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UAE property: What's next?

Is a bear market in store? Matein Khalid analyses

It is impossible for me to attend a dinner or social event without the conversation turning to the fall in the Dubai property market, particularly for villas in the Dh4 million to Dh6 million range. There seems to be hundreds of sellers and no real buyers, only futile phone calls from an endless number of brokers and Joe Habibi middlemen.
The macro zeitgeist makes it almost certain that the fall in the property market will accelerate. The UAE dirham has risen 25-40 per cent against most emerging market currencies and even the euro in the past year. The collapse of oil prices has meant lower government petrocurrency deposits in the UAE banking system. This means a fall in loan growth, rise in bank funding cots, tighter money market interbank rates and higher home mortgage finance cost.
The euphoric price rises of 2013-14, thanks to Arab Spring capital flows and the plunge in risk premiums after the successful $25 billion Dubai World debt restructuring, is over. The spectacular rise in the US dollar is a triple-whammy deflation shock for the UAE since it guts crude oil revenue, tourist arrivals (especially from emerging markets like Russia, South Africa, Malaysia, Turkey, etc, whose currencies have collapsed against the dollar) and property demand. The dirham's currency peg means the burden of adjustment falls on the local property and stock market. Note that Emaar peaked at Dh12 and Dubai villas/apartments peaked just as the King Dollar rally begun in late-spring 2014. This was the reason I had recommended selling equity exposure in May 2014. Now, 16 months later, the DFM index has fallen 30 per cent. It amazes me that even sophisticated investors are clueless about macro variables. If Wharton is expensive, try ignorance, a wit one advised me!
Since I expect higher US rates and a new Fed tightening cycle from the December FOMC meeting, I believe property investors worldwide are entering a danger zone. Overvalued property in emerging markets/commodity exporting economies is at grave risk of a protracted, painful bear market. At 2.03 per cent, the yield on the 10-year US Treasury note is at least 150 basis points, too low since I expect a Fed Funds rate to be at least two per cent in the next 12 months. This means leveraged property speculation could be a disaster in high risk emerging markets. Debt financing costs in the Gulf could easily triple in the next two years even as oil prices fall to $40 or lower, given the demand shock from China and the surge in Russian/Saudi output above 10.6 mbd each.
This means 2014-15 could be the first year of a typical six-year bear market in residential/commercial property in the GCC. Unlike the US, rising interest rates in the Gulf do not reflect economic strength, only King Dollar and tighter local interbank liquidity, factors that actually mean lower oil prices, capex, budget deficit bank loan growth and GDP growth in the GCC. This spiral has already begun. Saudi Arabian reserves have fallen $200 billion in 2015 while the IMF projects the kingdom will have a budget as high as 19 per cent of GDP and the Tadawul All Share Index is down 30 per cent from its peak even though the Saudi stock market just "opened" to foreign institutional investors.
Rising interest rates are to property markets what a cross of gold is to Count Dracula. Debt financing costs soar. Cap rates rise. Investment spreads fall. Cash flow and distribution income falls. Fund managers flee the sector. Valuation metrics fall. I have seen too many boom-and-bust property cycles in my investing lifetime not to fear the smoke signals from US monetary tightening.
Investors have not remotely begun to protect themselves against a bond market bloodbath that I believe is inevitable in 2016. It makes me gasp with horror to see my friends leverage their capital two or three times with private banks to get a double digit "yield" on illiquid assets whose prices will plunge as interest rates rise. The idea of getting a mortgage with 20 per cent down is, to me, financial suicide. Even if home prices stay flat, an investor will lose 10 per cent of his capital every year on mortgage financing costs and exorbitant service charges. Sadly, house prices will not be flat in 2016 but fall another 20-30 per cent, thanks to a 25 per cent new-supply glut.