Gulf Real Estate: Year in Prospect

Healthy macroeconomics:

What ought to distinguish an economic from a purely market perspective on real estate is as close a focus as possible on why market variables are performing the way they are, as a guide to how much they are likely to change in the future. The starting point, as ever, is macroeconomics.

Studies in OECD countries, which now date back many decades, have focused on population, employment, real disposable income, interest rates, retail sales, and loans outstanding^[1], trends in all of which provide positive support for the UAE real estate market in 2019. Somewhat dramatically, however, but in a fashion that will come as little surprise to those following the UAE real estate market, studies have indicated that long-run causality appears to go from property prices to bank lending; ie, that property price cycles, themselves incorporating changing beliefs about future economic prospects, drive credit cycles, rather than vice versa.

Economists have already, therefore, begun to look at which variables are correlated with, and especially, which are leading indicators of the UAE real estate market. The perhaps surprising conclusion of a 2012 study^[2], which used data between 2003 and 2010, was that both the gold price and the volume of total direct foreign trade were definitively determined to be positively correlated with UAE residential property prices. A similar study in 2016^[3] of more concern to real estate investors found that stock market performance drove real estate realities.

But in an open economy like the UAE’s, even macro-level policymakers have limited control over many of these macro-economic variables, such as the gold price, stock market performance or even levels of trade. They also have limited monetary policy options, with interest rate decisions largely pegged to US Federal Reserve moves. Other Gulf states have a limited additional range of manoeuvrability, but the disparity between US and UAE real estate cycles means that monetary policy may end up cyclical in the UAE rather than the desired counter-cyclicality. Greater effect is likely to be seen through control over domestic lending policies, where policymakers still have considerable latitude. Fiscal policy gives more latitude to the UAE government, with a record federal budget of 2018 likely to see its effects at first stabilising and then contributing positively to the real estate market. But when?

Outside and inside lags:

Unfortunately, markets do not respond instantly to macroeconomic policy setting changes. Relatively recently, policymakers at central banks have begun to pay greater attention to the outside lags of macroeconomic policy^[4] – about time, too, practitioners would say.

Ellis’s surely correct, if terribly belated insight is that lags take longer than conventional economic modelling has allowed for: several years, most probably.  Ellis further identifies three different types of outside lag. All three are relevant to the UAE real estate market in 2019. The first she calls process – just the time to act after a policy is announced. Construction companies take time to slow down their projects and there are structural factors impeding them from stopping abruptly. The second, stock-flow, is especially relevant to real estate markets. Analysts have long used the four quadrants of the Fisher-DiPasquale-Wheaton (FDW) model to explain the interactions between employment and required space, capital markets, annual construction and annual stock adjustment.^[5] As the UAE’s real estate sector reaches maturity in terms of the percentage of new construction relative to the stock already existing, the balance of supply and demand for stock will determine price. Developers increasingly become price takers not price setters. The third lag she calls learning, and Ellis recognises that the timeframe of lags may well start to diminish as information transmission mechanisms improve (eg, improvements in statistics such as greater decomposition and moving to monthly data releases). Perhaps unsurprisingly for a central banker, she omits inside lags: the length of time it takes policymakers themselves to react – a big advantage for a small, developed economy such as the UAE or Singapore is that this lag is likely to be shorter, as well as less necessarily nuanced, than in a large economy with conflicting regional pressures such as Australia.

The question of oversupply:

While policymakers can take some comfort in the diversified nature of the UAE economy, especially Dubai, and the decreasing correlation of real estate variables from the oil price in the long term, the story of residential oversupply in the coming year continues to dampen prices and widen yields. As a cause, the 2012 study also predictably found a negative long-run correlation between completions and prices.  Achieved prices are evidently oscillating in a relatively narrow band: Property Monitor data indicators that average achieved prices reached AED 1,156/sq ft in Q1 2019 compared to AED 1,176/sq ft in Q4 2018; DLD data shows a slight trend in the opposite direction. ‘Oversupply’ is a vague term, though – more precisely, the residential market is not clearing, with more stock being deployed and still more in the pipeline, because of a gap in expectations between vendors and purchasers, which in turn reduces market liquidity. The difference with the retail sector, where landlords have cut lease restrictions and offered turnover-only rents, is striking.

