Falling cost of finance to boost Abu Dhabi realty prices

The UAE dirham has a fixed peg to the US dollar, and while this is frequently discussed in the context of currency devaluation and local inflation, the impact on borrowing costs is sometimes overlooked.

By linking to the US dollar, the UAE Central Bank has to shadow US interest rate policy. Recently the Federal Reserve dropped its base rate to 2.25% and analysts expect 1% or lower before the end of the year, depending on whether the US economy comes out of recession.

The UAE by contrast is in an oil boom of the like not seen since the 1970s. Applying low interest rates here is like applying a turbo-charger to a Formula One racing car. You are going very fast, and then suddenly you are going even faster.

Turbo power

Now the real estate sector is particularly sensitive to interest rate policy, especially when it is already booming and local inflation rates are high. For if you borrow money very cheaply and then can immediately invest for a much higher return, the profits will be enormous.

In Abu Dhabi this is what is happening with off-plan property speculation. Investors borrow at low cost and then wait a few months, or just weeks, and sell their property at a profit, less the cost of borrowing.

The problem is that this sort of speculation quickly gets out of hand, and a boom will turn into a bust when something happens to disturb this virtuous profit circle.

At the moment in Abu Dhabi the release of apartments by the major developers is happening in a controlled fashion, and the market is not being flooded with new schemes. Partly this is a sensible attempt to keep the market stable; partly it must be a view on the capacity to deliver the product within a reasonable timeframe.

US rates falling

But as the cost of money falls, and analysts reckon US rates could fall to 1% or less this year, then the turbo-charger will be applied with even greater vigor to Abu Dhabi property, with more money at lower interest rates available to chase prices higher.

In these circumstances it would not be unreasonable to predict that the gap between house prices in the UAE capital and comparable cities around the world will be closed in record time.

That would almost certainly mean further upward pressure on local rents too, but in a true price spike then rental yields might fall back towards global norms as well, and that would lessen the impact on rents.