After three years of booming conditions in the region’s real estate sector, several markets appear to have entered over valued levels. Real estate prices in the main cities of the region have more than doubled during this period. Strong economic growth, increasing government spending for infrastructural projects, evolving legislation on real estate ownership that allows foreigners to acquire properties, renewed confidence in the region’s economic prosperity, high level of population growth and urbanization, low interest rate structure and surging liquidity inflows seeking investment opportunities in the region have all contributed to the boom in the region’s real estate markets.
Some of these trends are structural and will continue to underpin the real estate market in the medium term. However, other factors are already priced in and may not support certain countries or cities to the level that many are expecting. The extent of overvaluation in real estate is difficult to quantify, and without detailed information on real estate inflation, investors will not be able to assess the risks associated with their exposure to this sector.
Real estate prices cannot keep on rising at the rapid pace that we have seen in the past two years. At current levels of prices, supply will soon exceed demand and a glut will surface. This may not yet be visible, nevertheless, most adjustments of market imbalances tend to be well underway before the imbalances become widely identified. Usually protracted periods of big surge in real asset prices are followed by a downward adjustment in these prices.
Real Estate prices move much more slowly than share prices. While stock prices could correct downward by 5 percent in a single day, and 20 percent in few weeks, real estate prices often keep rising for a while even after a housing boom goes bust. So the news that the housing bubble is over will not come in the form of plunging prices.
It will be more visible in the form of falling sales and rising inventories, as sellers try to sell their holding at prices that buyers are no longer willing to pay. There are early indications that the process have already started in certain countries of the region and the super money making days in the region’s real estate market may be subsiding.
The rush into regional property has pushed up valuations to international levels. An estimated half of the upscale appartments sold in Dubai, Beirut or Cairo have been to buyers from the Gulf region. This leaves open the question of what happens if the regional property market stagnates or corrects downward.
The real estate boom of the past three years also occurred at a time when stock prices were surging and when mortgage rates were falling. Banks have been feverishly expanding lending to this sector, making it possible for people to buy houses which otherwise they could not afford and helped to propel the housing boom that started in 2002.
There are factors acting to dampen the surge of demand and supply in the real estate market of the region. Rising housing prices is making it prohibitively expensive for people to buy. Salaries have been increasing on the average by around 5 percent a year, compared to rents which have been going up between 10 percent to 20 percent. On the other hand, surging construction cost and difficulty in acquiring prime properties are reducing the willingness of contractors to build.
In several countries of the region house prices are currently at record levels in relation to rents. The ratio of prices to rents is a sort of price/earnings ratio for the housing market. Just as the price of a share should equal the discounted present value of future dividends, so the price of a house should reflect the future benefits of ownership, either as rental income for an investor or the rent saved by an owner-occupier. To bring the ratio of prices to rent back to equilibrium, either rents must rise sharply or prices must fall.
If rents are allowed to surge this would feed into inflation. Rents directly or indirectly account for around 30 percent of the consumer price indices in various countries of the region. Higher inflation may force Arab central banks and monetary authorities to raise interest rates more swiftly than those on the US dollar which could eventually bring forth a fall in house prices. Alternatively, if rents continue to rise at their current annual pace of 10 percent, house prices would need to remain flat for several years to bring the ratio of house prices to rents back to its long-term norm.
Interest rates on Arab currencies have been rising in the past few months. Monthly bank deposits currently exceed 4 percent, almost double the level at the beginning of the year. Mortgage rates are also moving higher underpinned by the benchmark rate on five years government treasuries which range between 6.5 percent and 7.5 percent across countries of the region.
The upward trend in short and long term interest rates is likely to continue, especially as US dollar interest rates rise further and inflationary pressures in countries of the region both in the real and financial sectors become more evident. Bubbles in the real estate or the stock market are always created by easy money.
Traditionally, home mortgages, unlike loans to buy stocks, had a calming influence when times are tough. If you buy stocks with borrowed money, a decline in prices can bring on margin calls and you must either put up cash or sell your stocks. Such forced selling would bring a bigger decline when a correction starts. Mortgage loans, unlike margin loans on stocks, do not become due just because the value of the property declines. Your mortgage will not be foreclosed as long as you meet the monthly payments, even if the house is now worth less than what you owe the bank. In the region, most mortgages do not have fixed interest rates but variable ones that usually rise with the general trend of domestic interest rates.
The right real estate product at the right price is selling and will continue to sell in order to keep pace with the region’s double digit economic growth rates. The commercial real estate markets of most Arab countries are still underdeveloped and need to expand further. To close this gap projects costing billions of dollars are under construction across the region.
However, those speculators who are only willing to sell houses and land at much higher prices than what they had paid for just few months ago are finding it increasingly more difficult to attract buyers. As more people realize that real estate prices will not keep on rising rapidly, they will reconsider their purchasing and financing plans. Some may choose to exit the market after realizing that the days of quick capital gains are over. This will reduce excess demand and deflate the bubble that has started to surface region wide.
— (Henry T. Azzam is founder & CEO of Amwal Invest.)