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From scores of under construction brick and-mortar structures in 2006-07 to shiny glass and neon storefronts and tall glass walls of new buildings in the present, Dubai has seen a sea change. Since the 2008 crash, a lot has happened. The reality of the Dubai real estate market today is quite different from what it was six years ago.
Making of a bubble
In the first quarter of 2008, with demand outstripping supply, the boom seemed to be never-ending. Leading property research consultants were reporting price increases in freehold areas of Dubai at 42 per cent in the first three months of the year. Still, to many people the fundamentals were positive, although there were some indications of overheating that were significantly overlooked.
In the GCC, Dubai pioneered the opening up of the real estate market in 2002, introducing laws that allowed foreigners to own property in areas designated as freehold. Following the passage of the long-awaited foreign property ownership law in March 2006, a deluge of foreign money came in, fuelling Dubai's ambition of creating a skyscraper city.
The real estate boom was helped by the long economic growth cycle, resulting in a rapid increase in the expat population, abundant liquidity generated by rising oil prices, easy access to cheap finance, large-scale government diversification and infrastructure investment programmes and incentives such as residency visas for foreigners investing in real estate. High rental yields with the possibility of capital gains also attracted investors to the market and increased the demand for housing. The decline of the local stock markets in 2006 also contributed to the money flow in real estate, which, as an uncharted territory, presented a unique opportunity.
In addition to demand from resident expats, the opening up of the real estate market to foreigners turned property into a popular investment asset. Demand surged from institutional and overseas investors, as well as speculators from the UK, India, Pakistan and surrounding countries. With limited ready supply and a large number of interested parties, demand heightened.
According to the Dubai Chamber of Commerce and Industry, total direct trade (imports and exports) surged by 52.3 per cent year on-year and re-exports also showed a substantial increase (73.4 per cent in the first quarter of 2008). The number of industrial licences approved by the government soared by 66 per cent during this period.
Property prices were growing at an insanely rapid pace. Between 2002 and 2005 it is estimated that Dubai realty prices doubled. It is also fair to say that prices doubled between 2005 and the first quarter of 2008. In fact, as per estimates by leading real estate services adviser CBRE, property prices shot up in excess of 60 per cent during the first half of 2008.
This belied a divergent movement in the rest of the world. The US seemed to ignore all the ominous signs in its housing market. Plus, owing to the fact that the UAE's real estate market was so young, people were unable to comprehend what was coming next. Most did not have a clue what was going on around them and many rebuffed the US sub-prime situation as random and incapable of affecting the UAE. Dubai was seen as a sacrosanct market and speculators were chasing the next shiny thing.
From bad to worse
Skyrocketing prices were mostly evident in the case of off-plan property. Repurchases were happening over intrinsic value, thereby penalizing the continuing holders. Property developers launched projects even before construction began and released a limited number of units in the market, which were then traded in secondary markets. The same developers released the second lot after some time with price tags that were invariably higher than the first tranche.
The strategy enabled buyers to put in a deposit of 5-10 per cent of the total amount on a staggered payment plan. There were no premiums for completed properties. The flipping intent was evident. The average residential lease rate increased by 17 per cent between the first quarter and the fourth quarter of 2008, according to CBRE. Office demand was shooting up, while most of what was available was being absorbed by major institutions and companies.
Oil price also started to rise from 2003-2004 and suddenly shot up in the second quarter of 2007 to reach $92 (Dh338) a barrel in January 2008 (see Graph 1). It crossed $140 in June and finally hit $147 in mid-July. Investors were ecstatic.
Lending to the construction and real estate sectors by banks increased substantially during the same period. With low interest rates and very high loan-to-value (LTV) ratios, investors borrowed heavily to buy and develop property. UAE Central Bank data revealed that bank exposure to direct real estate and construction loans increased to $60.7 billion in the third quarter of 2008, representing about 23 per cent of the total loans and advances.
However, the real exposure was believed to be higher as consumer loans were also used for financing. The UAE' mortgage market expanded rapidly. From December 2007 to September 2008, total mortgage loans rose by a spectacular 97 per cent to Dh115.7 billion.
When the US Federal Reserve successively cut key rates in 2008, the Central Bank was forced to track US monetary policy, causing inflation to hit a record high of 12.9 per cent. The Central Bank set its first benchmark interest rate (overnight repurchase rate) at 4.75 per cent in September 2007, giving the country slightly more flexibility in responding to changes in the US.
In December 2008, the UAE's benchmark rate was reduced to 1.5 per cent from around 3 per cent at the beginning of the year.
In fact, the property market went berserk in the first six months of 2008. The government responded by asking developers to raise initial prices by 20 per cent and demand proof of ability to finance the remaining 80 per cent (mortgage or personal finance). Many developers began to act responsibly by attempting to impose the stipulations on speculators.
A leading Dubai developer placed stricter terms by allowing only three transfers during the construction of off-plan property. Moreover, the transfer to the second buyer could only happen after paying around 40 per cent of the property's value. The second buyer could sell after paying 60-80 per cent and the third buyer could only sell after having paid 80-100 per cent. Buyers and sellers began to sign agreements on the price of the actual transfer of a property once the time limit expired.
The global economic crisis was more serious than the analysts had predicted. The market took its first hit on September 15, 2008 with Lehman Brothers filing for bankruptcy. The financial institution's collapse was such a seminal event that it intensified the crisis and contributed to the erosion of close to $10 trillion in market capitalization from global equity markets in October, the biggest monthly decline on record at the time.
To make matters worse, oil prices also fell sharply to less than $40 a barrel in December. The demand for oil dropped, resulting in the Gulf economies taking a hard hit. There was a substantial drop in capital flows and asset prices and the equity markets also took a huge plunge. The Dubai Financial Market followed suit.
The slowdown in economic activity also led to redundancies, which eventually affected the strong demographic support to the real estate sector. The generous mortgage lenders started tightening their grip, increased interest rates and reduced LTV ratios. Amlak and Tamweel, the UAE's two largest home finance companies, stopped offering loans.
Towards the end of the third quarter and the beginning of the fourth quarter of 2008, the realisation of overheating started to sink in. There was an undercurrent of fear and people began to offload property. The swing from a seller's market to a buyer's market was swift.
Real estate prices started dipping and the fourth quarter saw the first softening of prices in the six-year history of Dubai's freehold realty market, with the off-plan sector being the hardest hit.
Get a glimpse on adjusting to the new normal in Dubai's realty
Source: Sammyo Halder, Special to Property Weekly
The writer is an alumnus of Harvard Business School and senior vice-president of a foreign bank. The opinions expressed are his own and bear no connection to the outlook of his organisation