Policymakers in the UAE can respond to the issue in two different ways. First, they have taken decisions aimed at increasing demand. A good example, amongst several like the policy on free zones and foreign corporate ownership, is the introduction of residency visas for certain categories of retirees. The long-expected decision, now in effect, was eventually taken by the UAE Cabinet in September 2018. The law provides retired residents over the age of 55 a potentially renewable long-term visa for a period of five years. The eligibility criteria are relatively generous^[6]. Long-term, the positive impact of this decision is likely to be significant. Consider the demographics. Consistent with its development into a mature market, the UAE population has already begun to age. Currently, the percentage of UAE residents over 65 is only 1.14%, up from 0.8% in 2007^[7]. Simple extrapolation puts that at around 1.5% by 2027, which would mean up to 10,000 retirees annually, with this first, and possible succeeding policy measures, only likely to cause this figure to rise.

The effect of more retirees is both direct, in an increased demand for as yet unbuilt residential and mixed-use communities catering to the needs of the elderly, and indirect, in local investment, including in real estate. What remains to research is how quickly this new source of demand deploys into the UAE real estate market, but the effects are likely to take some years to appear.

The second potential response is the control of supply. Policymakers have a range of tools at their disposal, such as restricting land issuance, re-evaluating land pricing and even attempting to control the flow of funds into real estate construction. As yet, supply tools have remained unused in the armoury, but no one should imagine that they are not there in the event of any further deterioration in market conditions.

Policymakers tend to focus on the impact of tools available to them on the housing market, and this is no doubt as true of the UAE market in 2019 as any other. Concern over negative market trends is palpable and likely to endure throughout the year, with our view being that the coming year is likely to experience conditions similar to that immediately past. Viewing market liquidity and price trajectory across sectors, however, generates a different perspective on this year. Certain sectors are even undersupplied. Not retail, most likely, but such sectors such as short-term office rentals, smart warehousing and logistics are all likely to post price rises and yield compression, providing prominent evidence to policymakers that a one-size fits all response to the market is inappropriate.

Conclusion:

Ellis argues that faster and better macroeconomic outcomes can be achieved by telling better stories – more accurate stories, and stories that are more consistent with each other. I would add, for real estate, more detailed stories. While established markets are yet to stabilise, the recognition of specialised, niche market needs and appropriate responses to them is a key part of the maturity of any real estate market. And 2019 looks as if it will have a special place in that narrative in the UAE.

[1] e.g Hirata, H., Ayhan Kose, M., Otrok,C. and Terrones, M.E. (2012) Global House Price Fluctuations: Synchronization and Determinants. NBER Working Paper Number 18362, September 2012. Available at: https://www.nber.org/papers/w18362 Retrieved 3 March 2019; and Panagiotidis, T. and Printzis, P. (2015) On the macroeconomic determinants of the housing market in Greece: A VECM approach. London School of Economics. Available at: http://www.lse.ac.uk/europeanInstitute/research/hellenicObservatory/CMS%20pdf/Publications/GreeSE/GreeSE-No88.pdf Retrieved 3 March 2019.

[2] Hepsen, A. and Vatansever, M. (2012) Relationship between Residential Property Price Index and Macroeconomic Indicators in Dubai Housing Market. International Journal of Strategic Property Management  16(1) 71-84.

[3] Taşabat, S.E. and Aydın, O. (2016) The Modelling of Residential Sales Prices with Kriging Using Different Distance Metrics in Different Correlation Functions. Gazi University Journal of Science 29(3):627-633.

[4] Ellis, L. (2018) On Lags. Sir Leslie Melville Memorial Lecture, Australian National University

Canberra – 17 August 2018. Available at:  https://www.rba.gov.au/speeches/2018/pdf/sp-ag-2018-08-17.pdf Retrieved 2 March 2019.

[5]  Geltner, D.M. and & Miller, C.G. (2013) Commercial Real Estate Analysis and Investments (w/ CD) 3rd Edition. Mason, Ohio. Oncourselearning.

[6] Government of Dubai (2018) Retirement visa for UAE residents. Available at: https://government.ae/en/information-and-services/visa-and-emirates-id/types-of-visa/retirement-visa-for-uae-residents Retrieved 2 March 2019.

[7] Statista (2019) United Arab Emirates: Age structure from 2007 to 2017. Available at: https://www.statista.com/statistics/297597/uae-age-structure/ Retrieved 2 March 2019.