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Dubai property: Scenario in 2007

SIR Isaac Newton had his eureka moment under an apple tree and Archimedes in his bathtub.

My own eureka moment, the one insight that changes everything, occurred at a cosmopolitan Yuppy party at a friend's lovely pad in the Dubai Marina.

The Marina reminded me of all the other yacht speckled communities I knew in my past pre-Dubai incarnation, in Florida, the San Fran Bay Area, the Gold Coast on the Long Island Sound, the Bay of Anges in Nice. However, as is inevitable in any social encounter in the Xanadu of yuppiedom and given my existential fate as the KT media guru, seer, oracle and crystal ball gazer of all things financial in the UAE, a friend's wife asked me to forecast the property scenario in Dubai two years from now.

Before I could whisper "Beam me up Scottie" to my brokers in cyberspace, retreat to the safe familiar digital netherworld of Nasdaq and British pound futures trading (was not the 1.90 cable short a beauty?), I was compelled to respond. So here goes. My take on Dubai property in 2007.

I noticed that apartments in the Marina are priced at an implicit land cost of 1,000 dirhams (AED) a square foot. Ouch! No wonder even 2 bedroom cubbyholes without a view go for AED 1.6 million. However, real estate value, like beauty is in the eyes of the beholder or at least his real estate agent. Voila! I noticed (other than the fact that the Marina seems a ghost town, with barely 20 per cent occupancy), the greatest unexploited arbitrage in Dubai real estate. Villas in the Meadows, the fabled Street of Dreams, were available at 2.2 million AED. This would be an 8000 square foot plot and 4000 sq ft built area.

Assume construction cost is 300 Dirhams per square foot. So, the villa cost 1.2 million AED to build and land cost is therefore a rock bottom 125 per square foot. Hello? Which real estate buyer in his right mind would buy an apartment in the Dubai Marina for land valued at 1,000 AED a square foot when he can own a landed property a stone's throw away with land cost at 125 Dirhams? The Meadows is next to DIC, DMC, Knowledge Village. It is a community, not the boonies. Differences in construction costs? I was born at night but not last night.

Economies of scale make construction costs lower in towers. The view? Please. My intelligence is modest enough but kindly do not insult it. Yet this incredible value gap exists for the benefit of the entire planet. Have the laws of economics, let alone common sense really been repealed at the Dubai Marina?

Obviously, either land in the Meadows villas is being given away for nothing or the apartments are wildly overpriced. All over the world, from Bombay's Marine Drive to Hong Kong to San Francisco to Clifton, land cost is three or four times more than apartments in the same beachfront/seafront area. Yet Meadows villa land costs are one-eighth those in Marina apartment? Either the sellers of the villa gave them away as charity or the buyers of the apartments are eligible for Dunce of the Decade awards? You really do not need to be George Soros to figure out the answer to the above dilemma.

Let us fast forward to 2007-2008. Published figures suggest the Big Five developers will deliver 150,000 units. Since every loaded Joe Schmoe from Bombay to Lahore to Meena Bazaar fancies himself a developer, another 30,000 units can be added. There are about 80 private developers desperate to sell their projects in Dubai. This means the supply overhang is at least 180,000 new units even assuming no projects are announced in the next two years. So 200,000 new units in 2007-8 is a very conservative forecast for new supply.

Let us look at Dubai Municipality figures on demographics and rentals. The city's population is 1.3 million. There are existing 150,000 rental units in Dubai. Take out 300,000 labourers/housemaids who will never rent or own real estate here, 100,000 commuters from Sharjah and Ajman, 100,000 eight bachelors in an apartment (clerical and super kanjoos guys) and 300,000 UAE nationals who own their own homes, you are left with 500,000 people looking for 150,000 rental units. The international family average per rental unit is 3.5. So, because of an influx of expats, a small supply-demand squeeze caused rents to spiral up by 70 to 100 per cent in two years. But in 2007-2008, a phenomenal 200,000 new units will hit the market. This means that we need about 800,000 new expats who are not labourers, housemaids, tailors, minimum wage bachelors or the Sharjah/Ajman commuters to fill this unit. In essence, a doubling of the professional high income salaried population of Dubai in the next two years. Realistic? Not at all.

Lo and behold, the brutal economics of oversupply, the kiss of death for property bubbles all over the world, now begin to hit the market. There will be a collapse of rental yields in villas and apartments in the free zone. Think about it. Some poor "investor" has bought a 2 million villa. His cost of carry (bank loan) and maintenance means he has to make at least 11 per cent per annum to just break even. Yet this is impossible with the emerging economics of the rental market. What will the poor soul do? What choice does he have but to sell whenever he can?

It is tragic that some developers have manipulated demand and misled the market with fake "sold out" projects, phony sales figures and wildly inflating prices by keeping units in inventory. Seriously, I learnt the truth of the old adage that a fool and his money are soon parted when I went to a glitzy "privileged sale event" and found the place full of real estate brokers (2500 of this specie in Dubai and most make used car salesmen in South Texas the epitome of marketing ethics and consumer disclosure). This was not real estate marketing. It was a con game and, sadly, greed blinds human beings to jettison all ethics overboard. I just shudder to think about the class action lawsuits for misrepresentation when the bubble pops. A Big Six accounting firm in Dubai whose name is being used by a private developer's ad for its scheme should definitely seek legal advice to protect its franchise.

Apart from the ethics of developers, it is their finances that also worry me. How much due diligence do local banks conduct when sanctioning developer loans? What kind of safeguards exist to prevent buyer deposits from not being used to pyramid additional speculative schemes? Are buyers funds segregated in escrow accounts as is standard practice in international real estate finance? Do credit bureaus exist to enable banks to analyse developer risk? Of course not. Every bank CEO in town knows this. This is a source of systematic risk to banks if private developer defaults escalate in 2007, as I expect they will.

The cost of money is also moving higher. When China revalues the Yuan, long-term dollar interest and mortgage rates will soar. The market is soft and getting softer every week. Thousands of leveraged speculators are trapped owning apartments (the epicentre of the bubble) they cannot sell. In fact, properties marketed as "freehold" now can only be sold once from booking to possession, wiping out what little liquidity existed in Dubai real estate in the first place. Some banks have extended billions in loans to foreigners where possession claims have never been tested in UAE courts.

The process has begun and any analyst who is not brain dead has to see that the daisy chain of leverage is fatal anywhere where end demand is dwarfed by supply and distress sellers. The credit risk management protocols of some property finance banks make me gasp with horror. Imagine monthly instalments (and maintenance charges) as high as 15,000 dirhams for a poor soul earning 20000 dirhams. Unlike impaired personal loans, banks cannot just "create" a phony new "current" mortgage to keep the fiction of IAS compliance alive.

I came to Dubai as a child and returned here from New York as an adult. My wife and twins were born here. My best friends in life, many UAE nationals live in Dubai. The city gave me fame, money and most precious of all, deep friendship and brotherhood. It pains me to see greed crazed mercenaries jet into Dubai and manipulate its property markets, trigger cycles of deceit and speculation, build leveraged house of cards in the banking system. The people of Dubai deserve better. The root for the word credit is the Latin verb credere. Belief. Without belief, there is no credit. Please let usnot squander our credere for the sake of a quick killing.

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