Bad loan fears loom over Cityscape's extravaganza

A year ago, the property game was fun but now investors are growing nervous as conditions change.

UAE investors are bracing themselves for a possible correction.
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Lina al Madi, the wife of a general practitioner, owns five properties in Dubai with mortgages on three of them. She is worried. While she spent hours at Cityscape booths last year, this year she is not bothering to attend. A year ago, the property game was fun. Now, with the liquidity crunch and merger talks between the main mortgage lenders, Mrs Madi is getting nervous. "Everyone is talking of a price correction in the property market and at the same time, banks are being more difficult with home loans," said Mrs Madi. "I'm not sure how to act."

She is not the only concerned property investor who enjoyed the boom period in the past few years and is now worried about the future. The fear is growing that banks have lent recklessly to the property sector. If anything should occur to derail its boom, they will be left sitting on a pile of devalued assets, just as has happened in the US, Britain and Spain. It is also becoming clearer that global markets are more interrelated than ever. The Gulf region is no outcast to the trend. The turmoil has prompted foreign investors to pull their money out of the region, sending sensitive markets downwards and putting liquidity into a lockdown with an ensuing credit crunch in the UAE.

The Central Bank's capital injection of Dh50 billion (US$13.6bn), designed to encourage banks to start lending again to each other, is an indication that something needs fixing - in particular, that regional banks are exposed to an overheating property sector. "Local lenders have got a huge exposure to the real estate market by lending directly and indirectly through working capital, contractors' loan facilities, providing mortgages and heading up their own development arms, so exposure is quite substantial and in the back of everyone's minds," said Miles Payne, the regional head of Strutt & Parker, a UK-based property consultancy with offices in the UAE.

"Banks are heavily exposed and could take a hit if the property market declines, but because there's such a concern of having an impact the necessary precautions are already in place." As investors brace themselves for a possible property correction, nerves are wrought over who exactly would be at risk once the cards are shown on bank balance sheets. "Initially, the people taking out mortgages will be more at risk, but if prices go down and individuals decide not to pay - then it becomes the banks' problem," said Ashley Painter, a partner at the law firm Clyde and Co who covers the property sector. "Major banks have large government shareholdings, so if there was risk of defaults, it could potentially provide a safety net."

The Central Bank sets a lending limit of 20 per cent for banks to lend to the property sector, which could contain the issue. When times are good and business is growing, it makes sense for banks to be lending both to customers and to companies. However, when times turn bad, they need to be sure that they have not exceeded these limits. Moreover, Islamic banks and contractors are allowed to sidestep these limits, which means exposure could be more substantial than is let on.

Part of the risk is that many banks have a total exposure to the property market that exceeds their equity. According to research at EFG-Hermes, Dubai Islamic Bank has exposure of about 250 per cent of equity; Abu Dhabi Commercial Bank and the National Bank of Abu Dhab have 150 to 175 per cent exposure; and Emirates NBD has exposure of about 100 per cent of equity. "Banks' exposure to the mortgage sector is minimal compared to that in the US, the UK or Spain. The main exposure is to the contracting sector. Within that, 90 per cent is due to the main property developers," said Raj Madha, an analyst at EFG-Hermes who monitors the property sector. "It would take more than a 15 to 20 per cent decline in the property market to really adversely affect the banks. However, any loss beyond that wouldn't be on a linear scale." In other words, if property prices fall by 20 per cent, Dubai's banks will be in big trouble.

He added that a decline in the property market does not necessarily have an impact on banks unless it is associated with a weakness in the labour market, which has shown no signs of slowing thus far. While many analysts agree that a property market correction could be imminent, there are still signs of strength amid troubled times. Expatriates continue to flock to opportunities in the Gulf and avoid distressed markets abroad - and they need housing.

"Key markets, including India, Russia and GCC markets, are still buying into the UAE and economic fundamentals are still strong; oil has dropped in price but liquidity remains ample in the region. If necessary, SWFs [sovereign wealth funds] can be utilised to prop up liquidity, so I don't see complete meltdown," said Mr Payne. Mr Madha is also sanguine. "Any surplus in the property market can get soaked up because immigration is strong," he said. "If there was weakness in the immigration and labour market, which there isn't at this point, then problems in the property sector would get amplified, which would in turn adversely affect the banks as well."

Property stocks have shown a steady decline over the summer, and analysts have begun cutting target share prices for top property companies including Emaar and Union Properties. A Credit Suisse report released in mid-September saw "a high degree of speculation in the Dubai real estate market which is beginning to diminish, which will lead to a slowdown in property sales and put pressure on property prices in the short term".

The report continues that "we have a bearish case for future operations in Dubai whereby we cut our property sales forecasts in Dubai". As a consequence, Credit Suisse cut its target price for Emaar by 50 per cent, to Dh6.2 per share, from its previous estimate of Dh12.4. When Dubai emerged as a global destination and real estate centre back in 2002-2003, it was a boom period and people didn't have to think too hard about investing in property and generating high returns over short periods.

The market is now maturing and it's not as easy to make quick money. Cityscape in the next few days will be interesting to watch as new projects are launched and property investors eye each other to gauge the strength of the market. According to Mushtaq Khan, an economist at Citigroup, Dubai real estate is "too big to fail, especially since the booming financial sector is booming precisely because of real estate". Nearly every other sector of Dubai's non-oil economy - including tourism and retail - depended on a strong property market, Mr Khan wrote in a report.

Of course, most people thought that Wall Street was too big to fall, but in the space of a couple of weeks America's fourth-biggest investment bank was bankrupt, the two biggest mortgage lenders were effectively nationalised, AIG was bailed out, and Goldman Sachs and Morgan Stanley became ordinary banks. These are not normal times. However, analysts point out that the handful of government-backed developers who dominate the Dubai property sector have perfected the art of managing supply. An excess of homes and offices have already been built, but developers are holding back the new units to help ensure prices continue to rise.

The liquidity crisis was likely to hurt the smaller property developers "but government assistance for established players is expected", said Mr Payne. "Managing a soft landing for [the property] sector is likely to dominate policy concerns for the medium term, as built-up units are slowly released onto the market." Nonetheless, if an economic slowdown continues to pull down property prices around the world, Dubai is unlikely to be immune.