Guessing game: Predicting Dubai's market

Dubai's global brand image took a hit over the Eid Al Adha holiday in November when a confusing announcement about the delay of $26 billion of debt repayments at Nakheel and Limitless exaggerated into a new financial crisis.

As the dust settled and the PR machine belatedly put the record straight, it became possible to begin a tentative assessment of what this debacle might mean for the already depressed Dubai real estate sector. Only last month this column could highlight a few green shoots of recovery based on more local optimism about the business outlook. That confidence has clearly suffered a setback. Indeed, the more pessimistic property market assessments - such as the latest report from UBS predicting a 30 per cent house price fall over the next 18 months - will doubtless be taken more seriously now.

Another danger is that local interest rates may go up again as they did last autumn during the global financial crisis, if only to persuade rattled local investors to keep their money on deposit in the UAE. Interest rates as low as 6.5 per cent on mortgages were one reason for increasing optimism this autumn.There is also a particular problem now for owners of property built by Nakheel and Limitless. Will these companies continue to service and maintain buildings as promised? And will properties from this provenance now carry a ‘developer discount' as a consequence of these debt problems?

In the short term, it is hard to see the Nakheel and Limitless debt standstill as anything other than a negative for Dubai property. In the long run there is reason to be more hopeful, and grasping the debt nettle at this stage is arguably much better than letting this problem grow even bigger. In fact, much depends on what sort of restructuring emerges. For Nakheel and Limitless property owners there could be a beneficial change of management, for instance. And for the wider market, once the skeletons have gone from this particular cupboard then at least some of the worries over the outlook for Dubai in general and real estate in particular will be removed.

The statement from the Dubai Government about this being a ‘commercial decision' and ‘in the interest of all parties' is correct in that regard. The Dubai real estate market will be a more predictable and better place after a restructuring at Nakheel and Limitless. Swiss bank UBS published a controversial report late last month which predicts an additional 30 per cent fall in Dubai house prices over the next 18 months, down to 70 per cent of peak price levels, and for the market to take at least a decade to get back to the peak prices of summer 2008.

Deutsche Bank used to be almost as pessimistic but is now talking of prices bottoming out and a recovery early next year.

The problem with the Deutsche Bank argument is that this is not how markets usually behave. Markets might rebound for a while from a big fall, but they then generally continue on down to find a bottom, unless the fall was some kind of accident.

Nobody could really see the global financial crisis of last year as a passing accident, or if they do then a nasty reality probably still awaits them. In Dubai, the global crisis came on top of a cyclical property market boom that was close to bursting whatever happened. That meant a painful double whammy, something like Hong Kong in 1997 where a local property boom went bust at the time of the Asian Financial Crisis. From 1997 to 2003 Hong Kong house prices fell by 70 per cent, just as UBS is forecasting for Dubai now.

In Hong Kong in 1997, the government's response to the crisis was to keep on building. That resulted in a significant oversupply of property at the very moment that the market was weakening. Does this not sound like Dubai?

UBS also estimates that the Dubai population will drop by a net 8 per cent this year and 2 per cent next. This population exodus alone will leave 30,000 units empty, says its report. Then there are some 40,000 units to be completed over the next 18 months, and 20,000 units already lying empty. If correct, that leaves overcapacity at 90,000 units by 2011. Greater supply and falling demand is a recipe for lower prices, whatever government officials insist. UBS predicts average Dubai house prices are presently 50 per cent off their peak at $254/ft² and may drop as low as $164/ft².

What could happen to derail this unwinding process and help support prices? A stronger than expected recovery in the global economy and higher oil prices would be good news for the UAE. Low cost finance for homeowners would also be helpful, although if this also meant cheap finance for developers, the additional property supply would counter the beneficial effect on house prices.

Consolidation and mergers among the developers would eliminate some of the upcoming supply, although not all, and the 50,000 empty units would still remain by 2011. A halt to building work at Nakheel and Limitless after their debt suspension decision would also help. But if UBS is right about the future, how do you explain the market recovery this autumn? Villa prices are up, for example. Quite simply, supply is still limited in completed planned communities and these expensive units were overly discounted in the crash. The Nakheel and Limitless debt announcement has likely reversed this tentative recovery anyhow.

Overall, the UBS argument makes reasonable sense. However, a surge in general inflation levels around the world courtesy the massive global government stimulus packages makes a return to nominal peak values within a much shorter timeframe than a decade very likely in Dubai and elsewhere.

Those who choose to buy in 18 months time when the local property market will be as popular as the H1N1 virus may not have to wait very long to make a good profit, and those holding on now could be pleasantly surprised within three to five years.

* The opinions of this freelance contributor are not necessarily those of Al Nisr Media.