Bahrain
Kuwait
Oman
Qatar
Saudi Arabia
UAE
Print
Email
Discuss this article (13 Comments)Finding the floor
by This email address is being protected from spam bots, you need Javascript enabled to view it on Friday, 12 December 2008
PRICE PREDICTION: How low can they go? (Getty Images)
In times of market turbulence, be it in stock markets, commodity prices or real estate sales, the six million dollar question for investors is: where is the floor?
If futures traders consider $40 oil to be as low as it can go, the market should see a buying spree that will push prices up from that level.
There is evidence that stock market traders saw the floor for the Dow Jones Industrial Average at 8000; the FTSE 100 at 4000, and the Dubai Financial Market General Index at 2000 (traders love round numbers).
Because so much property in Dubai is a tradable commodity – it is traded as paper rather than as somewhere to live – the price has fallen far faster than even the most pessimistic of commentators predicted.
Buyers evacuated the market during September in such a rush that it was impossible to judge the value of property. As a result, there were virtually no transactions, a situation that continues to the present day.
The market will only restart when buyers feel the price of property has found some sort of floor, from which it will begin to rise. But what is that number?
There is no reliable index of property prices that can be used as a guide but, if there were, I think the floor would be at 30 percent of peak prices.
In other words, buyers will only return to the market when 70 percent has been wiped off the value of villas and apartments in the city.
I do have one caveat: the market for completed property will significantly outperform the market for un-built property because rental rates are so high that the financial case for buying property is more compelling if families subtract the inescapable cost of rent from their cost of owning a property – even if it is depreciating in value.
To explain why I think the floor for the property market is 30 percent of peak values, you have to consider what drove prices to their peak before summer this year, and what are the prevailing market conditions today and for the year ahead.
Much of my thinking is outlined in my last commentary “Property Poker”. To summarise, amateur gamblers that made quick money flipping property in the boom times kept reinvesting their profits in more and more expensive developments.
This has continued to the point where very few of them hold cash, but they all hold property in which they have made hefty down payments – normally 30 percent of the asking price.
Very few of these speculators can afford to be holding the freehold to these properties when the building is complete, because at this stage they need to raise the other 70 percent of the asking price in the form of a mortgage.
And, guess what, the banks will not be lending them the money because they will not take a risk on an asset that is already worth dramatically less than its original sale price.
If speculators cannot raise the finance to pay the outstanding balance, they run into default, a situation that is currently very poorly regulated (a subject I will return to in another article, and I would love to receive comments on at the end of this article).
But the best guess at the moment is that the original developer will repossess the property, leaving the speculator with nothing.
The full 30 percent down payment will be lost, and there is even speculation that developers will pursue defaulters for any further losses they incur as repossessed properties flood the market.
This is why I think 30 percent of the peak is the floor. The least bad scenario for a speculator is to dump all properties before they get handed any keys to completed villas and apartments. At least they get their original stake back, even if they have made no profit during the period they owned the property on paper.
The complication for this theory is at what point you consider the peak of the market to be. This is will come down to speculators’ portfolios, and is dependent on when they bought their properties.
If they bought off plan in 2007, they saw their portfolios grow in value by roughly 50 percent in the first half of 2008, so the 30 percent rule applies to the price at which they bought property, not the value at its peak in mid-2008. (The vast majority of speculators that bought before 2007 will have already flipped the properties since so can be largely discounted).
This points to even worse news for those that bought right at the peak this summer. Speculators bailing out at 70 percent below the price they bought at in 2007 will sell at around 80 percent below the value of the summer peak.
Taking this additional negative factor into account, and building in the more positive impact on prices created by people moving from renting to buying, I think the 30 percent theory is the best I can offer.
Regrettably, my greatest fear is that 30 percent is optimistic. If buyers do not collectively agree that this is the floor they will stay out of the market until it falls even further.
This will leave masses of speculators trying to raise mortgages to cover the outstanding 70 percent balance of the price at which they bought, and very few able to do so.
Developers will be left pondering whether to exercise their rights over defaulters, or support speculators by giving them more time to pay – probably by delaying the completion of thousands of properties.
When all this pain has worked through, Dubai will emerge as a strong and vibrant metropolis in which hard working families will be able to own property at reasonable prices, and get on with the businesses of building lasting rewarding lives in the city.
READERS' COMMENTS
Disclaimer: The views expressed here by our readers are not necessarily shared by ArabianBusiness.com or its employees.
