Lessons To Be Learnt From Real Estate Crisis in Dubai in 2009
By Viraj Bagadia
Accommodation Times Bureau
Dubai Real Estate Crisis:
In Nov 2009, Emirate of Dubai, which had a total debt of $80 billion, proposed to delay the debt repayments. It asked creditors of Dubai World, which had to repay debt of $59 billion out of the total $80 billion, for a moratorium of six months. It needed to restructure its debt. In response to the government announced moratorium of Dubai World’s debts, both Moody’s and S & P’s
Investors Services heavily downgraded the debt of various Dubai government-related entities with interests in property, utilities, commercial operations and commodities trading.
What led to Dubai Crisis:
· Dubai financial crisis occurred primarily due to speculative investment by foreigners and it was virtually akin to trading in real estate.
· The demand of property was very high from foreigners who wanted to convert their black money to white. It was done without finding out about project cost, area, location, facilities and booking the property on the day of its launch even though it was to be delivered three years later.
· Big developers were attracting only investors and the end-users had been literally wiped out of the market.
· For developers such as Nakheel and Emmar, people were using their contacts to get appointments and no one checked the prices or completion date of projects they were buying.
· Investors traded in real estate by buying one moment and selling in another. The whole market was operating primarily on foreigners’ money.
· During this real estate boom period, even projects of smaller developers were in hot demand. Some not very well known developers started mega projects and people without thinking booked properties. Everybody in Dubai was buying selling and trading in real estate.
· Banks and financial institutions took the risk of granting loans to projects without being assured of its revenue model.
· But due to the financial crisis & with recession in the West, foreign funds started ebbing leading to the artificial escalation to deflate.
· The oil prices fell steeply.
· People who lost their jobs couldn’t pay for the mortgages. Others who had paid the down payment were stuck with expensive properties that had no buyers.
· There was stockpiling of buildings, too many buildings were ready with not actual endusers to stay there.
The market suffered from a liquidity crunch & crashed. Buyers who hadn’t researched about developer credibility lost a lot of money as developers fled the market leaving unfinished projects. Dubai was a bubble where no financier did their homework or due diligence on the market or the developer.
Can such real estate crisis happen in India:
· In India, even though trading in real estate was rampant during the boom period, a majority of funds came from domestic investors and there were some actual end-users too in the market at all times.
· The rules for lending are stricter. Reserve Bank of India has put in place very strict risk management practices, especially concerning lending to real estate. The entry of foreign debt into sovereign debt is quite limited. The share of FIIs in sovereign debt is quite limited.
· Even though there could have been higher prepayments and higher defaults but it would not take the proportion of a crisis, as home buyers still put in a large proportion of equity in homes and also mortgage market is very different in terms of debtor liabilities.
· Also an inherent strength of Indian lending norms is being very conservative in the way the loan eligibility is determined in terms of the income of the borrower as well as the loan to value (LTV) of the property ratio.
Lessons in Real Estate to be learnt from Dubai crisis:
The genesis of Dubai financial crisis was the relentless trading in real estate on the back of foreigners’ money and lenient lending by banks and financial institutions.
· The biggest lesson borne out of the Dubai crisis is that speculative investments are not good for any real estate market in the long term. Easy liquidity spawned by the sumptuous stimulus packages of various governments led to excesses both in the stock market and in the property market.
· Developers should launch buildings as per actual demand and not erect virtually a city a day with high-class facilities. Millions of high-rises in the emerging markets could spell doom.
· Diversification is the key. Dubai had built a towering empire on the shoulders of the commercial real estate sector. A nation can’t build a healthy economy on the back of one, single sector but needs economic activity from multiple sectors, to lessen the impact of potential bubbles. A diversified economy can go a long way to lessening these bubble effects.
· Also debt structure is important. Taking on debt can seem like an easy way to finance future growth, especially when the profits are rolling in. But endlessly issuing debt without consideration for future ability to repay that debt can engender a crisis down the road. Dubai took on massive amounts of liability, figuring that the real estate boom would continue to thrive and keep its construction companies building. But bubbles happen, and so do the after effects of those bubbles deflating.
· Foreign investing can be risky: In addition to traditional company-specific risk, there are added dangers of political, legal, and currency risk.
· Regulations: Governments should take strict measures to check housing investment and speculation, and only extend preferential policies to buyers who will occupy the homes.
Favorable lending policies for second-home buying, which have fueled speculative housing demand, should be abolished.
· A set of strict examination procedures, such as on individual financial status and credit records, should be adopted to ensure applicants are suitable for home mortgage lending.
Dubai won’t be the last victim of financial collapse as the global economy gets itself back on track. Though Dubai’s troubles don’t appear to have seriously affected the rest of the world, but that may not be the case next time. By stringent regulations, diversifying, focusing on highquality and financially stable investments, and accepting and limiting portfolio risk, investors can take steps to make sure their portfolio is protected from the worst of any coming financial storms across the globe.
View Expressed by Author is of his own, the paper may, may not subscribe to the views expressed in the article.- Editor