Real estate to lead growth of UAE financial sector

The relationship between the real estate sector and the financial sector has long been recognised in the economic literature. That is why real estate prices are used as indicators of the financial system soundness and they play a significant role in making monetary policy decisions. Therefore, it is important to check whether there is a relationship between the real estate sector and the financial sector in Dubai economy and discusses the policy implications of that relationship.

According to the standard classification of economic activities in Dubai, there are two activities that qualify as real estate sector in the sense that is used in this article. The first activity is construction which comprises site preparation, contracting of civil engineering work, building installation and building completion.

The second activity is real estate, renting and business services which comprises management, lease, rent and sale of residential and commercial buildings. Although these two activities are classified as two distinct economic sectors, but for the purpose of this article they are treated as one aggregate sector, called the combined real estate sector.

On the other hand, the financial sector includes all financial and monetary institutions, insurance and pension funds and financial intermediation institutions. Examples for these institutions are commercial, savings and deposits banks, stock brokers, financial services companies and insurance companies, etc.

The percentage share of the combined real estate sector in Dubai total GDP grew from about 9 per cent in 1985 to about 23 per cent in 2004. This gives an annual average GDP share growth rate of about 5 percentage points.

Within the combined real estate sector, the percentage share of construction sub-sector in Dubai total GDP grew from about 5 per cent in 1985 to about 12 per cent in 2004. This gives an annual average GDP share growth rate of about 5 percentage points. On the other hand, the percentage share of real estate, renting and business services sub-sector grew from about 4per cent to about 11per cent.

This gives an annual average GDP share growth rate of about 6 percentage points. If we think of construction (site preparation, building installation and building completion) as representing the supply side of the real estate market, while real estate, renting and business services (lease, rent and sale of residential and commercial buildings) as representing the demand side of the market, then the demand for real estate has been outstripping supply by an annual average rate of about 1per cent during the period 1985-2004. This may partially explain the rising real estate prices and rents in Dubai.

Regarding the financial sector, its percentage share in Dubai total GDP grew from about 7per cent in 1985 to more than 9per cent in 2004. This gives an annual average GDP share growth rate of about 2 percentage points. As figure 1 shows, the financial sector is closely related to the combined real estate sector, and the trends of their shares in Dubai total GDP are almost identical during the period 1985-2000, with some divergence after that period. It is noticeable from the figure that in 1994 the share of both sectors went up sharply.

The statistical analysis shows that there is a correlation coefficient of 0.81 between the share of the combined real estate sector in Dubai total GDP and that of the financial sector. The regression results, which prove to be statistically highly significant, show that 65per cent of the variation in the share of the financial sector in Dubai total GDP is explained by the variation in the share of the combined real estate sector.

In the report, the following chart indicates quarterly weighted average share price of two property companies [Emmar and Union Property (UPP)] and two banks [Dubai Islamic Bank (DIB) and Emirates Bank International (EBI)], during the period 2nd quarter of 2000 to 2nd quarter of 2004 in Dubai Financial Market (DFM). Emmar and UPP are chosen because they are the only real estate companies listed in DFM. DIB and EBI are chosen because they have time series data that goes back to the beginning of DFM. During this period, the share price of property companies grew by a quarterly average rate of about 2 per cent while that of the banks by about 4 per cent. As figure 2 shows, the trends of their shares prices are closely related.

The statitical analysis shows that there is a correlation coefficient of 0.88 between the share price of the property companies and that of the banks. The regression results, which are statistically significant, show that 74 per cent of the variation in the share price of the banks is explained by the variation in the share price of the property companies.