By now we’ve all heard about the ‘global financial crisis’ and its growing discontents. We’ve also been hearing and reading about the ‘sub-prime crisis’ prior to what transpired into the financial crisis as we know if it now. This article will discuss the beginning of the crisis, its causes, the current situation and predictions from the real estate market perspective in London and Dubai. Most of what will follow is first-hand experience and observation of the author, in addition to valuable press and research material and other empirical analysis.
London
Since early 2007, the leading United Kingdom publications like the Financial Times began to write of the sub-prime crisis, toxic debt, credit crunch, collaterialised financial instruments, foreclosures and so on from ‘across the pond’, i.e. from the United States. Much of these terms were new, even to the financial practitioners here. Frankly, despite initial trivial observations, most of the real estate players in London did not pay too much attention to it. Since the fall of the Iraqi regime after the Allied invasion, London property prices were experiencing only one direction: upwards. There was no cause for concern: jobs were in abundance, debt was easily available, ‘self certified’ mortgages were rampant, over 100% loans plus legal costs and stamp taxes were incorporated into the loan, 2006 had experienced the biggest bonus in the City (financial district) of London of over £21 billion (in addition to salaries) for the financial and professional industry alone. Literally, there were thousands of residential mortgage products in the market in pounds sterling denominations, in addition to foreign currency loans from offshore branches of UK lenders. ‘Flipping, gazumping, gazzundering’: property terminology associated with brute tactics to make more money were normal. Developers in prime locations were inundated with demand, brokers didn’t reply to buyers’ calls since there was too much demand, and sellers were having a laugh. By mid 2007, the property game in London was on.
As the bad news from the US filtered into the sentiments of the London mortgage lenders, property developers and investors, the mood began to soften. In economic terms, usually, if things go bad in the US, they go bad in the UK. It was just a question of time, waiting for the tipping point before things turned around. Perhaps the turning point, among others, was the drying up of the inter bank debt market. In the UK, it was the much publicised collapse of the Northern Rock in November 2007; at that point one of the largest mortgage lenders. So significant was the fear that depositors lined up to get their cash out before its coffers dry up! This was the first bank run in over a century. The government stepped in to guarantee all deposits at Northern Rock and nationalised the lender in February 2008, costing around £30 billion (then $60 billion) to the taxpayer. It had lent over 100% of property value to over 33% of borrowers. Towards the beginning of 2008, significant changes in the UK property market started to emerge: mortgage products decreased, money supply dried up, deposit required shot up, lending criteria hardened, sentiment went down, fear became rampant, job security became shaky, and severe uncertainty took its positions.
Mercilessly, the media opened the floodgates to one bad news after another: large corporations going down, interest rates decreasing, fears of taxes rising, unemployment figures increasing, petty financial crime on the rise and so on. This was real, it was happening. Transaction volumes went down to record lows, brokers started chasing investors while sellers competed to get their stock out by lowering the prices. The tables had turned. Cash was king once again, but debt was hard to secure. And then came the spectacular fall of the UK’s symbol of capitalism: The Royal Bank of Scotland (RBS), with over $3 trillion in global assets. The cumulative government bailout of RBS in November 2008 stood at £37 billion, with 60% shares now owned by the government. Similarly Lloyds TSB Bank and HBOS Bank (one of the top three lenders in the UK) received over £20 billion in government help, including direct injection and guarantees. At the same time the share prices of these financial institutions had nose-dived, wiping dozens of billions of pounds from the London Stock Exchange. The credit market had almost jammed. With the cycle of payments and liabilities under extreme strain, employers felt the pressure and started laying off workforce. Orders dried up, demand from consumers lowered to record lows.
By early 2009, the London property prices were down by a comfortable 30% from its high in mid 2007, and reasonable forecasts suggest another drop of 15% in 2009, taking it to around 45% drop, which should be classified as a crash by any standards. Lenders who had released debt of anywhere above 55% LTV (of peak prices) would be highly exposed as the borrowers are currently in negative equity territory. We must not, however, ignore the fact that the government had been easing monetary policy and providing fiscal stimulus through direct cash injections, guarantees and influencing the credit mechanism to revert to prior lending positions. For instance, the Bank of England lowered interest rate to below 2%; its lowest in over 300 years and currently at 0.5%. This, of course, had had the desired result of easing monetary pressure on companies and home owners.
