Developer leverage can’t stem decline in transactions

One of the benefits of the passage of time in the freehold markets in Dubai has been the quality of data that has improved, allowing statisticians to observe the impact of various factors that have influenced decision making. This allows for comparisons to be made with international markets, and ascertain what stage of market maturity Dubai is currently at. This can be determinsed primarily with the use of mortgage data, which over time has come to play an increasingly dominant role in the housing market.

What we observe in Dubai (similar to the rest of the developed world) is pro-cyclical mortgage lending, which is sometimes referred to as endogenous leverage. This works as a cycle amplifier, as mortgage lenders relax their underwriting constraints during ebullient times. Consequently, in the first boom-bust cycle that culminated in 2008, average loan-to-value (LTV) ratios in certain communities increased to as much as 85 per cent, with certain developers even offering zero per cent down payments.

In the second cycle, with Central Bank curbs in effect, mortgage lending from banks were curbed, but in many instances, were replaced by post-handover payment plan incentives by developers, as a means of not only stimulating demand, but also to curb price declines. These schemes effectively reduce the user cost of financing (which is the difference between the mortgage rate and the expected capital gains, and in equilibrium equals the rent to price ratio).

Lowering the user cost of financing incentivises home ownership, but it also incentivises speculation, a phenomena that was witnessed in the spectacular sub prime bubble in the US. Closer to home, in the second cycle, anecdotal, as well as selective sample evidence indicates that in Dubai, the probability of default among multiple unit holders has been higher than in single unit holders, as the former sub set was more likely to be optimistic and hence more inclined to “buy and flip”. These patterns (although not comprehensively documented) conform to what has been seen in international markets over the last decade, from the US to China and even South Korea.

Developer leverage has not been able to stem the decline in transactional activity in Dubai in 2018; with a re-allocation towards ready properties as the price gap between the two markets has widened considerably. However, it is pertinent to note that part of the reason for the decline in off-plan activity has been the reduced expectation of capital gains that has become part of the decision making, thereby actually increasing (as opposed to reducing) the user cost of finance.

Incentives for ready properties

In point of fact, developers in the ready space have also responded by offering post-handover payment plans of their own (largely as a means to clear inventory). However, in the process, investors and end-users alike have been spoilt for choice, and as the relative cost of holding ready assets have fallen, have re-allocated demand towards the secondary space. This experience has been similar to what was witnessed in Korea, where there was a high correlation observed between housing prices and developer incentives post the 2008 bust scenario.

Of course, these are still early days in the evolution of the Dubai freehold landscape, but it is interesting to note that mortgage demand (the level of credit supplied by the banking system) has remained remarkably stable, despite interest rate increases. The mortgage market in Dubai remains relatively conservative, and is expected to further expand its breadth, as more lenders resort to asset-backed financing, but this is more likely to be gradual, and amplify only in the next price rise cycle.

Until such time, it is likely that post-handover schemes (among the major developers) will continue to act as a demand lever, both in the ready and the off-plan space, with investors increasingly opting for the ready space (and more likely being of the single unit purchaser category). This implies that for the second half, project launches will remain lower than what has been observed in the last couple of years.

Part of the reason for the decline in off-plan activity has been the reduced expectation of capital gains