Negative speculation
Posted by Aftershock, dubai, uae on Friday 16 January 2009 at 00:50 UAE time
Sorry guys, but this article along with many of the comments posted here are nothing but speculation. All of us were criticizing flippers and speculators for driving the prices up and all what I see here is pure speculation on how low the prices will go. Agreed, the market needed a correction or a wake up call, but surely not a crash!! Real would't have droppped that much if the whole world around us was not collapsing and banks were still lending. Such articles are doing nothing but push the market down even further.
Everyone should realize that this property crash has an adverse impact on all of us, regardless of whether you have invested in property or not. When prices go down that much and too fast all other business sectors will be affected. 30 to 40% of Dubai's workforce is directly involved in the real estate and construction sector - the vast majority of these guys will soon be jobless! Needless to mention, there are numerous sectors that are directly or indirectly dependent on this important sector - banks, real estate agents, material suppliers, advertising/media agencies, publications who rely on ad space sales and even car dealers, shopping malls, retailers (yes even the small grocery store located next to any labour camp!!) This sector was fueling demand in other areas of the economy. Yes, it was also driving inflation, but with prices dropping by 70 and 80% like what many of you guys are hoping for, then we are undoubtedly looking at deflation now. Why do you think we were securing good job opportunities in Dubai and our salaries were considerably increasing every year!! I personally changed my job 3 times in the last 5 years and was easily getting a 40-50% hike in my compensation every time, even though i have nothing to do with real estate. The economy was booming and real estate was one of the key drivers (along with oil prices, tourism, retail, exports etc). Needless to mention, when banks take a big hit on their real estate portfolios they will definitely curb lending even further to cover their looses, multiple the credit shortage you see now by 2 or 3 times, what banks are doing now now is only preparation for what is coming in 09. This simply means no credit and no growth. It's a vicious cycle that will impact everyone sooner or later regardless of your business sector. So even if you've luckily managed to keep your job, then forget about next year's salary increment and bonus – perhaps the following year as well. Companies benchmark salaries and both real estate and banking are 2 of the highest paying sectors, so expect the benchmark to come down very soon wether you are in marketing, sales, finance, engineering etc...
The stock market will never bounce back except when real estate recovers. Wondering why? Because the majority of listed companies are real estate, construction or financial services . If the stock market doesn’t recover then company valuations will continue the downward trend, ratings will follow and credit will become impossible. Simply put, the whole economy will hardly recover.
This is what economists call deflation and it's what scaring everyone in the US...hence, the hefty stimulus packages!! The key difference is that it's happening too fast in dubai.
If Dubai's key asset class which is supposedly securing the $80 billion debt (land, real estate) is severely declining along with oil prices, retail and tourism. Then you (as part of this economy) will not be worth what you are worth today, at least if you are planning to stay in this country. With the recession hitting many other countries more severely, I strongly doubt you will find a job elsewhere. So unless you are a filthy rich guy with lots of cash and waiting on the sidelines to pick up distressed assets, then start preparing yourself for a bumpy ride and by the way you still won’t be able to afford property even at distressed levels.
Posted by Aftershock, dubai, uae on Friday 16 January 2009 at 00:50 UAE time
Sorry guys, but this article along with many of the comments posted here are nothing but speculation. All of us were criticizing flippers and speculators for driving the prices up and all what I see here is pure speculation on how low the prices will go. Agreed, the market needed a correction or a wake up call, but surely not a crash!! Real would't have droppped that much if the whole world around us was not collapsing and banks were still lending. Such articles are doing nothing but push the market down even further.
Everyone should realize that this property crash has an adverse impact on all of us, regardless of whether you have invested in property or not. When prices go down that much and too fast all other business sectors will be affected. 30 to 40% of Dubai's workforce is directly involved in the real estate and construction sector - the vast majority of these guys will soon be jobless! Needless to mention, there are numerous sectors that are directly or indirectly dependent on this important sector - banks, real estate agents, material suppliers, advertising/media agencies, publications who rely on ad space sales and even car dealers, shopping malls, retailers (yes even the small grocery store located next to any labour camp!!) This sector was fueling demand in other areas of the economy. Yes, it was also driving inflation, but with prices dropping by 70 and 80% like what many of you guys are hoping for, then we are undoubtedly looking at deflation now. Why do you think we were securing good job opportunities in Dubai and our salaries were considerably increasing every year!! I personally changed my job 3 times in the last 5 years and was easily getting a 40-50% hike in my compensation every time, even though i have nothing to do with real estate. The economy was booming and real estate was one of the key drivers (along with oil prices, tourism, retail, exports etc). Needless to mention, when banks take a big hit on their real estate portfolios they will definitely curb lending even further to cover their looses, multiple the credit shortage you see now by 2 or 3 times, what banks are doing now now is only preparation for what is coming in 09. This simply means no credit and no growth. It's a vicious cycle that will impact everyone sooner or later regardless of your business sector. So even if you've luckily managed to keep your job, then forget about next year's salary increment and bonus – perhaps the following year as well. Companies benchmark salaries and both real estate and banking are 2 of the highest paying sectors, so expect the benchmark to come down very soon wether you are in marketing, sales, finance, engineering etc...
