When one travels the world to talk to investors about the Dubai real estate market, the usual first question arises: "When does the bubble burst?"
Historically, all asset classes, including real estate, go through a four-phase cycle: recession, recovery, expansion and contraction. In a real estate market recession, the supply of real estate declines or it is low, demand falls, rents go down and investors do not want to make transactions. The impact on real estate values is obviously negative.
In the recovery phase, supply is minor and demand is increasing, with vacancy rates becoming more balanced. This prompts investors to return to the market.
In the expansion phase, this process continues, with demand being strong and supply rising, resulting in strong price appreciation. In Dubai, we are in this expansion phase, and the question is, for how long? A correction happens in the final phase, contraction, where supply is increasing faster than demand. Prices are stabilising and are finally starting to decline. In some cycles, real estate prices overshoot, resulting in a so called "bubble". The US real estate market saw the creation of a bubble between 1996 and 2006. It is now correcting down.
Historically, interest rates, economic growth and inflation have been drivers in real estate markets. US market research by S&P Case/Shiller shows a negative correlation of house prices and interest rates (lower rates mean higher house prices) and a positive correlation between economic growth and real estate prices. What about Dubai?
The strong mortgage market and lower interest rates are solid drivers for real estate prices. Also, the growing economy is a positive factor. Finally, people invest into real estate in order to fight inflation. Market confidence is currently high for Dubai, driven by all these factors.
Equally important in regard to real estate pricing is supply and demand. We cannot deny that on the supply side, in Dubai, a great number of projects are under way. Construction capacity is limited and delays are more pronounced, holding effective deliveries to acceptable levels, at least for the time being.
Demand is estimated to be increasing steadily, with two main trends: First, UAE nationals continue to be buyers, with their wealth burgeoning due to the high oil price and a booming local economy.
More importantly, the workforce here increasingly considers buying rather than leasing. This trend is well supported by lower mortgage rates, now at or below six per cent, roughly 200 basis points lower than six months ago. Also, there is continued strong international demand.
The recent improvement of the legal property framework and the establishment of the Real Estate Regulatory Authority have boosted foreign buyer confidence. But even before this, Dubai had longstanding experience in foreign property ownership.
According to data of the Dubai Lands Department, GCC nationals are the most important non-UAE foreign buyers since 1973, almost accounting for half the transaction value. Saudi Arabian and Indian nationals are the single biggest foreign investors, both accounting for more than Dh5 billion of transactions since 1973, followed by the United Kingdom, with a value of just below Dh5bn. Our estimates are that over the past 12 months, as much as 25 per cent of total real estate demand was driven by international buyers.
However, there are some first clouds in the sky, such as recent issues around Damac (Palm Springs project), or Deyaar (embezzlement). The Dubai real estate market is becoming more risky (no return without risk), and surrounding emirates are offering competition. I believe that location becomes more important and that buyers are fleeing towards quality real estate developers.
Historic cycles show that an important factor for the real estate market is psychology: "Unless I buy now, I will not be able to afford a home later".
In my view, this is the current environment in Dubai creating collective pressure not to stand apart.
Usually, such are signs of a bubble in the creation, but I believe we are only at the beginning of such a phenomenon. History shows that cities such as Hong Kong as a door to China, Singapore as a business hub for South East Asia or Miami as a gateway to Latin America have seen real estate prices going up for longer than anyone had expected.
If we believe Dubai is the business hub for the Middle East, the upside could also last longer than expected.
- The author is Director of Research, EFG-Hermes, the Middle East's largest listed investment bank.