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When the US Federal Reserve increased its key interest rate in December, real estate investors and homebuyers understandably felt edgy, after all higher rates mean more expensive mortgage cost. While the decision had an immediate impact on millions of Americans, the move's long-term effect reverberates across different countries. With the dirham pegged to the US dollar, the UAE was among those that reacted swiftly to the rate hike, raising the interest rate on its certificates of deposits by 25 basis points a day after the US Federal Reserve's announcement.
No one is absolutely sure how the market would respond to the new interest rates, but industry pundits believe the UAE's property market will not be seriously affected by the move. Apart from the fact that the Fed's rate increase has been minimal (a target rate of 0.25 per cent to 0.5 per cent), industry insiders point out that cash buyers still account for a significant part of property deals, hence, a marginal change inmortgage rates will have limited effect on the real estate market.
''The Federal Reserve rate increase causes the interbank borrowing rate to increase,'' says Andrew Banks, Executive Director and Head of Retail Assets and Liabilities of NBAD. ''This affects the UAE banks as the dirham is pegged to the US dollar. Hence, this will potentially lead to a rise in the cost of borrowing.
''In reality, the Federal Reserve rate increase had been expected, and the Emirates Interbank Offered Rate [EIBOR] had largely adjusted before the Fed announcement. Thus, this modest increase will have minimal impact on the UAE property market. However, a succession of increases would certainly make real estate investment less attractive and private purchase more expensive.''
While interest rates are important, it is also necessary to note that property prices are influenced by many other factors, such as end-user and investor demand, salary increases and consumer confidence, limiting the impact of mortgage rates in determining property prices, adds Banks.
The UAE property market has already experienced the effects of a strengthening dollar, which has resulted in a decline in activity among foreigner property buyers, specifically from Russia, India, the UK and China.
''We have already witnessed the emirates interbank rate creeping up,'' says Pawan Dhawan, Head of Home Finance at Noor Bank, noting that any increase in UAE rates are also dependent on the local liquidity situation. ''With liquidity pressures, the cost of borrowing will become expensive, which would lead to a rise in interest rates. However, we don't anticipate the rate increase to be so significant that it will affect the real estate sector immensely, since a huge chunk of real estate transactions is cash based.''
The last time the Fed increased interest rates was in June 2006. This year, further rises are anticipated depending on various factors and economic variables, says Dhawan. ''The US Federal Reserve is expected to raise rates by a further 0.5 per cent this year or even more and the UAE is likely to follow suit because of the dirham dollar peg. My view is that the current and expected rise is well within the affordable range in the UAE, where rates are low compared to the 7 per cent average in 2007-08.''
Candice Reed, Senior Mortgage Consultant at Mortgage Finder, says the interest rate rise will only mar ginally affect end users buying property. This is because the cost between renting and buying continues to show a wide disparity in monthly repayments, with rental prices remaining strong throughout last year, says Reed.
''For end users, an increase in rates still shows significant saving per month compared with renting,'' says Reed, explaining that the cost per million for a borrower under the age of 40 will see an increase of Dh502 per month on an average two year fixed rate before and after the rise. ''The existing borrowers who have taken a mortgage on a variable rate of interest might experience a slight increase on their monthly repayments. However, the majority of lenders had already absorbed this recent rise, which means the customer will not be affected by the rate change.
''However, investors who have leveraged their investment on a variable rate will be more affected, as their return on investment will decrease. This may encourage many such investors to look to repay these loans and many will likely do so by reducing the size of their portfolio.''
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Source: Hina Navin, Special to Property Weekly