The stock market will never bounce back except when real estate recovers. Wondering why? Because the majority of listed companies are real estate, construction or financial services . If the stock market doesn’t recover then company valuations will continue the downward trend, ratings will follow and credit will become impossible. Simply put, the whole economy will hardly recover.
This is what economists call deflation and it's what scaring everyone in the US...hence, the hefty stimulus packages!! The key difference is that it's happening too fast in dubai.
If Dubai's key asset class which is supposedly securing the $80 billion debt (land, real estate) is severely declining along with oil prices, retail and tourism. Then you (as part of this economy) will not be worth what you are worth today, at least if you are planning to stay in this country. With the recession hitting many other countries more severely, I strongly doubt you will find a job elsewhere. So unless you are a filthy rich guy with lots of cash and waiting on the sidelines to pick up distressed assets, then start preparing yourself for a bumpy ride and by the way you still won’t be able to afford property even at distressed levels.
The faster they rise the harder they fall
Posted by Trojan on Thursday 1 January 2009 at 21:48 UAE time
Rob,
I think the first question you should ask is: who would want to buy with the mass layoffs and the real-estate dependent economy of Dubai contracting severely? That question aside, though I generally agree that prices have to fall by a large amount, I don't quite agree with your math. If a speculator gets his/her down payment back, be it 30% or whatever else, he/she still owes the remainder, the 70% or more. That is not going away, the developer still wants that amount and someone has to pay it.
As for how far price will drop, I think the closest we can get is a ball park figure - my crystal ball is as good as yours. History may offer some clues: the 85% drop in Singapore real estate in the late 90's in a matter of just 18 months. Here is one thing a lot of people might fail to notice: during this whole economic mess in the US house prices dropped an average of 20% from their peaks. In comparison, average prices in Dubai dropped by that much and in some areas by as much as 40% in a just a few months. That just goes to show how severe and fast the crash could be. I and a few (crazy) others have been warning of this exact scenario for the past year on this site's blogs, and I don't mean just the correction, but the speed and severity of it. As I said before, that is how bubbles burst, speculators go away faster than anyone could have imagined.
Therefore a 70% drop is completely plausible, so is 80%, or 90%; who knows! You could try other methods to estimate the drop, such as a discounted cash flow valuation of future rents (though realistic rents, not the outrageous rates owners still ask for but can't find takers). You could also calculate it based on an affordability index. Whichever method you use, you have to keep in mind that this real estate casino was fueled mainly by easy credit (not high oil prices as many still believe, though it did have a role) and easy credit is gone, for a very long time at the very least. So the fuel that has been feeding this frenzy is gone and huge drops have to happen before anyone will buy. But maybe no one will really want to buy, at least not enough to meet this huge surplus of supply.
Posted by Trojan on Thursday 1 January 2009 at 21:48 UAE time
Rob,
I think the first question you should ask is: who would want to buy with the mass layoffs and the real-estate dependent economy of Dubai contracting severely? That question aside, though I generally agree that prices have to fall by a large amount, I don't quite agree with your math. If a speculator gets his/her down payment back, be it 30% or whatever else, he/she still owes the remainder, the 70% or more. That is not going away, the developer still wants that amount and someone has to pay it.
As for how far price will drop, I think the closest we can get is a ball park figure - my crystal ball is as good as yours. History may offer some clues: the 85% drop in Singapore real estate in the late 90's in a matter of just 18 months. Here is one thing a lot of people might fail to notice: during this whole economic mess in the US house prices dropped an average of 20% from their peaks. In comparison, average prices in Dubai dropped by that much and in some areas by as much as 40% in a just a few months. That just goes to show how severe and fast the crash could be. I and a few (crazy) others have been warning of this exact scenario for the past year on this site's blogs, and I don't mean just the correction, but the speed and severity of it. As I said before, that is how bubbles burst, speculators go away faster than anyone could have imagined.
