I have been trying to write a piece on the above subject, but time has never permitted me to do so. This question was posed to me first by my friends four years ago, when we were visiting Dubai, and my answer to them was: “undoubtedly, yes. Dubai is a bubble”. Along the way, as I have been frequenting Dubai numerous number of times and the same question keep popping up time and again by various people, and off course my answer remains the same. And now, as the global financial crisis is going on, many more people asked me the same question, and off course, you would have guess the answer would be the same.
The fact is Dubai has been a real estate bubble in the making all the way from the start; and in you refer to my article on the “Anatomy of Crisis”, you will see that all elements of the crisis is written all over Dubai’s real estate market. However, as typical as in any bubble, nobody admits that it is a bubble; they will say that Dubai is “different’ from other places in the world, it is truly “unique” and you cannot compare it to other places, and then they will go on deliberating all the “difference” Dubai has compared to say Tokyo real estate markets and so on. People will say what they want to believe in, rather than backing their words with hard facts and data; even if they have the facts and data, the interpretation will be extremely biased – and that is exactly the situation for any bubble in the making.
However, of late, I believe that a little bit of somber mood is overtaking the market in Dubai (as I have been spending my time for the last two weeks here). The beginning of the end of the bubble has clearly arrived and everyone, silently begin to admits that is the case. Off course, there are barrages of announcements by officials and corporate chiefs from Dubai denying the market is slowing down and keeping the mantra of growth on. However, no matter how hard they try, market players are no longer having the mood to play on.
So what is really happening in the Dubai real estate market?
First, I have to admit that Dubai market has been nothing less than a phenomenon, in terms what they have achieved in a relatively short time. The ideas are original, the projects are unique, and how they push through the program on frenetic pace is truly a source of admiration. But then, what has gone wrong?
As I have explained in the “Anatomy of Crisis”, a bubble may start and comes from purely “innocent” and “genuine” market environments. Early development of Dubai is taking advantage of the liquidity and rigidity of laws and regulations in the GCC region. There is so much money going around with little to invest in, except in other markets. So why not create a “local” market and makes them the source and destinations of investments. It was a brilliant idea and approach; and it really works to Dubai’s advantage.
After the early success, Dubai immediately grows into a speculator’s haven. What makes it an attractive place are the fact that the entry level was low (you don’t need large capital to get in), and the profit was extremely good. A simple example are as follows: one person buy’s a villa, say, in the Palm for AED2 million; he has to pay only 10% of it, which is AED200,000; and within a few months, he can sell the property for AEDAED3 million; the next buyer pays him AED300,000 (being the 10% deposit), and he has an immediate gain of AED100,000, plus a schedule payment’s of AED3 million. In this case, with 200,000, he gained 1 million, with his capital fully paid and profits over the rest of the period to be collected. This is how the game is being played. It is very lucrative, quick and easy money.
The developers, on the other hand, utilize the collected monies to pay for the expenses of the consultants, marketing and others. Some developers bought the land in the same manner how the individual properties are sold, and hence, they will also use the money to pay for the installments on the land they bought. As more money is collected, they will then utilize it to finally construct the property that was supposed to be delivered to the end purchaser. Some “developers” also play the same game, by buying lands, and then partially developed it, and then after that sell the land to the next buyer, and so on. So in totality, the whole property market is like a stack of cards, laid one upon another, where the profits are linked from one purchaser to the next.
It was rather funny, when I first came to understand the market, as I enquired, how much was the Dubai property were financed by bank mortgages, and the answer that I got was, only as little as less than 5% of property was mortgaged financed. Everyone was saying that Dubai property are not “highly leveraged” and therefore are not prone to crashes like other property market. The truth is the property was “leveraged” by way of purchasers who are in fact speculators. In fact out of the total purchasers only as little as 10% to 15% are real end users. Others are in for a quick in and out exercise. That’s why, if you look at completed properties, the prices are quite stable, compared to the “newly launched” projects that are still long time away from completion, because they have much room for price increases (i.e. speculation). In summary, the market was not only a very highly leveraged version of property play; it was also very unstable since it depends on future payments by individuals rather than banking or financial institutions.
While the property was on the upward movements, the above game seems to be working as it attracts more and more players into the market. The marketing technique and strategies became more and more smart and slicks as well as the marketing reach were also getting wider and wider. So the question is: how long could it last? It cannot last forever, but as long as the music continues, the game is always on. It seems that the recent banking crisis is the end of the music. Panic and fear steps in, everything may come to a standstill.
But some would argue that Dubai and the GCC are cash rich, and they can support the market from crashing down. The argument however, holds very little grain of truth in it: the market has grown to be too big for anyone to prop, which falls back to basic tenet that I believe about the market: it is always bigger than anyone else, including the government (an example is the US financial market – it is much larger than US government by many thousand folds). Therefore, despite any assurances and sweet talk by anyone, the market cannot hold itself.
The next question is: what will then eventually happen? My hypothesis is quite simple: the highest end and the lowest end of the market will suffer the most. The highest end are the “iconic projects” which are priced at many times higher than the market base will not be able to be sold and hence there will be only net sellers and no buyers. There won’t be enough money collected, and hence either the developer will pay for the construction from his own pocket (since no banks are funding them to begin with), or scaled it down, or totally revise the whole program or abandoned it. These are hard choices. While the lowest end will not continue simply because the players are usually playing with little cash, and highly leveraged exercise; they will simply abandoned it, since they do not have much cash to go around to begin with. While the squeeze is hardest at the highest and lowest end, the middle ones will also suffer. Those with enough money and are more efficient, will survive, will others may suffer losses or may join the band wagon of the uncompleted projects.
Let me just give you a general idea about the size of the market: in total, projects that were launched, announced and planned for Dubai is in the range almost a trillion Dirham. Whilst on the other hand the size of the banking system in Dubai is around 200 billion dirham; and total existing mortgages is extremely small, about 30 to 40 billion Dirham. There is no way they can prop the market. Many developers (even the big ones like Nakheel), have launched projects whereby they have collected a good some of money from purchasers/investors. In the best case scenario, total money collected is no more than 30% of the total costs. The key issue is for the 70% balance to be paid: If these people opt to not to continue to pay, or defaulted on their payments, what are the options that the master developers have?
All I can see is that there will be many defaults taking places, and litigations and suits will be sent left and rights, and in a high multitude. It will be a nightmarish scenario that probably was never seen before. Many of the laws are new and untested, and hence there will be a lot of grey areas. The rights of the purchasers are not well defined, and hence many will feel that they are cheated – much in parallel with the US sub-prime markets: where many signed agreement with little or total ignorance of their rights. One thing that I can’t predict is the prices: whether it will tumble down or remain somewhat stable. I have a suspect that it will not be going down that much, and probably, just a little bit; But one thing that I am so sure: it won’t be going up like in the past.
If we look from another angle: these whole exercises are probably good for the market and the region. Careful look tells me that the region has enough demands for properties, and these events provide a check and stabilize the market, which are good for the long term. The prices has been skyrocketing and hurting the market more than helping it. The costs of construction have gone so high that it hurts the local GCC markets and the local populations. A dose of water over hard burning fire is probably what is happening.
If we remain focus on basic needs and requirements of the people –such as affordable and reasonable housing, as well as basic working facilities, general recreation and places – it will remain the core of the human needs. We should be alright. As far as general liquidity is concern, the GCC countries are still cash rich. The losses in the banking system in the US, while affected some banks and financial institutions in GCC, it was not a systemic and quite manageable. My only caution is that it may take six months or so before a full effect is realized, and for many adjustments to take place. So be ready for a wild ride.