Markets are complex, and consumers often struggle to understand pricing decisions, resorting to conspiracy theories. For example, in countries with floating petrol prices – the UAE is a new member of this club after subsidy reforms – consumers are convinced that retailers are far quicker to raise petrol prices when global oil prices rise than they are to lower them when global oil prices fall, a phenomenon they attribute to Machiavellian collusion between petrol stations.
Such fears are ill-founded, as petrol prices exhibit symmetric sensitivity to global oil price movements. However, the same cannot be said of property markets, as landlords are generally very slow to drop rents, even when their properties are full of vacancies, while they rapidly seize upon any opportunity to raise rents when demand is high. Many renters in the UAE are searching for an explanation for behaviour that seemingly runs counter to landlords’ interests.
There is, in fact, a logical explanation for the asymmetry and part of it relates to the interdependent nature of decision-making among residential tenants.
In the case of conventional commodities, such as apples, the enjoyment you derive from consumption is based exclusively on the amount that you consume. You do not care about how many apples your spouse, best friend, boss or accountant intend to devour. That means you can base your consumption decision on the price alone.
Housing is more complicated. The identity of your neighbours plays an important role in your rental decision. People are reluctant to live next to criminals or neighbours who play loud music. At higher rungs of the income ladder, renters seek neighbours from a similar social class and education level, in an effort to network and to convey a certain image when they host friends and colleagues. This has important implications for the relationship between price, demand and supply for housing.
In particular, the rent that a landlord can charge a prospective tenant is highly dependent upon the existing clientele. If the current tenants are educated, rich and of high social class, then new tenants will be willing to pay a significant premium to rent. The landlord will oblige by charging a high rent for two reasons: higher rents mean higher profits, as is the case in any conventional commodity; and, the desirable attributes of tenants are all correlated with ability to pay and so by charging a higher rent, the landlord is able to screen out less desirable prospective tenants, and reinforce the agglomeration of elite clients.
If the above makes charging high rents seem like an easy choice for landlords, the key hurdle is the Catch-22 of securing high status tenants: to get elites renting, you need elites renting. This is a considerable challenge and it explains property developers’ aggressive marketing campaigns when they are seeking their first batch of tenants, within the UAE and all over the world. Landlords realise that catching a big fish at the start can set them on a virtuous and self-enforcing path to a stable, elite clientele and so they invest heavily in projecting an image of luxury and pomp.
What does this imply for rent dynamics? With normal commodities, if a seller has excess inventory, lowering the price is the logical remedy. But should demand persistently exceed what you a seller can provide, the sensible course of action is to raise the price.
Price dynamics are complicated in housing because of the interdependent nature of consumption. Raising rents has two mutually opposing effects on demand: on the one hand, as with apples, consumers can afford to buy less and alternatives become relatively cheap, meaning that demand decreases; on the other hand, low-status actual and prospective tenants drop out of the running, while elite ones enter the running, making those who value being around elite tenants increase their demand.
The net effect of these countervailing forces is uncertain, transforming rent-setting into a more complex endeavour than farmers pricing their produce. Thus, when you are wondering why your Dubai landlord is apparently stubbornly refusing to drop rents even though half the building is vacant, recall that he or she may be playing a game of cat-and-mouse with elite renters. Lowering rents may well help fill the building up in the short-term but if the new tenants are not to the liking of the high-status target clientele, then in the long-run, the landlord may permanently exit the high-rent, elite-tenant virtuous circle, hurting profits irreparably.
Analogous dynamics can be observed in many commodities where image, exclusivity and prestige are critical aspects of the enjoyment derived by consumers. For example, many luxury clothes and perfume brands, such as Prada or Chanel, use raw materials that are only marginally more expensive than those used in mainstream brands, but they are able to charge astronomical prices simply because they have locked in to an elite clientele. If Porsche halved the price of its cars, we would expect an increase in demand as many low-status consumers scramble to project an image of wealth and pomp, followed by a crash in demand once the brand ceases to signal elite status.
As Dubai witnessed in 2008, eventually, landlords realise that even the elite’s means are diminishing and so they will respond to vacancies by slashing rents. As UAE renters wait for property markets this year to correct – a process impaired by the status game landlords and tenants play – they should remind themselves of American rock star David Lee Roth’s claim that: “Money can’t buy happiness, but it can buy a huge yacht that sails right next to it.”
Omar Al Ubaydli is programme director for international and geo-political studies at the Bahrain Centre for Strategic, International and Energy Studies and an affiliated associate professor of economics at George Mason University in the US.
business@thenational.ae
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