Therefore a 70% drop is completely plausible, so is 80%, or 90%; who knows! You could try other methods to estimate the drop, such as a discounted cash flow valuation of future rents (though realistic rents, not the outrageous rates owners still ask for but can't find takers). You could also calculate it based on an affordability index. Whichever method you use, you have to keep in mind that this real estate casino was fueled mainly by easy credit (not high oil prices as many still believe, though it did have a role) and easy credit is gone, for a very long time at the very least. So the fuel that has been feeding this frenzy is gone and huge drops have to happen before anyone will buy. But maybe no one will really want to buy, at least not enough to meet this huge surplus of supply.
Ready property
Posted by Man on Monday 22 December 2008 at 17:04 UAE time
I dont see anything that will improve the market. Once the confidence is lost it is very difficult to get it back. My property will be going to ready in Jan 09. I have put it in the market for last one month but no buyers. I have cut down the asking price now to the Orignal price. Lets see if i get a buyer
Posted by Man on Monday 22 December 2008 at 17:04 UAE time
I dont see anything that will improve the market. Once the confidence is lost it is very difficult to get it back. My property will be going to ready in Jan 09. I have put it in the market for last one month but no buyers. I have cut down the asking price now to the Orignal price. Lets see if i get a buyer
How low can it go?
Posted by viva_la_crash, Dubai, UAE on Wednesday 17 December 2008 at 08:44 UAE time
Rob,
Interesting argument that counters some of the very deluded perspectives touted about town. (Dubai Pearl being major sponsor of the recent film festival surely must have won the 'best comedy' gong). The crashing 'property' market is an event many of us normal people here in Dubai have been eagerly anticipating for some time.
But I've got to ask though - apart from opinions expressed by pundits and observers, "when will this actually start to affect the asking prices?" I've been tracking several specific buildings in the Marina for 10 months and while the ludicrous price increases seem to have halted - the advertised asking prices are still holding at the summer peaks (ignoring the ridiculous spike that occurred just at the end).
I recently contacted a seller with at least several properties in this building and when I sensibly responded to his 'summer peak' asking price, he countered "not in my building." Obviously this one conversation doesn't indicate an entire market - or does it?
The other chap (Vikram) who posted that he's trying to sell several apartments and has not had a single credible offer - did you employ a basic principle in supply & demand i.e. lower the price?
The longer the inevitable is denied - the harder it will go down and yes, "in your building also." The so called 'premium' properties will not be immune as the oversupply that clearly already exists (held by speculators - lights off, door locked) will drag the whole market down - even the ones with a German bog and a 'free' TV.
I feel for the suckers who invested their pensions etc here and will be eating dog biscuits the rest of their lives - but there won't be many tears shed for the greedy and the arrogant who have effectively caused their own undoing.
I'll be sitting back with a box of popcorn and enjoying the show and I won't be reaching for my cheque book until the credits are rolling.
Posted by viva_la_crash, Dubai, UAE on Wednesday 17 December 2008 at 08:44 UAE time
Rob,
Interesting argument that counters some of the very deluded perspectives touted about town. (Dubai Pearl being major sponsor of the recent film festival surely must have won the 'best comedy' gong). The crashing 'property' market is an event many of us normal people here in Dubai have been eagerly anticipating for some time.
But I've got to ask though - apart from opinions expressed by pundits and observers, "when will this actually start to affect the asking prices?" I've been tracking several specific buildings in the Marina for 10 months and while the ludicrous price increases seem to have halted - the advertised asking prices are still holding at the summer peaks (ignoring the ridiculous spike that occurred just at the end).
I recently contacted a seller with at least several properties in this building and when I sensibly responded to his 'summer peak' asking price, he countered "not in my building." Obviously this one conversation doesn't indicate an entire market - or does it?
The other chap (Vikram) who posted that he's trying to sell several apartments and has not had a single credible offer - did you employ a basic principle in supply & demand i.e. lower the price?
The longer the inevitable is denied - the harder it will go down and yes, "in your building also." The so called 'premium' properties will not be immune as the oversupply that clearly already exists (held by speculators - lights off, door locked) will drag the whole market down - even the ones with a German bog and a 'free' TV.
I feel for the suckers who invested their pensions etc here and will be eating dog biscuits the rest of their lives - but there won't be many tears shed for the greedy and the arrogant who have effectively caused their own undoing.
I'll be sitting back with a box of popcorn and enjoying the show and I won't be reaching for my cheque book until the credits are rolling.
Mobile
