Credit Crunch

The Credit Crunch - Part 2

Since publishing our first in house views on the credit crunch things have moved on quickly and dramatically. The IMF has recently predicted a major global slow down and on all fronts the world seems pretty bleak. As such we felt that it was time to continue with our commentary, to keep you informed of our current views and how the current market turmoil will impact on the markets we focus on.

 

In our last article we discussed how we felt the various real estate markets would be affected by the fall out of the subprime collapse in the United States. This could be summarised as “believing that the Anglo Saxon markets over exposed to stretched credit limits would be the worst hit and will flounder for a number of years”. Little has changed to alter this view particularly in the longer term, however currently the panic has spread much further, with doubt and fear moving to every market across the globe.

 

As newspaper, websites and blogs furiously report and debate (some, distressingly enough, with an element of glee), we aim to provide a balanced commentary highlighting recent global market swings, and their impact on regional movements in the markets we feel should be better insulated.

 

Over the coming weeks we will be focusing on our different markets and aiming to keep you all as well informed as possible. The articles will be punctuated with independent research just click on the links to view the documents.

 

To begin with, this week we are focussing our attention on the UAE.

 

Lets start by looking closer to home, it is important to state that daily or weekly immunity from price swings in any global market is impossible. Such is the uncertainty that currently grips all market participants, it is inevitable that the psychological focus placed on the current falling market is – “how far, how long and surely nothing is safe?”

 

If we look at the recent falls in the world’s major stock and housing markets it is easy to see why investors feel this way.

FTSE

 

DOW Jones

Dax

 

With all participants in the same frame of mind this rationale is actually reflected in the heavily debt exposed markets of the west – those with the riskiest banking fundamentals, and then spreads to other markets. As investors worry that all investments will fall, rational assessment of risks makes way for position protection by taking out cash – which leads to the first stage of the uncertainty, “how far”.

 

The liquidation of these positions starts the fall, then in the short term further non-participation results in more price drops as markets are unsupported by buyers not willing to commit to a purchase – here is your second stage of uncertainty,  “how long”.

 

Once the drops have become so severe in the stock markets of the West, the fear spreads and leads us into the “surely nothing is safe” stage.

In our opinion this is the issue we currently see affecting many of the emerging economies that are still widely expected to continue positive GDP growth despite the possibility of a significant slowing of global productivity.

 

This then leads us onto the question - will Middle Eastern and other Emerging Markets recover faster and suffer less (based on their stronger fundamentals now and in the future) or is the future as bleak as that of the more advanced economies.

 

The best way for us to tackle this question is to study the effects the current turmoil is having in the West and then examine the knock on effects in the specific region.

 

With the root cause behind the current global turmoil being bad debts, it was widely believed that the oil and the cash rich states of the Emirates would be immune from the market turmoil. However over the past month or so, as confidence drained from any remaining market that contained a level of optimism, the share indexes of Dubai and Abu Dhabi both begun to see falls and last week a crash.

 

We consider the delay between bearishness in the Western markets and those of the UAE to be a significant observation.

 

ADX – Abu Dhabi Stock Market

 

As you can see the index rose steadily during the course of the year even when other markets were  falling. Sharp falls have only been witnessed recently as panic has spread and market participants have looked to exit in haste to preserve wealth rather than to take a risk on testing the markets strength.

 

Is this justified judging from domestic market fundamentals? We feel not. The falls have been characterised by a lack of transaction volume on the markets. The companies listed on the Abu Dhabi exchange generally have strong capital structures and operate in a core market (UAE) that is still expected to see strong GDP growth in ’09 and has one of the highest GDP per capita levels in the world.

 

A good example of how this “vacuuming of participants” has led the market is with Aldar Properties, the second largest real estate company in the U.A.E and the largest in Abu Dhabi. Currently listed on the ADX they have strong capitalisation and some of the most popular projects currently under construction in the region. Every project they have launched so far has achieved close to if not actual 100% take up. Profit growth in 2008 was 203% and growth prospects for the Abu Dhabi property market remain strong.

 

Asteco Report - Abu Dhabi

 

Shares have now dropped to a point where they are priced significantly under the assets on the companies’ balance sheet and so the company is now planning a significant share buy back.

 

These market drops highlight panic and uncertainty rather than a fair reflection of future value and growth on a macro scale in the U.A.E.

  

It has now been widely reported by many analysts that Dubai should see price corrections in real estate values of 10 -15% over the next 12 months. This research and  the above conclusion was reached by Morgan Stanley in a recently published report.

