The loan danger

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The sale of off-plan units underpinned the UAE’s speculative property market and, while this model works well in a boom, it is less reliable in a bust.

As the credit crunch takes its toll, banks and property companies are increasingly concerned they may be left with toxic debt in the form of unpaid loans and incomplete payment schedules.

Sherry Visayan has nine credit cards and AED180,000 ($49,000) in outstanding loans. The 31-year-old HR assistant faces jail, as her AED8,000 ($2,175) salary does not even cover the AED10,500 ($2,860) she is required to repay each month. She has already defaulted five times.

“When I first got here, it was very easy to borrow, but now the banks are threatening me with jail,” says the Filipina. “I don’t want to run and forget my obligations. I am currently in debt, big time, and I know it’s my fault as I borrowed too much. But the banks don’t care and are not willing to help.”

Visayan is among tens of thousands of Gulf expats facing a similar personal debt mountain. She admits she overstretched herself in the boom years, making the fatal mistake of using credit cards to pay off existing debt. However, while Visayan is determined to stay in Dubai and face her debts, not everyone in her situation is prepared to do so.

Last week, Egyptian investment bank EFG-Hermes published a report saying the UAE economy would contract 1.7 percent in 2009, triggered by a population fall of 5.5 percent. It added that Dubai’s population is forecast to shrink by 17 percent this year alone in the wake of widespread job losses, mainly seen in the construction, real estate and financial services sectors.

Developers and banks who encouraged and then enabled people to take large loans to speculate on the UAE’s property bubble, are already finding their bottom lines significantly impacted by the global economic slowdown.

At the same time, as job cuts kick in across the UAE, many expatriates who find themselves unemployed have no option but to return home — and not all are able to clear their debts before they depart the Middle East.

As a result, developers and banks now face the threat of those same speculators defaulting on their loans, with consequences that range across a wide variety of sectors.

“There is a very strong case for default in this part of the world,” warns Saud Masud, a UBS analyst in Dubai. “Based on conservative estimates, if investors start walking away from these properties, you have about $25bn of exposure for the developers.”

The sale of off-plan units was the catalyst for the UAE’s speculative property market. Masud argues this model works in a boom, but can fail in a bust.

“Dubai is a pay-as-you-go model: if you don’t pay, you don’t build,” he says. “You are at the mercy of the investors paying into the property and escrow pools. The investor who bought last year, who is 20 percent through his payment schedule, can easily walk away. There is no problem.”

Indeed, the investor who chooses to walk away may even be entitled to recover some of what he or she has paid, according to Dubai Land Department (DLD) rules. In November, the DLD announced that buyers who breach contracts or default on payments only have to forfeit 30 percent of the sale price to the developer, though that rule is currently under review by the department.

Under such a model, if the end-user defaults, there is a knock-on effect for companies who rely on the developer’s cashflow for payment. If the developers are not being paid, then neither are those companies owed money further down the line. As a result, associated industries such as construction firms, architects and structural engineers, are also feeling the liquidity squeeze.

“We haven’t seen this whole default scenario [yet] — although it’s not only restricted to buyers but to contractors. If they are not paid on time, they can’t pay their suppliers on time and this has a knock-on impact. They stop building,” explains Sana Kapadia, an analyst at EFG-Hermes.

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