For months, the question has been the subject of a fierce debate among economists and property executives: to what extent has Dubai's housing economy been fuelled by speculators trying to make a quick profit? Now that the credit crisis has started to hit the Gulf, we are getting the first clues. Developers expect default rates for off-plan properties to rise as high as 40 per cent in Dubai if banks do not boost lending and developers do not modify instalment payment schedules soon, according to the Real Estate Regulatory Authority.
What is happening is this: speculators can no longer "flip", or rapidly resell, their purchases because buyers have been scared off. But they can no longer hold on to their purchases, either. They must make additional payments over time but banks are no longer lending readily to make this possible. So many are simply defaulting, handing the property back to the developer and forfeiting a portion of their payments.
"The default rate will indicate the level of speculative investment in the market," said Rami Tawfiq, research manager of Colliers International. "Those are the buyers that have trouble first when sales slow down." The answer to the speculator-level question is important. They are the people who drove prices higher. The more of them there were, the more the market could fall as they are squeezed out, in some part due to deliberate efforts by the Government to reduce their numbers but in larger part as a result of an intensifying credit crunch.
But there is a silver lining. If speculators depart in an orderly fashion, the market can stabilise at a more affordable level for those who plan to actually live in the homes. "It might be painful in the short run, but it's not necessarily a bad thing," said Marios Maratheftis, the regional head of research for Standard Chartered Bank. "The market was not sustainable before. The whole economy was overheating, so if this slowdown can be orderly and moderate, it could be something that benefits the economy in the long run."
The 40 per cent default rate - representing thousands of units across the emirate - does not surprise analysts who have been predicting for months that sales could slow and prices suffer a correction. Not only were the signs of an overly frothy market visible on the streets, with people known to wait outside for as long as 12 hours to buy a flat during sales launches, but it was in the numbers. Mr Maratheftis co-wrote a report in July called Dubai - A tale of two housing markets that described the market as overheated.
To the researchers, the clearest sign of abundant speculation in Dubai was buyers willing to pay more for properties from developers than from private sellers on the secondary market. This was because buyers need only a small downpayment when purchasing from the developer, while on the secondary market buyers must take over the existing payment plan. Speculators want to put down as little money as possible, so will pay a higher price to buy from a developer.
Another discrepancy, the researchers found, was that off-plan properties were selling for the same price as a completed property. In mature property economies, a finished property almost always commands a premium because a buyer can move in or let it out. Mr Maratheftis said a 40 per cent default rate for off-plan sales would be no surprise. "These speculators are no longer able to flip," he said. "They are getting squeezed out of the market."
So far, developers have been trying to avoid having to take properties back from buyers and resell them by extending payment plans. But eventually they will have to deal with the reality of having to sell some of the apartments again and this will hasten the correction of prices. It could also dent their earnings reports for the next few quarters as they put the property back on their balance sheets.
Robert McKinnon, managing director of research at Al Mal Capital, said there would be considerable "downward pressure on real estate prices". And because the only buyers left in the market are people who need a home to live in, the entire market would have to shift towards middle-class housing. "I believe eventually that the issue is actually more about affordability," he said. "Real estate prices are going to come down to a point where consumers or end-users find it attractive for them to buy."
The true mystery is whether Dubai will see large numbers of off-plan project cancellations. Disputes would abound and some companies could take a credibility hit. When Damac Properties tried to cancel its Palm Springs project on Palm Jebel Ali this summer, investors and buyers rebelled and eventually the company had to reinstate the project. Project delays, on the other hand, appear to be inevitable as companies have difficulty paying contractors and sales slow.
Martin Seward-Case, the chairman of the UAE chapter of the Royal Institution of Chartered Surveyors, said the credit crisis had put "developers under threat". "There is a real risk that whole developments will start grinding to a halt," he said. "If we don't see a change in the way credit is being managed by banks towards developers and end users, the situation could deteriorate further." Mr Seward-Case said the authorities should pressure the banks to be more flexible in a bid to prevent the economy from worsening.
With a price correction already emerging, the Government appears to be trying to engineer a soft landing for the economy. Since the property industry is now controlled almost exclusively by home buyers, the key is to provide credible buyers with the ability to finance their purchases. This week has seen the arrival of two government-backed mortgage lenders, Emirates Development Bank, a rescue vehicle created by merging the top two home finance companies and two banks, and Abu Dhabi Finance, a partnership of five leading Abu Dhabi companies.
"What the economy needs now is liquidity," said Chris Dommett, the chief executive of the regional office of mortgage advisory John Charcol. "These may be just shots in the arm at this point, but they are needed to get things going again." @Email:firstname.lastname@example.org