UAE: Reality Of Realty
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UAE: Reality of Realty

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UAE: Reality of Realty

April 27, 2008, By Navin Goyal, Email: navin_goyal@hotmail.com

Even though UAE has survived the subprime crises and has not felt the heat of slowing housing market in the United States, there are concerns in the long run due to increasing external debt, increasing inflationary pressure due to high liquidity and increasing demand for real estates. EFG Hermes’s recent study of the nascent UAE mortgage market indicates a ten-fold growth from USD 4.4 billion today to USD 44 billion by 2012. Mortgages will be driven by property transactions which were till recent equity financed. Rapid money supply growth has severe implications for current and future inflation. This will not only affect goods price inflation but also asset prices. The Swiss Investment bank UBS warns that the realty market may become more challenging by the year 2010 when the housing market swings into oversupply

The slowing housing market and the subprime crisis hit the USA last year and this cold soon caught many other regions including Europe, Japan and few Asian economies like China, Malaysia and India. Since the subprime crisis, banks and other financial institutions has written of more than USD 250 billion from their books. Most of the analysts now feel that the subprime crisis is almost at its end. They believe most of the bad news is already out in the market and banks are writing off their losses thick and fast.

Economies having strong financial linkage with the US financial market were badly hit by the subprime crisis. Mortgaged Backed Obligation (MBO)/ Collateralised Debt Obligations (CDOs) having subprime assets were bundled along with high grade Assets Backed Securities (ABSs) and were sold further by the mortgage companies to the banks, hedge funds and other financial institution churning out more liquidity. These MBOs and CDOs were further sold multiple times in the market. This makes it hard to trace the true holder of subprime assets and quantify the impact. Emerging economies like India and Middle East were least affected by these subprime crises because the banking industry in these countries did not hold major chunk in the financial asset.

Economic Outlook for Developed Economics

Many big financial institutions found it hard fulfilling their commitment. They were hit by huge amount of losses and were close to bankruptcy and a target of take over. Beside subprime, the slowing housing market has also hit the US economy. It is feared that the US economy is slumping into recession. Blaming the twin forces of deteriorating financial market conditions and the continuing correction in the US housing market, the IMF predicted that the United States will slip into a "mild recession" in 2008, from which it will recover only modestly in 2009. [1]

To revive consumer confidence and to rescue banks from subprime crises, Federal Reserve had to pump billions of Dollars into the market. The fed rate was dropped by 300 basis points from 5.25% a year ago to 2.25% today. Similar, stance was adopted by the Central bank of the United Kingdom[2] and others, in an effort to encourage banks to lend and promote more economic activity.

Economic Outlook for Emerging Economics

The rapidly globalizing emerging economies have so far been less affected by financial market turbulence and have continued to grow at a rapid pace, led by India and China, although economic activity is beginning to moderate in some countries. China and India--which grew at 11.4 percent and 9.2 percent in 2007, respectively-are projected to grow at 9.3 percent and 7.9 percent, respectively, in 2008. Middle East which grew at 5.8 percent in 2006 and 2007 is projected to grow at 6.1 percent in 2008 and 2009.

Economic Outlook for Middle East

Subprime Impact: Gulf Arab officials, including central bankers, have repeatedly said the region's banks were largely shielded from the crisis triggered by defaults on subprime mortgages, or home loans for people with a poor credit history. UAE banks had only "marginal" exposure to US subprime mortgages and the credit crisis didn’t have a "significant impact" on the profits. Of the 20 largest Gulf banks by market value, only Abu Dhabi Commercial Bank (ADCB) has reported any subprime losses, writing down USD19 million in the third quarter.[3]

UAE Mortgage Market: In recent conference, the Islamic banking and finance specialist Sabahuddin Azmi informed that outstanding credit in the UAE housing market stood at AED 17 billion at the end of 2006 and would AED 20 billion by the end of 2008. It is expected to rise sharply between now and 2011 as real estate growth exceeds an estimated AED 419 billion during this period. The UAE's mortgage market will leap from AED 20 billion by the end of this year to AED 64 billion over the next three years.[4]

EFG Hermes has recently published a study of the nascent UAE mortgage market, which points to a ten-fold growth from UDS 4.4 billion today to USD 44 billion by 2012. Up until today, as the EFG Hermes study underlines, the vast bulk of property deals in the UAE have been equity financed, and the mortgage borrowing usually associated with property in more mature markets has just not been present.[5]

The mortgage penetration rate in the UAE is understood to be about two per cent of gross domestic product, or GDP, representing an overall market size of AED 16 billion. Mortgages will be driven by property transactions, which in the short term will be driven by property supply and further out by population dynamics. Mortgage lending grew 9% in the second quarter, compared with 80% in 2006.