Dubai
Unlike London, which has been and still retains its position as a leading and pre-eminent global centre for finance, culture and arts, education, law and tourism; Dubai, conversely, is new in the game. Particularly post 9/11, large amounts of cash from the Gulf and other Muslim countries and Muslim expatriates based in the West started flowing in addition to the Russians. Not many questions were asked: you open an account with minimum requirements, and deposit cash or have a wire transfer. And where would this cash be parked? The asset base most people understood and felt safe was real estate. The so-called ‘Property Law’ was approved by royal decree in 2002, which gave boost to confidence and ushered in the era of clustered developments where non-GCC nationals or companies could buy into off plan developments with a small deposit, usually 10%. Initially, the developers were very large-scale and government backed like Emaar and Nakheel, but later, more participants were allowed to give into some healthy yet controlled competition. ‘Fly by night investors’, ‘mom and pop developers’, local sheikhs with a foreign partner (who does the work), small- time flippers, housewives, low level bankers, jewellers, Joe Bloggs, travellers with a stop over in Dubai: all entered the real estate game. Every one had an expert opinion on future events. And they all made money.
For the government, it was a cash cow: selling sand to companies incorporating Gulf and other developers, with a deposit and payment plan, who then had architectural drawings approved and then ‘sold’ their development to ‘investors’ who lined up the night earlier, usually in a fancy hotel, to buy into the development years before it would be completed. Even tickets for the event had premiums. Flight loads of buyers would land in Dubai on the eve of the ‘pre launch’ or launch from Tehran, Karachi, Mumbai and London mostly. One developer claimed to be ‘the largest private developer in the Middle East’ without even having 10% of announced developments delivered, let alone on time. Not surprisingly it had to be bailed out by the government. We’ll have to give credit though for the scale, depth and level of achievements both in terms of the government’s ambition and desire to make it happen and for the other participants to see it through. Some of the developments like the Burj Al Arab hotel, Palm Jumeirah, Dubai Marina, and the under-development Burj Dubai tower are world class projects, second to none.
The ‘investors’ or to be more precise, speculators, then sold off their floors, or multiple units or single units to other speculators via brokers. Major newspapers had dozens of pages daily for such classifieds of one development or another, with such and such payment plans, price per square foot, the developer concerned, juiced up images of the building, location etc. Premiums would go up daily or weekly, depending on where the herd was moving. If the payment plan stipulated delayed payments or bulk towards completion date, the unit would be more desirable as less equity outlay would be required. There were also the so-called ‘under writers’, up-market brokers who would buy the entire building or project usually from a B or C class developer, then market it in a desirable way and sell on to speculators further on. The speculators in their good books were treated in luxury, sometimes flown to Monaco for sumptuous parties. This was real.
The brokers came in all shapes, names, sizes and professions. Apart from a couple of reasonably professional brokerage firms, there were brokers of all kind; admittedly with little or no knowledge of either the market or the product or laws and procedures. The motto was simple: sell, sell, sell. Towards the mid of 2008, compulsory Land Department training was required in order to sell property, but except a change in form there was no true change in substance. Doctors, mid ranking bankers, speculators, retailers, and even taxi drivers from Pakistan were pseudo brokers. The developers couldn’t care less, since they charged 2% as ‘transfer fee’, even though admin charges hardly crossed 5,000 dirhams ($1,362). This was later changed after the Real Estate Regulatory Authority (RERA) introduced laws to charge this transfer fee itself. From a lenders perspective, it was tricky. The lenders had their in-house list of approved developers, specific developments, named employers and so on. If the borrower did not tick those boxes, he had no chance. Local and international lenders, especially British ones like Barclays, Lloyds TSB and HSBC were selectively active in the market. Large developers had their own lending arm like Tamweel.
