April 30, 2011

Dubai 2011: A Real Estate Dream Bubble Crash (Guest Post)

By: Andrew Butter

If you drive out on the highway towards Abu Dhabi past the Jebel Ali Free Zone, look on the right and you will see, partly covered in sand, the remnants of the billboards that used to declare, “Where the Vision of Dubai Get’s Built”.


I met a guy who claimed to have come up with that tag-line. He was a young American, very nice and very-very smart, based in New York working for a big-name branding company, with absolutely no clue of what Dubai is/was about. But he was making really good money, and that’s fundamentally what everything is about, in Dubai.

That particular “vision” was going to be bigger than Hong Kong. My conversation with the nice young American was a big factor in what made me decide to “retire” the part of my business that did real estate consulting.

Up to then I could explain what was happening and if I did a ten-year projection on the revenue stream for a shopping mall or a hotel, I’d have a pretty good chance of being within 20% on Year Ten. Starting 2007 my models broke down. The “crunch” came when I gave my “”opinion of value” to an investor on a “fantastic-once-in-a-lifetime” plot of land that was being offered at a very special price that only someone “really connected” could get, of $200 a square ft of GFA.

I told him that was a stupid price and he should not buy; three months later he called me in a huff to complain that the land had been flipped at $300. I said “OK but you were going to develop (a four-to-five year commitment), not flip; and anyway I don’t do gambling”. That didn’t go down well and we haven’t spoken since; although I did notice his Ferrari in the long-term parking at the airport a while back, covered in dust.

Anyway, the “vision” that I’d been working with until then was the one that Sheikh Rashid told to my mate Eric Tulloch (sadly departed) in 1978.

“I will build the infrastructure and the rest will follow”.
At some point in all the excitement, that vision got changed to:
“We will build the rest and the infrastructure will follow”.
Back then, I knew nothing about bubbles but I was fascinated with Dubai and how and why the economy had more than doubled in size from 1990 to 2000, and then more than doubled again from 2000 to 2005. In 1990 Dubai was 15% the size of Singapore; in 2005 it was half its size and Singapore is no slouch when it comes to allowing free-market economics to rip, like when you start main-lining Adam Smith mixed with Speed.

Then there was the bubble, then there was the bust, and here we are.

What Next?

This is a chart that I put up in July 2009 which was when I think I finally figured out how bubbles work. I’ve updated it to my estimate of where prices are now (the Orange dot).


That orange dot is about 10% below where I predicted, I think the reason for that is I had not anticipated how much the bust would affect economic activity and also I under-estimated how much pipeline inventory there was. Although in my defence by that time I’d found other jobs for my researchers so I was eyeballing.

What caused the bubble in property in Dubai was pretty simple, (although I admit it took me about a year to “twig” what had been going on).

Up to early 2007 the price of housing (rentals and owned) had tracked the ratio of economic activity divided by the numbers of housing units, just like it does everywhere in the world. Sure interest rates are important but local interest rates hardly changed over that period.

But there was a lot of growth in the economy, on top of that was the start of property that foreigners could own, called “freehold”, which created a bit of a feedback loop as more and more people got involved in property, and they all needed a place to live, so more and more people got involved in property, round and round.

Then people piled in from far-and-wide with money in their pockets so then there was a shortage of new places to live, and so prices got bid up, for anything that was available. That resulted in a huge discrepancy between rents/prices for new units and what tenants in the older units paid in rent (there was no market for sale in that sector since foreigners could only buy freehold), so prices of the new stuff almost doubled. Everyone was looking at the “new” prices, which reflected only a sub-section of the market, rather than the market as a whole.

The red line “Other than Market Value”, is where (in my opinion) prices ought to have gone if the market had been “efficient”, and would probably reflect the whole market of rental (practically everyone rents in Dubai), if the “older” units were included. But there are no statistics on that; in fact there are hardly any statistics on Dubai, and those that there are, are one-year to eighteen months late, which is pretty useless in a place that’s changing that fast.

In my opinion, the lack of meaningful statistics was one reason there was a bubble, which was a classical example of “asymmetry of information”, people would look at the newspapers, they could see that an apartment could rent for say $25,000, and that the nominal yield was say 5%, so it made sense to pay $500,000.

But the “assumption” they made was that the price they could rent-out a new unit for today was a reflection of what the whole of Dubai was paying, on average. And as we all know, “Assumption is the Mother of all Frappuccinos”.

