Monday, December 22, 2008

Dubai Reads the Writing on the Wall

The writing was on the wall two years ago. Research then predicted that Dubai’s real estate bubble would burst. Best estimates spoke of a 30% drop in prices by 2009. That was long before the current global economic crisis and the only question was what would trigger the downward spiral. At the time, no one paid attention. Life was too good to be true.

Predictions of a downturn and common sense that an unrealistic, speculative bubble could only burst did little to stop the frenzy. Banks fuelled the six-year frenzy with mortgages of up to 95% often to speculators who had no intention of paying their second loan instalment in the expectation that they would be able to flip the property at a profit before another payment was due. Real estate developers and brokers viewed analysts sounding a cautionary note as mars men from another planet. Today many in the industry as well as in construction accept up to 30% salary cuts and reduced housing allowances and other perks just to save their jobs as thousands are being laid off. Others gratefully accept transfers to other Gulf states where the real estate and construction markets have yet to be seriously hit. That however may be holding on to straw. Kuwait, where real estate prices have dropped by 56% in recent months, serves to prove that Dubai is not an isolated case.

For the finance sector, the chicken is coming home to roost. With stocks of real estate developers nose diving and the market screeching to a virtual standstill, home owners are stuck with properties worth up to half their purchasing price. Increasingly banks are foreclosing on bad mortgages as over-stretched borrowers default because their assumption of continued price rises and demand outstripping supply evaporate. Banks are rightfully paying the price for throwing caution into the wind. But regulators and authorities let it happen.

As banks scramble to protect themselves and the UAE Central Bank prepares for what could be a massive bailout, the question rises whether other sectors of the Dubai economy may have to re-evaluate their prospects and re-examine the assumptions on which they are being built. Take healthcare and retail. They are being developed on the assumption that medical and shopping tourism is as important as domestic UAE consumption. Saudi Arabia, hardly a tourist destination beyond the religious, has a world-class, cutting edge medical and healthcare sector. India despite the recent Mumbai attacks already is a medical tourist destination. What should give Dubai an edge, its freewheeling, liberal environment, is increasingly less of an attraction as other countries push development and position themselves to grab a slice of the pie. The same is true for retail leaving aside that consumers in times of economic downturn and uncertainty are spending less. Shopping malls are springing up across the geography.

Nonetheless, Dubai deserves the credit for developing a model that the larger region – the Indian Ocean, the Gulf and the Middle East – is emulating with whatever tweaking and adjustments. In doing so, Dubai had a first-starter advantage. The trick is to turn that window of opportunity into something that is sustainable and durable. Dubai can learn from the lessons of Bahrain, an island nation that was in some ways Dubai in the 1970s and 1980s and failed to capitalize on its achievements. In the wake of the Lebanese civil war, banks moved their operations from Beirut to Bahrain, making the island a regional financial hub. Bahrain International Airport was the region’s transport hub where global airlines such as British Airways and KLM centred their operations between their European home bases and the Far East. Dubai has taken over that role as Bahrain struggles to catch up but needs to ensure that it stays ahead of the game. That will involve a transition from its gung-ho, can do, build and they will come attitude that served it well but has served its purpose into ensuring that its initiatives are sustainable and can weather the storm.

For the banking sector in Dubai, that transition point is arriving. Some banks may not survive widespread foreclosures on real estate. Exposure to the market expanded tremendously with the boom as well as with the emirate’s decision in 2002 to allow foreigners to buy property and qualify for financing. Foreclosures may not be the solution. Beyond the fact that there are currently no buyers to offload distressed property to, newly enacted laws allowing banks to repossess are untested. Similarly, efforts by real estate firms to prevent foreclosures by easing payment terms may fail as prices drop and homeowners are saddled with negative equity. Just how bad the banking crisis will be is uncertain. While real estate and construction account officially for no more than 20% of the UAE economy, bank exposure is likely to prove far higher. Many loans extended for projects in other sectors are likely to prove to have been diverted to the property sector.

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