The problem with off-plan projects

The economic forces stacking up to push UAE house prices higher and higher are enormous at the moment. It is the complete reverse of the picture in many developed countries right now where housing bubbles created by ultra-low interest rates are bursting.

The exact opposite is happening in the UAE. First, competition among local mortgage lenders and falling US base rates are lowering the cost of housing finance from previously high levels.

Secondly, the supply of completed property is insufficient as contractors cannot build fast enough and existing owners are not selling.

Thirdly the UAE economy is undergoing a huge boom thanks to record oil prices, and activity in all areas is expanding rapidly causing a massive increase in demand for accommodation from a surging population.

And finally house prices are low by global standards because freehold for foreigners is new, and property still offers an excellent return for investors with yields of eight per cent to 10 per cent.

The authorities say the pressure will come off rising rents later this year as many new projects are completed and this could cool price increases. But to date all new supply in the market has been quickly absorbed.

Commentators said the same six months ago about the delivery of the 6,500 apartments in the Jumeirah Beach Residence and the even larger International City from Nakheel. Yet it is more difficult than ever to find completed property in Dubai today.

This brings us to the latest revelations about the cancellation of certain off-plan projects in Dubai. The cancellation of the Palm Springs apartment project on the Palm Jebel Ali has angered buyers who are being offered their money back with interest or an apartment on another Damac project at a 15 per cent discount.

The problem is that many owners bought in the second-hand market and face a loss on the original price and therefore have little practical alternative but to switch to another development.

Damac may actually be doing them a favour as the infrastructure of the Palm Jebel Ali is now not scheduled for completion until 2012, when presumably construction could finally begin.

However, some off-plan buyers on other schemes have apparently been handed their money back simply because rising construction costs have made the project unprofitable to the developer. In a few cases the developer has reportedly then gone on to re-launch the project at higher prices.

At least, there is some justification in terms of rising construction costs. Over the past year, the price of cement and steel rebar has gone up by 30 per cent.

Units that sold for Dh600 per square feet now cost Dh1,000 per sq ft to build. But does that mean a sale can be abandoned? What about the sale contract? This is the sort of market abuse the new Real Estate Regulatory Authority and compulsory escrow or trust accounts for off-plan monies are designed to tackle.

And it is going to be interesting to see whether a developer can be forced to proceed with a project in the knowledge that a loss will be made. If this does not happen, and the phenomenon of withdrawing off-plan schemes from the market becomes more common, then this is going to add yet another upward pressure to house prices.

For then the rising cost of construction is going to be fully reflected in the cost of apartments. And this will reduce the supply chain and increase demand for those units actually available, forcing prices up.
 
Indeed, agents are already counselling people, who are worried about buying off-plan, to look at the second-hand market. A switch in buyer interest from the off-plan sector towards completed property will put further pressure on the dwindling supply of available units.

It is quite notable in the hefty property advertising publications that the same units are often repeated in many adverts and that completed units in many finished developments are in short supply.

An alternative to buying a completed home is to purchase an off-plan scheme that is already under construction. For then you will have a better idea of the likely completion date, and that the unit will be completed.

It is much harder when you buy something where the developer has not yet broken ground, or is promising to in the near future. But that is also why off-plan units generally sell at a good discount to the finished product, as part of the development risk is off-loaded on to the buyer.

However, whether it is also reasonable to expect off-plan apartment buyers to take a risk that their apartment will never be built is now under the microscope.