Is UBS right about a 30% additional house price fall in Dubai? (Re-post)

Swiss bank UBS published a controversial report late last week which predicts an additional 30 per cent fall in Dubai house prices over the next 18 months, down to 70 per cent of peak price levels, and for the market to take at least a decade to get back to the peak prices of summer 2008.

Deutsche Bank used to be almost as pessimistic but is now talking of prices bottoming out and a recovery early next year.

The problem with the Deutsche Bank argument is that this is not how markets usually behave. Markets might rebound for a while from a big fall, but they then generally continue on down to find a bottom, unless the fall was some kind of accident.

Global financial crisis

Nobody could really see the global financial crisis of last year as a passing accident, or if they do then a nasty reality still awaits them. In Dubai the global crisis came on top of a cyclical property market boom that was close to bursting whatever happened.

That meant a painful double whammy, something like Hong Kong in 1997 where a local property boom went bust at the time of the Asian Financial Crisis. From 1997-2003 Hong Kong house prices fell by 70 per cent.

In Hong Kong in 1997 the government’s response to the crisis was to keep on building. That resulted in a significant oversupply of property at the very moment that the market was weakening. Does this not sound like Dubai?

UBS estimates that the Dubai population will drop by a net eight per cent this year and two per cent next. This population exodus will leave 30,000 units empty says its report.

Then there are some 40,000 units to be completed over the next 18 months, and 20,000 units already lying empty. That leaves overcapacity at 90,000 units by 2011.

Greater supply and falling demand is a recipe for lower prices, whatever the government propaganda machine cares to insist. UBS says average house prices are presently 50 per cent of their peak at $254 per square foot and may drop as low as $164.

What could happen to derail this unwinding process and help support prices? A stronger than expected recovery in the global economy and higher oil prices would be good news for the UAE. Low cost finance for home owners would also be helpful, although if this also meant cheap finance for developers the additional property supply would counter the beneficial effect on house prices.

Big oversupply

Consolidation and mergers among the developers would eliminate some of the upcoming supply, although not all, and the 50,000 empty units would still remain by 2011.

But if UBS is right about the future how do you explain the market recovery this autumn? Villa prices are up, for example. Quite simply supply is still limited in completed planned communities and these expensive units had been overly discounted in the crash.

Hence overall the UBS argument makes sense. However, a surge in general inflation levels around the world courtesy of the massive government stimulus packages makes a return to nominal peak values within a much shorter timeframe than a decade very likely.

Those who choose to buy in 18 months time when the property market will be as popular as the H1N1 virus may not have to wait very long to make a good profit, and those holding on now could be pleasantly surprised within three to five years.