 

We do not completely disagree with this statement however it is very important to highlight two issues that are often over looked and that we believe were overlooked in Morgan Stanley’s findings

 

1. From what level will prices drop from?

2. If Dubai under-performs, do all the other Emirates in the UAE follow ?

 

As with any mature property market, the real estate prices in Dubai vary greatly throughout the Emirate. In many cases it is difficult to see the justification for the prices being asked by some sellers, particularly when you compare the prices being asked for some developments with those on the open market (or re-sale market).

 

Due to high developer pricing forcing up the entry cost in Dubai, many new projects have become unaffordable, in much the same way the UK has seen. Its therefore clear that the market participants charging high prices will need to bring those down to more acceptable levels to in order to kick start sales again, particularly as more and more units are delivered to the market over the next 2 years.

 

Because of this un-affordability, an emerging trend is beginning to unfold whereby Expats and long term residents are looking to move to the much more affordable northern emirates such as Ras Al Khaimah, Ajman and Umm al Quwain. Prices for real estate in these Emirates are considerably cheaper than other parts of the UAE and will offer a more scenic and a less congested lifestyle. Growing tourist demand, favourable tax laws and healthy employment in the region continues to lure people looking to expatriate from all over the world.  This is just one reason why we feel demand should continue on well priced and well located accommodation within specific regions in the UAE. We also expect to see price stability and moderate growth, even in these difficult times.

 

Asteco Report - Ras Al Khaimah
 

ARCHIVED ARTICLES

The Credit Crunch Part 1 -  Past, Present & Future

The interesting debate going forward is how will this effect the world as a whole and who will be affected the most?

In this statement we aim to share our view and although it may be different to yours we would be very interested to hear what your opinion is. Please post replies to the “Credit Crunch” thread on our forum http://www.emconcepts.co.uk/forum/index.php?topic=12.0
 

Please note this is not written as a comprehensive study or guide. It is aimed to give a background and open debate for the future. The views expressed are our personal opinions and should not be taken as advice.

Where it all started

Following the aftermath of the attacks on the world trade centre, the US economy fell pray to a major lack in consumer confidence.

In response to the worst terror attack in US history, Alan Greenspan  (then chairman of the Federal Bank) felt that monetary stimulus to prevent a recession must happen at all costs.

To do this, US interest rates were slashed to 1% in order to facilitate consumer spending and keep the American economy on track. It worked, with money so cheap people could not spend enough and as night follows day borrowing began on a mass scale.

At this time the US mortgage market, the worlds largest debt market, was still well regulated with banks vetting applications on a means tested basis. However that a large section of the population were missing thisoppertunit to borrow. The self employed and low income/bad credit rated demographic of the US were missing out on home loans. Their inability to prove income and financial stability meant that banks would simply not lend.

Brokers, however, sensed an opportunity and were keen to develop this large untapped market. They could borrow cheaply from banks and then flip these loans to the sub prime market, charging large risk premiums (difference between the borrow and lend level) to these borrowers.

These premiums started off relatively narrow for an introductory period, and increased after the intial period (around 2 years) elapsed. The Banks then repackaged the loan exposure as complex derivative products, mortgage-backed securities (MBS) and collateralised debt obligations (CDOs), and sold these to the highest bidder.

Asset prices begin to inflate

Even with the high risk premium on mortgages, interest rates were so low that most borrowers could still afford the home loans and so the housing boom began. More people borrowed, buying and selling property betting on what was seen to be a one-way market. More money was lent to the sub prime sector so they could buy ever more valuable houses – sometimes at 100 – 125% LTV.

The banks, now heavily exposed to this sector, felt they were onto a win win situation. As the loan is paid back, the spread is retrieved. If the loan defaults, the house is repossessed and sold at a profit. Money was being made and this led to a lot of banks posting huge profits. Furthermore, due to the high yields attached to the derivative options their own stock was also rising.

Trouble brewing

Low interest rates and heavy consumer spending led to the inevitable rise in inflation. Americans and the British were buying anything they could - cars, houses and then repackaging their over borrowing into “consolidation loans” . With the dollar falling fast (due to its low yield and the ever widening US trade deficit) prices of imported products were also on the rise.

In order to counter these inflationary pressures Alan Greenspan and the MPC began to raise interest rates in the US and the UK. This happened in the US at a remarkable rate of 0.25% every month for until the target of 5% was reached. This was the level the Federal Bank perceived as the equilibrium point for inflation capping without stifling growth.

