How strange that just prior to the US credit crunch there was no market in the world quite like the Dubai and United Arab Emirates property market. Investors were literally falling over themselves to get exposure to this area of the world, banks were doing record levels of business and the local authorities were more than happy with the substantial increase in the area’s profile.
However, once confidence starts to seep from the market it can be very difficult to turn the situation around as the snowball effect comes into play and everybody joins in the damnation of the market.
Any investment market, no matter where in the world or what assets it is based upon, needs confidence in order to keep on growing and prospering. There needs to be a confidence in the local economy, the country, the asset and those likely to invest in the market. If any one of these elements is missing the impact on the market can be substantial and cause serious financial distress.
The UAE property market
The UAE property market has been dominated by the Dubai property market which has attracted substantial interest from overseas investors, overseas businesses and overseas visitors. This significant upturn in the region seemed to breed greater and greater confidence in the market and quite literally investors were fighting to get exposure to the region. We saw prices move higher and higher, we saw banks lending more and more and we saw property prices detaching slightly from the real world.
When confidence was booming it seemed there was only one place to be which was the United Arab Emirates and apply in particular Dubai. Even when the credit crunch in the US emerged there were many suggesting that the UAE property market was insulated from the impact of the worldwide slowdown, something which in a very short space of time attracted even more attention from overseas investors. So what went wrong?
The banking sector in the United Arab Emirates has the highest exposure to real estate amongst any banking sector in the region. Credit Suisse recently issued a report suggesting that around 35% of all UAE banking loans were related in some way to the real estate sector. When you compare this to the likes of Saudi Arabia, where a more conservative approach has been taken, the average banking exposure to the real estate market is only 7.5%.
However, it is worth noting that even the likes of Credit Suisse and other leading financial companies were not warning investors of this high exposure when the market was flying high. Once the market turned it seems everybody was looking for a scapegoat and a reason for the downturn.
What does this mean for UAE banks?
The fact that so many bank loans are based upon real estate assets gives the banking sector a massive exposure to the property market and with prices falling the chances of loan defaults have increased substantially. When you also consider that buyers have effectively gone on strike in some areas of the UAE property market many investors are not only find it difficult to make money in the sector but difficult to liquidate their assets to cover their liabilities.
In what is effectively a self-fulfilling prophecy, as more and more property investors become more and more desperate to dispose of their assets to pay off their loans, banks then reduce their exposure by reducing liquidity in the mortgage market. So not only are the banks placing pressure on their customers to liquidate their assets and pay off their liabilities but they are starving the market of new liquidity which buyers depend upon to acquire assets.
Loans to deposit ratio
The loans to deposit ratio is a very worrying factor for UAE banks with relatively modest deposits backing substantial loans, meaning that much of the funding in the UAE banking sector is from the money markets (i.e. very much like the Northern Rock situation in the UK). This was the first area of the financial system to be hit when the credit crunch and worldwide economic slowdown finally hit the region. While finance did not disappear completely there was a massive increase in the cost of finance which decimated profit margins for UAE banks and placed many in serious financial difficulties.
This has alerted the ratings agencies such as Moody’s and Standard and Poor who believe that the risk on the downside for UAE banks is markedly higher than many other areas of the world. The high dependence on money market finance, which was fairly cheap prior to the credit crunch, has come back to haunt many of the leading banking institutions and severely restricted their ability to operate as “normal”.
As we have seen in areas such as the UK it is very much down to the local authorities and government to try and instil confidence in the banking sector, which will at some stage translate back into the property sector. However, the UAE property market has been tightly controlled by the authorities for some time and investors are concerned about what action the authorities may take. There is a feeling that short-term issues could be sacrificed in order to defend the medium to longer term viability of the UAE property market and UAE banking sector, something which could see many investors and banks face significant hardship in the short-term.
The property sector in the UAE is a major element of the local economy and a massive influence on the banking sector. As the initial flurry of sellers snowballed into a massive storm of distressed asset sales this has had a significant impact upon the local economy and local income. Many people also forget that the UAE property market is fairly immature when compared to a number of other significant property markets around the world therefore overall confidence is maybe more fragile than in more mature markets.
This is very much a chicken and egg situation in that what came first, a recovery in the property market or a recovery in liquidity levels in the banking sector?
Many investors have made significant profits over the last few years but until buyers return to the region and finance becomes more readily available we are likely to see stagnation at best and continuing falls at worst.
However, the property market will at some stage find a level which attracts both local and international investors and this would be the first building block in the rebirth of what has been one of the more lucrative property markets of recent times. Confidence is a very fickle emotion and often very difficult to predict but until it returns to the marketplace there is very little likelihood of a significant upturn.