London rentals, why not London house prices?

You would not imagine that property would be selling at a discount to global prices in the Middle East's commercial capital during an oil boom. And yet remarkably this is still happening.

The benchmark is the price of completed property. Take a standard Meadows villa in Dubai. This sells for $600 per sqft. You are not going to find a similar property in a London suburb for less than $800 per sqft and in the centre you will pay double that amount.

Yet if you compare the immediate economic outlook in Dubai to London there is quite a contrast. London is feeling the full impact of the global financial crisis, high oil prices and falling house prices. Dubai is benefiting from oil price inflows to the region, booming real estate and bankers are coming to live here to recycle petrodollars.

Negative real interest rates

More importantly the fall in US interest rates has been matched in Dubai because of the local currency peg. This has turbo-charged real estate price increases in the past couple of months delivering some of the highest price increases seen in the current boom, around 10%-15% on anecdotal evidence from the property adverts.

Now local investors are naturally asking: how long can this continue? How high can prices go before new supply knocks prices back?

Well, property up trends often last for a good deal longer than most skeptics expect. London prices looked high to some observers in 1998 but still went on to treble in the next decade. Is Dubai going to be any different?

The difference is that Dubai is an emerging market with a large new supply of real estate under development. London never had this new supply so prices kept on rising as the economy grew and people borrowed what now look like absurd amounts of money to invest in housing.

Dubai property prices will eventually correct due to new supply but from a much higher level of prices than those currently seen in the marketplace. It is going to take time to deliver that supply in any case.

Russian and Middle Eastern buyers

Who will be the buyers at these higher levels? Perhaps not the UK second home market which is in trouble, rather it will be the oil-rich Middle East and Russians that decide to invest in Dubai real estate over the next couple of years, and force prices up to an even higher level. That is what happened in Central London and Monaco, why not Dubai?

At the same time the increasing supply is likely to impact mainly on rents - stabilizing them - and buyers will have to accept a lower return on their investment in Dubai property. With interest on dollar deposits at less than 2% this is still likely to be attractive to buyers.

Dubai rental yields are presently way too high at 6% to 8% and this is where the down pressure will be felt, not on prices which still have a long way to go up to meet global prices that are on the way down.

See also:
House prices will spike in autumn
Yield compression to drive property prices higher