However, with many sub prime mortgage rates at 3-4% above base rates (once the cheap introductory period expired), home loan repayments of up to 9% on large loans were going to prove too rich for the sub prime sector.

Pop

At the end of 2006 and the beginning of 2007, consumer credit levels in the US and UK were incredibly high.  Worryingly as 2007 unfolded, loan defaults in the sub-prime market were on the rise and house prices had begun to fall.

The banks started to show concern and scrambled to analyse and evaluate how much exposure they had to the ever rising value of US consumer bad debt and more importantly their exposure to the rapidly falling value of MBS’s and CDO’s - the products in which ths debt was hidden.

When the results started to tick in, the math’s on loan recovery and the values of complex derivative products did not look good – both paper and real losses began hitiing ther books.

UBS, CITI Group, HSBC and every other major global bank began announcing huge write-downs. Northern Rock  was exposed heavily to the mortgage and securitization market and had to eventually be nationalized. Towards the end of 2007 the economists were predicting global losses to reach USD300bn.

With the losses still piling up and with the possibility of banks going bust, liquidity began to dry up. Banks would not lend to one another for fear of the loan falling into a black hole and the debt not being repaid.

Inter-bank lending rates rose to almost the highest level over base rates in modern history. The risk premiums on loans to businesses increased, reducing highly geared (large levels of borrowing over share capital) firms profitability. Reducing exposure to bad debt and cutting costs was and still is a major priority for banks.

Present

Where we are now

The losses of USD300bn, as predicted by the economists, seems to be conservative. Current losses are said to stand at over USD300bn and some predict that write downs may continue until they hit USD600bn perhaps reaching the trillions.

As banks are not willing to provide each other with liquidity, their desire to continue lending to private investors/ borrowers has also waned and the fees they charge on debt (interest rates) have risen.

Countries - mainly the anglo saxon nations - with a population largely exposed to personal debt are seeing property prices fall, consumer confidence wane and GDP fall. Unfortunately, for many of us, this is exactly what we have seen and continue to see in the UK and the US.

Our Opinion - The broad effect on global property prices

US Housing

The problem with housing in the US is exasperated by the over supply of new housing. This has led to yields and prices falling and giving no bottom to the market. It seems this will continue until, as Alan Greenspan states, “the over hang of new build property is taken up” or indeed until the US population feel they are getting fair property values again. Either way prices look like they are set to fall further.

UK Housing

To some extent the same is true in the UK – albeit for slightly different fundamentals. Banks are currently unwilling to lend and therefore many people are unable to buy property or re-finance their existing one. Unsurprisingly, prices are falling, and they will continue to fall until the banks regain confidence in their lending regulation and criteria and allow people to start borrowing again.

The interesting counter point in the UK though is the undersupply of housing. Our rapidly expanding population and lower number of people buying properties  means there is more competition amongst those looking to rent and landlords are likely to increase rents to cover mortgage costs. As rents rise to levels that provide sufficient cover for mortgage costs, buying will become attractive again and the drop in prices may slow.

This could change, rents may fall if a large number of owners choose to leave the UK and offer their property for rent property (increasing the supply of unoccupied properties) in the hope of riding out falling asset prices. This increase in competition amongst landlords may put downward pressure on rents; force more sales as rents struggle to keep up with mortgage costs, tipping prices lower.

We feel this is unlikely though and given current yields to interest exposure on a 90% LTV mortgage, house prices should fall 10-12% over a year/ 18months. By then banks should be looking to get back in the mortgage market and paying a mortgage will seem to make more sense than paying rent.

Emerging markets

It would be fool hardy to state that an area of the world will not be affected by the current credit crisis. Inevitably huge losses in the West will have an effect on the countries that feed them and feed off of them. However tomorrow world looks to be different to that of the past. 

As this crisis spreads, to us it seems that many of these markets have a cushion of growth, low levels of consumer debt and strong agricultural exports to feed the ever -increasing numbers of mouths in the East and West. The riches being created by this growth means large corporate companies are moving into these markets, creating jobs and an ever-increasing desire for up market living accommodation.

Many of these countries also provide low cost of living and improved surroundings in which to live. Therefore the trend for people looking to retire and move to these environments is on a steep upward trajectory.

As world growth slows, the rapid growth in emerging market economies may wane, but steady and consistent expansion should prevail. Investors seeking rapid asset growth promised by many may find themselves disappointed but those looking for strong, rising yields and growth that should outstrip the west should be focusing their attention on emerging markets.