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The dollar’s strength is the most significant barrier now preventing a recovery in the property markets. In 2015, foreign buyers accounted for more than 80 per cent of real estate investment in Dubai. And 55 per cent of total investment originated from non-Arabs.
Of course, the buyer’s passport does not always match the origin of their capital — for example, expatriates living in Dubai may use funds earned in the UAE to acquire properties. So a unit purchased by an Indian national living in Dubai may not be directly influenced by fluctuations in the rupee.
Yet, the evidence shows currency fluctuations do impact property prices. Indians, Brits and Pakistanis are the top three foreign buyers of Dubai real estate and constitute about 30 per cent of real estate investment.
Unsurprisingly, regression analysis shows the Indian rupee, British pound and Pakistani rupee have a strong and significant impact on Dubai property prices.
Exchange rates impact Dubai property directly in two ways. First, general dollar appreciation creates an inflationary shock — appreciation of the dollar immediately increases the price of Dubai property for buyers purchasing wholly or in part with weaker foreign currencies. The results: a disincentive for foreign capital inflows into Dubai.
Second, weak currencies can create investment opportunities in foreign markets. For the dollar to strengthen, other currencies must weaken, which reduces the cost of assets in those foreign markets.
This encourages opportunistic investment, assuming the weakening of the currency is not associated with an increase in risk not captured in the return. The result: an incentive for foreign capital outflows from Dubai.
Not only is capital diverted, but there is an incentive to liquidate assets in strong currency regime and move that capital to the weak currency regime, all else being equal. There is sufficient qualitative evidence demonstrating this trend.
For the past two years, long before the Brexit fallout, Dubai real estate owners have been selling assets and using the funds to acquire property in markets like the UK and the Eurozone. More recent events in key markets have increased uncertainty and perceived risk, which often impacts currencies — the pound declined 11-12 per cent since the referendum.
These shocks will continue to have a direct — and often proportional — impact on real estate demand. Although such events usually erode investment appetite, institutional buyers have already allocated funds for these markets, which, it seems, may augment the pre-Brexit yield seeking strategy with an opportunistic investment strategy, albeit with adjusted return expectation.
Since mid-2014, the dollar started to strengthen and, concurrently, both oil prices and property prices fell. There is an inverse relationship between the dollar and oil prices, for a confluence of reasons, most evident since the early 1990s.
This link throws a one-two punch at the local property market because it also reduces liquidity and capital flows from the GCC into Dubai. Investors from these (mostly) dollar-pegged regimes may not face currency-driven inflationary shocks, but they do experience capital constraints. Currently, almost all of the main buyers of Dubai real estate face either inflationary shocks or capital constraints. So, the combination of a strong dollar and low average oil price simply reduces investment demand for Dubai real estate.
It may be tempting to look back for answers, but this down-cycle is driven by different dynamics than the one in 2009-11. It is important to remember that the dollar was weak and oil price was high by the time the market troughed in 2011.
Phidar publishes a Real Estate Investment Demand Index (REIDI), which is a weighted basket of GDP and currencies from the 22 top countries investing in Dubai real estate. Since 2011, the REIDI currencies decreased 27 per cent relative to the USD, using a simple average.
Even in 2009, average Brent crude oil price was above $60 (Dh220) per barrel. By 2011, it surpassed $100 per barrel, higher than in 2008. During the last trough, regional liquidity was high, the dollar was cheap, and the massive supply overhang was absorbed by the ensuing job growth and auxiliary demand from regional emigration caused by the Arab Spring.
There were clear and strong dynamics underpinning the 2012 recovery.
Unlike the last cycle, the current down-cycle is not a supply-side story. The annual stock completed in 2014 and 2015 was at a 10-year low, yet prices still declined.
Even though projected supply for 2016 is higher than 2015, in absolute terms the increase in homes is on par with the typical population growth.
In the first half of 2016, there have only been about 2,000 more units handed over compared to the same period last year. Dubai usually absorbs this level of additional supply in five weeks.
This is a demand story, a tale of low investment demand and low occupier growth. Slow demand growth is most prevalent in mid-high to high income housing, where rents and sale prices have declined strongest in the past two years.
Even if developers continue to slow the pace of construction and launches, until there is an economic spark that can trigger job growth across income brackets, a supply-demand mismatch lingers. A strong dollar has one final major albeit indirect impact on local property markets: the economic impact on the travel, tourism and retail industries. Through the reliance on international tourists, these industries are sensitive to currency fluctuations.
These industries, combined with real estate, constitute up to 60-70 per cent of GDP. So, a slowdown in these industries impacts job growth across Dubai. Now, capital constraints and soft demand erode sale prices and rents. The reduced capital flows into local real estate investment increase the scarcity and therefore value of capital. Thus, individuals and institutions with capital to deploy will likely seek higher return requirements, which creates additional downside risk on asset values.
The result is a potentially lucrative investment window, particularly if active investors understand the divergent dynamics within each market sector and product type.
Source: Jesse Downs, Special to Gulf News, gulfnews.com
The writer is Managing Director of Phidar Advisory.