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Fri 12 Dec 2008 11:34 AM

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Finding the floor

How low do property prices have to go before buyers are tempted back to the real estate market in the UAE, ponders Rob Corder.

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.

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David 11 years ago

Rob, I think you have come pretty close in this article to expressing what most of the pundits are thinking. It is possible though that your worst fears will be realised in terms of the percentage decline, which many believe will be closer to the 80 percent level, almost in a "re-run" of Singapore in the early 90's. Prices at 80 percent below the peaks of 2007 will bring a sense of reality (and reasonable affordability) back to the market, but true sustainability will only kick in if sufficient governance processes are put in place to curb the other problems in the sector, such as the "creative revenue generators" that some of the developers have come up with these past few years (like exhorbitant maintenance charges etc). The other question on everyone's lips is regarding how quickly this will all pan out... 6-12 months?

Aadil 11 years ago

I hope your conclusion comes through but something tells me that with prices that far down, there'll be plenty more speculators to start again buying and flipping, especially if developers delay thousands of units. When the market finally bottoms out the transfer duty for uncompleted properties should be increased to 4 percent or 5 percent to discourage future speculators. However I don't see that happening.

troy 11 years ago

There is no doubt that property prices are declining at an alarming rate, but I can’t really get your 30 percent theory. Are you suggesting that prices will go down significantly to be only 30 percent of the prices we witnessed this summer? Do you mean 30 percent of the premium or the total value of the property? Does this imply that one will be able to buy an Emaar property (let’s say 1 Br in the marina) which was trading at 1.7 to 2 million this summer for only 600k? Don’t you think that this is a bit too much considering that they were sold by the developer in 2006 or 2007 for 900K to 1.1 million and they are ready to move in? Even if we look at properties that were sold when the Dubai boom started, lets take the springs, the 2 br townhouse was selling at 2.6 to 2.8 million at the peak, do you really think that it will go all the way down to 860k (2004 or 2005 prices!!!). I guess you didn’t take into account that that these properties have been sold at least 3 or 4 times (if not much more) and the present owner will have paid a premium over and above the original price which will be his bottom price. Otherwise, s/he can opt for rent which can generate very reasonable returns. However, there are some owners who kept there properties from 05 and 06 and they are the ones who are offering bargain deals nowadays and still making healthy premiums. I think you need to shed the light on what you mean by wiping off 70 percent of the value, whether you mean off plan or ready property, premium or total value. Even if it’s off plan, then the speculator would have bought it in 07 from the developer at a relatively high price per sq foot and his bottom will be in the range of 10 percent or 15 percent below the original price i.e. a negative premium of 10 or 15 percent. I also don’t think that those speculators have only paid 30 percent of the property with the remaining 70 percent due on handover. I’ve never seen such payment plans (30-70 or 20-80) except in Abu Dhabi. By and large, payment plans in Dubai are 15 to 20 percent every 3 or 6 months. So by the time handover is due the owner should have paid 70 or 80 percent of the original value plus any premium in case he/she got it from the secondary market.

Arsalan Tabani 11 years ago

The method of assessing 30 percent as the floor based on default seems incorrect, as on forfeiture, the amount that the speculator will loose is up to 30 percent if he is not able to pay installments. Which leaves 70 percent as the floor price the speculative investor would expect. In other words, if it is to be sold at 30 percent of the bought price, it would practically mean that the selling investor undertakes to forgo 30 percent deposits plus pay another 40 percent to the developer or the new buyer while leaving only 30 percent to be paid by the new buyer, which is of course not practical. An investor who has graduated from even pre-school would rather wait till he has paid 70 percent in installments before committing to make a loss today.

Peter Lee 11 years ago

I guess this is the classic Catch 22 situation… Rob’s suggestion of 30 percent as base floor or bottom out price is totally fair from the consumer’s point of view, but I seriously doubt that it will make economical sense to sub developers, especially when land plots were acquired at a premium from master developers. Look at the Waterfront “LUXURY” projects that were launched during the October to November period. I don’t think any of these “LUXURY” projects’ developers would ever consider building the projects at 30 percent of the launched prices. Should the price drop to 30 percent, I think many of these projects would be shelved or even worst, the master developer would have to deal with high number of defaults or “run-away” sub developers. Imagine this, ‘Twice the size of Hong Kong’ becoming ‘Twice the size of Hong Kong in terms of uncompleted or abandoned developments’. This is pretty scary… To improve the current free falling of the property price, maybe the government could help by regulating the new supplies to the market, such as any new project can start off-plan sales only when the developer has completed the ground floor, or even better, the roof. This will ensure that there is at least eight to nine months, if up till ground floor; and 18 to 24 months, if up till the roof, conditioning period for those launched projects to make necessary market re-adjustments and will also give the much needed assurance and confidence to the purchasers or investors in off-plan properties. This will also further filter out those ‘fly-by-night’ developers and developer “wannabes”. Finally, I feel that the market requires more transparency with transaction data and indexes that allow purchasers to exercise their “caveat emptor”, whether is it for the purpose of investment or own occupation. This would help resolve the “blame game” we are experiencing at the moment…

Vikram 11 years ago

Just to add, I had put my properties(ready & leased) on the market sometime back and listed with 3-4 agents. To date, I have not received a single tangible offer. Meanwhile I am still in the black because I continue to receive rent at roughly 10% of my investment. I can't afford to think short term, simply because my properties won't sell.

Baker 11 years ago

The assessment of 30% from the original price is very feasible, given the decline in property markets worldwide. However, the situation is much worse for those whom bought and fully paid for apartments and the developer failed to deliver even after 1 year of the delivery date in the sales contract. The owners are losing money because they are paying rent for one extra year and then could not sell the property at the peak due to negligence by developers to deliver on time. The question is should those people take the developer to court and file a law suit case against them!!! Developers are part of the problem, as they have collected the advance payment from unworthy speculators (bad guys) and now the good guys whom bought property to live in have to pay the price!!!!

Anonymous 11 years ago

If the credit markets open again... and if the price of oil rises above $50... and if the developers don't default... and if their sub-developers don't default... and if their contractors actually deliver the units... and if the delivery is clean... and if Dubai expats still have large packages... and if Dubai expats feel confident in their jobs... and if RERA doesn't increase the cost or difficulty of property transfer... and if Dubai property still seems competitive, relative to the incredible deals available in the UK & USA... Then PERHAPS we'll see as much as 30% of peek prices for ready-units in Dubai. And even these lucky sellers are still in for a long wait, as nothing is selling at the moment. For the sake of Dubai, I hope things improve! I love this city, and I would love to see the Dubai vision come to life. I believe Dubai can get through this, but not without some pain. Once people believe we've seen the bottom, we'll have a good shot at a recovery.

Obelix 11 years ago

The calculations are a bit vague and that is the beauty of half baked information. I've wanted to buy here but am beginning to be convinced that it's not worth it. Just recently the maintenance charge in JBR has gone up by almost 200% and for a one bedroom apartment it's the much more than the school fees of my kids put together ! I've worked out that as long as my rent is less than the interest I would pay on the property it is worthwhile to rent and you don't have to worry about any maintenance issues. What drove prices up here was unabashed greed and funds of speculators from outside UAE. No wonder since more than 70% of the investors do not reside in Dubai.

viva_la_crash 11 years ago

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.