Complex Made Simple

House prices jump as interest rates fall

Last week the US Federal Reserve cut interest rates to 2%, an action quickly followed by the UAE Central Bank, as the currencies remain pegged.

But falling interest rates have already put Dubai house prices in an upward spin this spring, with 10%-15% increases in asking prices across the board. However, prices are already going much higher.

The so-called ‘carry trade’ used to be something for hedge funds. It sounds complicated but the idea is simple enough: you borrow cheaply in one currency and invest that money in another that gives a higher return.

Now the same principle is being applied to Dubai property by an increasing number of foreign and local buyers. Moreover, because the US dollar is pegged to the dirham you have no currency exchange risk. In fact, your only currency risk is a revaluation which will make your house in Dubai worth even more in dollar terms.

The authorities have dismissed the idea of a revaluation for the time being, although the current resurgence of the US dollar – from a very low base – could cause them to revise their plans as a revaluation could be accomplished now with little negative impact on the greenback.

Dollar resurgence

But the resurgent dollar will likely be a further prompt to foreign buyers, especially from Europe and, increasingly, Russia.

The US dollar bouncing back makes Dubai property investments rise in parallel in euros and rubles.

However, the carry-trade argument for buying is stronger than fears over the US dollar, which could well resume its collapse this autumn. Indeed, it is hard to see the current financial crisis coming to a sudden and neat end – the average duration of past financial crises has been three years, with the greatest suffering for investors usually coming in the latter stages.

Dubai property with its 6%-10% rental yield looks an excellent buy in a world of 2% money. Of course, borrowers generally have to pay more but cheap money is definitely back. Look at the 4.3% Nakheel is paying on its latest issue of Islamic bonds.

Prospective buyers should also realize that this downward shift in borrowing costs takes time to work its way through the system. Local mortgage rates, for example, have not moved much recently.

Interest rates

But as the ultra-low US interest rate persists – and it could go to 1% or even 0% if the financial crisis lasts – then UAE borrowing costs will drift lower and lower, and carry trade money will appear in the market.

This is bound to stimulate yet another round of investment in real estate in search of higher yields in the case of completed property, deposit inflation in off-plan developments and price inflation for land purchases.

Prices that look attractive today could be out of reach for many by the late autumn as a house price spiral takes off fuelled by lower and lower US interest rates.

That could even prove to be the economic force that breaks the dirham peg – but then property owners would love that one-off boost to their investments, at least in US dollar terms.