Then, the big-name branded real estate consulting companies who didn’t have any more of a clue of how Dubai worked, than the nice American branding expert; piled into town, and they got paid big bucks “facilitating” the new-boys-in-town bankers like RBS and Deutsche Bank to lend $100 billion to developers based on “sure-fire” RICS valuations; plus a total misunderstanding about how the constitution of the UAE works, as in “sorry sweetheart, Uncle Abu Dhabi is not your fairy godmother”.

But that was good money if you could get it, and if you had the ethics of a sewer-rat and if you didn’t mind your customers leaving their Ferraris at the airport.

Anyway just as the new-kids-in-town declared that 2009 was going to be an “even better year than 2008”, the penny dropped. Or more precisely the demand for the sub-market of hugely over-priced property started to get satisfied by new inventory, and then there was the “pop”.

The pop was helped along by a decision to make it more difficult for people from non OEDC countries to get visas, which was a factor feeding the market. But “visas” were not the cause of the bubble; up to 2006/7 the market had been driven by “fundamentals”, which included people who live behind the barbed-wire fence that separates the rich nations from the threat of influx from poor nations.

There’s nothing wrong with that; Dubai works, first because it has modern infrastructure including reasonably good standards of the rule of law (at least compared to its neighbours, and sure the courts are not Dubai’s strong-point), it is safe, and outside of the “vision” thing, there an absence of petty corruption that is endemic in the “Third World”. Second it’s open; anyone who has money can come to Dubai and set up a business (that often does not do any business in Dubai).

As in the line from Confucius on how to get a city to prosper, “Make the local people happy, and attract foreigners from afar”, which is something China has been very successful at doing.

Dubai was then, and still is, the best place to base a business for 2,000 miles in any direction; and now that property prices have come down from where they were when everyone was having “visions”, it’s even better.

The black dotted line that dips down to 150 was the prediction that I made in July 2009 about where the bottom would be, although you would have had to be pretty quick to catch it, and it was pretty “theoretical” because there were practically no transactions.

The thing about Dubai is that there isn’t a proper law on foreclosure so when you take a loan, you just write a hundred post-dated cheques, and if the cheque bounces, you go to jail, or you run away before your name is posted on the computer at the airport. Foreclosure takes a lot longer, so the market didn’t exactly “clear”, it just stopped.

But I know of some transactions that followed that path; a friend of mine wanted to buy on the Palm in early 2009, and he asked for some free advice. I said “if you want to live there” (I couldn’t imagine why anyone would want to live on the banks of an algae-filled canal), “then now is the time”. He was offered a “standard” villa for $1.75 million; I said “grab it”.

But my friend is real-smart which he says explains why he has much more money than me. My theory by the way is that’s more to do with my deep vein of human kindness, as in giving free advice to people who can afford to pay, and if they did pay they might be more inclined to take it. Anyway he told me, “I Never Accept the First Offer”.

So he messed around looking for a better deal, and what he did was typical Dubai; instead of trusting the agent he was using, he went to see ten other agents. And every one of them found the same property, and they all told the owner they had a “cash buyer” in their pocket. So he figured that with ten “cash buyers” in the market he was going figure a way around whatever it was that was forcing him to sell at that juncture, and he put the price up, so my mate was gazumped by himself (as in “shoot yourself in the foot”). Nowadays you won’t find a unit like that for less than $2.3 million, which pretty much fits the curve.

Right now (in my opinion) the price of property in Dubai more or less reflects the fundamental of supply and demand.

Prices are down on pre-bubble (say January 2007) because there has been a lot of new inventory (and there is more to come), and also the amount of economic activity has gone down (a bit) in nominal terms since then (my opinion also).

That explains why a temporary 40% over-pricing ended up in a fairly short-lived 60% decline; that subsequently bounced (a bit).

Where Next?

No one with any brains is building new property in Dubai at the moment; unless they managed to get some really cheap land (construction costs are rock-bottom), but most good land is tied up in litigation and has a half finished building on it; all that’s happening now is that some of the half-competed units are slowly getting finished.

One of the things about Dubai was that many developers (not the ones I advised mind), forced contractors to take risk and signed lump-sum contracts rather than taking the risk of price changes in steel, concrete and MEP during construction themselves; now those owners are crying.

What will drive the future now, is the rate of growth of the Dubai economy.

