Irvine and Sacramento.
Similar trends were witnessed in areas from Paris to Mumbai; in all cases, this led to the correlation of global real estate returns jumping significantly from a modest 0.29 in the preceding decade to 0.65 since 2011, strongly indicating that the same dynamic of concentration of assets has played out in most countries.
In all these areas, subsequent underperformance was largely based due to the prior concentration of assets that were held by a smaller demographic. This concentration limited the ability to sell such assets and it is this lack of liquidity that contributed to the ‘New Normal’ hypothesis.
In Dubai, while we do not have concrete data, it is apparent that a similar trend has played out. In freehold, there was an increasing concentration of assets and these tended to cluster at the “trophy” segment of the market, resulting in the holiday home and the investor phenomena being played out, as investors chased capital gains as the opportunity cost of money moved lower.
Looking at the data, the average occupancy family size is a below average 1.8 in the freehold market, as compared to more than 4 in the leasehold segment of Dubai, suggesting a large holiday home effect that has already played out.
With the strength of the dollar, combined with the fall in oil and equity prices, the purchasing power of the marginal investor in real estate reduced significantly, and it is this reduction that has contributed to the softening of prices.
Interestingly, when looking at peak-to-trough price action, the luxury segment of the market has fallen by nearly twice as much as the mid-income segment. This is because there has been little concentration of assets in this segment and consequently has been relatively unscathed.
It is clear that with the withdrawal of the monetary stimulus that has been with the global economy since 2006, monetary policy is no longer the only game in town. What this implies for real estate returns is a period of sluggishness … but only in areas where there is a concentrated holding of assets.
Undoubtedly this will ricochet to other areas of the economy, but it is critical to note that the purchasing power of the middle-class has been relatively unaffected by this.
A renewed emphasis on this spectrum will be the defining attribute of real estate asset allocation in the coming decade.
The writer is Managing Director of Global Capital Partners.
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