From 2004 to early 2008, the market was hot. There was no capital gains tax, so all you made went straight into the next punt. News of the crisis in the West started to filter into the Dubai sands in 2008, and by mid 2008 we felt there was a problem. There seemed to be many sellers and less buyers. Things were changing. Since it was summer, many believed hot months are not usually that hot in market activity terms so things would pick up later. News of the fall of Lehman Brothers wasn’t encouraging either. Lenders started to tighten their belts and approval criteria. Then came Ramadan, and hence the excuse for fasting and lazy afternoons. So, the punters now held high hopes for City Scape exhibition to be held in October, after Ramadan. This used to be the largest yearly real estate event in the world, but things were set to change this time beyond people’s wildest dreams.
Recognising the severity of the situation, the Dubai government prohibited all sales at the event, although transactions could be done subsequently. The event was a disaster. It broke the back of the Dubai property market, for the time being. Still, many people were in denial. Prices started to go down, based on transactions. Buyers vanished from the market. People got severely afraid. Sellers were being encouraged by the brokers to reduce prices in order to sell. There was panic everywhere. There was no market anymore, especially for the underdevelopment properties. Those on the ground could testify that prices went down between 30% to 60% in a matter of few weeks, depending on the development, developer, location, stage of completion etc. Many speculators were liquidated over night, literally. Medium and small developers could not receive installments from buyers, but had to pay the contractor, which they defaulted on. The contractors could not pay the workers, suppliers of materials and services in time. The construction machinery owners got under severe financial strain as they had to pay instalments to the bank. Consolidation and compromise became the name of the game. Recently, the government accepted its debt (inclusive of the various companies that make up Dubai Inc.) to be above $80 billion, larger than Dubai’s GDP.
Non-GCC citizens who lost their jobs had to leave the country immediately due to visa regulations hence there were around 300 cars deserted at the airport every week. Entrepreneurs, speculators, mid and upper level professionals, blue collar workers: people began to abandon Dubai in hordes, leaving their hopes and lives behind. Rents began nose diving. Previously landlords would demand and get one cheque for the rent up front, and then, even quarterly payments at lower rates became acceptable. EFG Hermes Bank estimated that Dubai will lose around 17% of its population by the end of 2009. If it was a place with a genuine base economy then perhaps the exodus would be less, or if expatriates felt there was a short term economic downturn. It, however, turned out to be far deeper and more severe than expected.
What next?
This takes us to the most pertinent question: when will the property prices begin to rise? For the prices to begin to rise, they have to first end the current decline. We understand, broadly speaking that there is a general base demand for residential units in London and Dubai, if their respective populations remain, for the sake of argument, at current levels. If, as is being observed in the Dubai scenario, expatriates continue to leave the city in great numbers and there is no new significant delivery of residential stock then prices will continue to fall as landlords compete to sell and let their properties out. This would get worse if the expatriates are leaving and there is surplus new supply.
Lets assume that the London population remains the same, since it is not only a financial centre, it is also home to long-term residents from all parts of the world, plus immigrants arrive here regularly for non-economic activities, like education, healthcare, retirement, and so on . It also has a cumbersome, lengthy and controlled planning mechanism which arguably in this market would further discourage new builds. However, London’s main attraction as a financial centre has been hampered due to, among other reasons, large job losses and cuts in salaries and bonuses of the financial professionals. More job cuts are inevitable. According to the survey across a range of businesses and countries by Napier Scott recruiters, London bankers saw an average drop of 62% in their salaries and bonuses for 2008, and took home 40% less in remuneration than their New York counterparts. The pollsters noted that the devaluation of the British pound against both the dollar and the euro over the past year helped make London bankers’ pay appear smaller. Much of the punch to the property prices here were a result of robust pays coupled with generous bonuses, which is there no more. This, of course, has to be distinguished from the investments by wealthy individuals from Russia, the Gulf, South Asia and the Far East, which has fuelled price growth, but has demonstrated caution as of late 2008.
The April G20 summit has provided some stimulus to the larger scheme of things globally, but we have to see how it impacts two extremely important factors: retention of jobs and creation of new jobs. In case of London and Dubai, the property markets will remain on the downwards path unless the general layoffs end and new jobs are being created, news of the new jobs being created filters through the general population including investors, the mortgage lenders begin to ease their criteria and healthy competition ensues between them in their respective markets, and sentiment takes a positive turn. Since the root of these problems began from the US, it can be argued that the alleviation will also commence from there. When will we see the above criterion being met is a moot point, but we will possibly not be getting there for the next few years.