Of course, no one really knows what the size of the Dubai economy is, since there is not really any tax and so there is no direct way of measuring it. And the valiant efforts to estimate the size of the economy (typically done by benchmarking some not particularly reliable proxies), are a year to eighteen months late.

But you can build pretty good models if you know your proxies; here are some that I use:


That data is all “public-domain”, as in you can look it up on the net or in the Dubai Chamber of Commerce Library. Of course if you know your way around and you pay a bit extra, you can get it in “real time”, but then that’s not “Official”, and if something is not official in Dubai then it’s a rumour; although in some cases even if it’s “official”, it’s a rumour too. I hope that’s clear!

Anyway, sticking with the “public” stuff; my comments are as follows:

1.  Net Airport Arrivals: That’s the numbers who came into Dubai Airport less numbers who left and it’s a pretty nifty way to get to population. Although not all of the people passing through the airport live in Dubai, and Abu Dhabi Airport is catching market share, but for the first time in many years, in 2009 more people left Dubai Airport than flew into Dubai Airport.

Notice how it’s gone down quite dramatically, like 17%; the last time that happened was in 1998 when they had a purge on the “illegal” immigrants (people who had over-stayed their visas). Those all came back the next year, but the ones who left Dubai in 2009 and 2010 probably won’t come back, unless they want to subscribe to Dubai’s unique guaranteed sure-fire weight-loss program, as in debtor’s jail.

2.  Occupied housing units are from DEWA; anyone who does not have an electricity connection in Dubai is “not economically active”; so that’s a good benchmark. Interestingly those were still going up in 2009, probably reflecting migration of people with jobs in Dubai from next-door Sharjah.

3.  Light passenger vehicle registrations are a reflection of how much money is being spent (new-car sales). Although there is a complication there because many cars are re-exported from Dubai which affects the ratio of new-buys, and to get to the bottom of that you have to look closely at that which is really tedious; big picture, that flat-lined in 2009; reflecting a drop in economic activity (the amount of money being spent).

4.  City Deluxe Hotel Lodging Revenues used to be one of my favourite proxies (goes to business travellers who relate to the way Dubai’s economy works), but when occupancies go over 90% annually there is price elasticity; plus I suspect the property bubble migrated into that market, people who think they are rich when in reality they are not, spend big on luxuries like first-class hotels.

5.  GDP is a bit of a mystery, up to 2006 that was published promptly (i.e. never more than nine months late) by the highly efficient and very professional, Dubai Municipality. Then that job was transferred to the newly formed Dubai Statistics Centre, which only recently published the outcome of it’s deliberations for 2006, 2007 and 2008, so now it’s running two years late.

What’s interesting is that the numbers put out by Dubai Municipality (before) used to be posted on their website, but now they are not there any more; as if they have been “expunged”. That’s quite a mystery; a possible explanation is that the people putting the new numbers out were at the time, very much into the “new” vision of Dubai that you can see on the road just past Jebel Ali. Plus of course when you are having a conversation with the guys you owe $100 billion to, $90 billion GDP has a better ring to it than $60 billion.

The Future

The ultimate driver of economic activity in Dubai is the price of oil and the price of oil has gone up and is going to go on going up.

Dubai hardly has any oil; revenues are about $2 billion a year out of $91 billion GDP claimed “officially” in 2008; but it services a region that is full of oil; which is why it works.

Now that the “visionaries” have run out of foolish bankers to lend them money so they can create housing bubbles and clog up the roads with their Ferraris, the rest of Dubai can get back to what it did before, with the bonus of a great infrastructure, a pretty decent government (particularly after the re-shuffle), and very cheap property prices relative to anywhere within 2,000 miles (for the same quality).

Insofar as property is concerned, as I said, prices are on the “fundamental” now; they may go down a bit as the last of the developments get finished which will drive the fundamental down (that could take another one or two years, realistically). After that, prices will start to rise, albeit quite slowly.

After so much “vision”, it’s nice to get back to reality.

Related Reading - Dubai: Floating on an Island of Debt

About the Author - Andrew Butter is Managing Partner of ABMC, an investment advisory firm, based in Dubai that he set up in 1999, and has been involved advising on large scale real estate investments, primarily in Dubai.  Andrew's email - hbutter@eim.ae.

The views and opinions expressed herein are the author's own and do not necessarily reflect those of EconMatters.

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