Dubai's population is growing at an average 7.9% a year and may rise to 1.9 million by 2010 from 1.4 million now, a recent research report from Egyptian investment bank EFG-Hermes said. Over the next five years, we estimate a population increase of 1.4 million people, implying property transactions of AED 683 billion. In total, residential supply will be about 277,000 units through 2010, with most slated for delivery in late 2009 to mid-2010.

High External Debt: The UAE’s total external debt, both public and private, is expected to continue rising sharply, increasing the external vulnerability of the corporate and private sectors in the country, according to investment bank UBS. The bank, in its latest research on the UAE economy, cited estimates by the Institute of International Finance (IIF), showing the country’s public and private foreign debt has risen sharply, from around USD 17 billion in 2003, or 19 per cent of GDP, to an estimated USD 106 billion, or 55.7 per cent, in 2007. Of this, only a small part, perhaps USD 13 billion, can be directly attributed to the public sector, whereas the majority – USD 93 billion is owed by the corporate sector, mainly by the UAE’s banking sector. With the loan-to-deposit rate of the UAE banking sector around 100 per cent and domestic deposit growth constrained by interest rates, banks are increasingly dependent on foreign funding in order to expand domestic credit growth. However, the external funding situation for the UAE banking sector has become somewhat more challenging due to the decline in support conditions in international credit markets. Also, there was a rise in foreign deposits apparently linked to the attempt by foreign entities to profit from a potential revaluation of the dirham against the dollar.[6]

High Inflationary Pressure: Banks working in the country have high capital and liquidity. Rapid money supply growth has severe implications for current and future inflation. There is plenty of money circulating in the economy and this will not only affect goods price inflation but also asset prices.[7]

The UAE Central Bank’s report on banking indicators for 2007, which showed high money supply growth in the country, raised concerns about high inflation rates, increasing liquidity and higher prices of assets and commodities. The bank’s money supply growth figures for the end of 2007 grew to AED 692.5 billion, a 36.7 per cent increase.

There is a rapid increase in banks’ lending facilities, which reached AED 722 billon, a 40 per cent increase compared to 2006. In this kind of environment consumer prices are likely to rise. Asset prices are also likely to strengthen as those with surpluses look to real estate and the equity markets as more effective stores of value than bank savings, which will actually lose money in real terms. This will create artificial demand for real estate as investors purchase more property, not because of their real needs but as hedging for their capital because of the depleting dollar value and, accordingly, lower dirham value, along with increasing inflation.

Risk of Realty Bubble: In its latest research report, the Swiss Investment bank UBS has warned of its concerns regarding the risks of a real estate “bubble” to the UAE economy and that it presents a greater threat to growth than inflation. The report says, after 2010 the realty environment could become more challenging, leading to a slowdown in Dubai and a shift of focus to the property market of Abu Dhabi. UBS expects about 150,000 residential units to be completed in Dubai over the next two years, bringing the market into balance some time in 2010. Thereafter, the housing market might well swing into oversupply. The risk of oversupply currently appears most relevant for the high-end of the residential market, which is seeing much bigger supply growth than the mid-market segment. There are already indications that occupancy ratios in the high-end segment are markedly lower than in the mid-segment of the market. This could have a wide reaching impact on the economy because construction and real estate sectors contribute heavily to GDP growth in the UAE – about 26 per cent in 2007. They believe that any significant slowdown or even a crash in the real estate sector would likely reduce UAE growth substantially. In this case, the burden on the balance sheets of banks, construction companies and developers, and of many investors and households, could be very substantial.[8]


[1] Report by IMF: http://www.internationalmonetaryfund.org/external/pubs/ft/survey/so/2008/RES040908A.htm

[2] http://www.guardian.co.uk/business/2008/apr/21/bankofenglandgovernor.mortgages

[3] http://www.arabianbusiness.com/509285-subprime-crisis-to-hit-gulf-banks-earnings

[4] http://www.gulfnews.com/BUSINESS/Real_Estate_Property/10203987.html

[5] http://www.ameinfo.com/142917.html

[6] http://www.business24-7.ae/articles/2008/4/pages/foreigndebt.aspx

[7] http://www.gulfnews.com/business/Economy/10200386.html

[8] http://www.zawya.com/story.cfm/sidZAWYA20080424031635/SecMain/paghome

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