You can argue whether or not the interest rate cuts in the UAE that followed the Federal Reserve’s 0.75 per cent cut are a good thing for local stock markets. It is certainly bad news for local savers. But it is a big boost for local real estate, particularly completed property.
Knock 0.75 per cent off the former Fed discount rate of 4.5 per cent and that means that borrowing is instantly 17 per cent cheaper. It gets better. If the Fed knocks another 0.5 per cent off next week, as some economists predict, then the cost of finance is down by 27 per cent.
Because the dirham is a proxy for the US dollar due to the fixed exchange rate regime, that means interest rates will come down here by the same amount – regardless of the booming UAE economy.
Now where are those with capital most likely to invest? In the turbulent global stock markets, collapsing global real estate, or for that matter the UAE stock markets, which just crashed and then recovered? Even the interest paid on savings in a dirham-deposit account will have diminished.
Step forward completed UAE property. This asset class has very attractive rental returns, which are even more attractive now that interest rates have fallen, while the cost of finance to buy that same property is down, making the total return for the landlord even bigger.
Moreover, the supply of completed property is tight, indeed almost non-existent in Abu Dhabi. Introduce a surge in demand into an already tight market and market forces can only mean one thing: higher prices.
This will have an impact on the off-plan market too, which does not have an income stream from rentals, as price rises in the secondary market will establish a new benchmark for off-plan selling prices.
The falling cost of finance will also encourage people to buy to make off-plan property investments, as the margin on leveraged investments will rise.
What we have in fact are all the ingredients needed to produce quite a sharp price spike in the UAE real estate market, at least in the short term until new supply starts to come on stream. And this is a date with destiny that is constantly put back in Dubai and not really considered yet in Abu Dhabi.
At the Dubai Property Group breakfast earlier this week members heard a strong presentation from the new Real Estate Regulatory Authority about its sterling work in creating a fairer marketplace with transparent rules to protect all parties in the sector.
It is the right time to be undertaking this necessary task, sorting out the market while it is still booming so that this can be done with the least pain possible. The use of trust accounts for funds paid for off-plan developments, the registration and policing of the real estate sector, the introduction of standard contract forms and mechanisms to settle disputes, this is all going to underpin confidence.
What a long way this is from the days when sceptics thought that Dubai property was a bubble, and said they would buy when it collapsed. Actually the sceptics should have realised that their own confidence in being long-term buyers indicated that a real collapse was unlikely.
Any growing market climbs a wall of worry, and the property market in the UAE is no exception.
The pioneers were seen as brave and a little foolhardy. Those who followed have been happy with their experience in general. And the last wave of buyers will include some of the initial sceptics who are at last convinced that this is a good investment.
Of course, investment markets do eventually overshoot and correct. But falling interest rates are definitely an upward pressure to house prices for the reasons outlined at the start of this article, and with high local inflation, real interest rates are negative.
If nothing else, the gap between the cost of renting and the cost of buying a home has just got wider. And anybody can appreciate that if the cost of renting is significantly higher than the cost of buying then you will take the cheaper option, unless your personal circumstances are not suited to home ownership – that is, you do not have the deposit or are not planning to stay for long.
It is hardly difficult to locate home finance in Dubai, and lenders are offering to turn around your application within hours these days. And it has to be said the availability of finance is at least as important as nominal interest rates.
The implications for house prices in 2008 are clear to see. It could be that this is the year that house prices in the Emirates close the gap with the traditional developed real estate markets that are likely to be moving in the opposite direction. Selling a home in the West to buy here could be the arbitrage opportunity of the year.