peninsula briefing - gulf real estate woes not just …...sector, we also think it’s worth...

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PENINSULA RESEARCH

Gulf Real Estate Woes Not Just a Question of Supply - Part 2:

‘Malthus in the Desert’

Dr. Christopher Payne

www.peninsula-reh.com

KEY FINDINGS:

• Between 2013 and 2018, transaction volumes of new and pre-existing residential real estate in Dubai fell every year bar one. Transaction volumes in 2018 were 43% lower than in 2013. As a proxy for the region, lower volumes in Dubai signify the key role that weak demand has played in the downturn.

• A similar pattern of lower volumes and prices can be seen in Dubai’s stock market. As with real estate, the market peaked in terms of both volume and prices in 2014. All GCC stock market indices reached cylical highs in 2014.

• Population change is a short-term driver of real estate prices in the Gulf because of the high proportion of expats. For example, in Abu Dhabi, where data is available, as the domestic economy slowed in 2018, the population shrunk by 3.6% in 2018.



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PENINSULA RESEARCH

Gulf Real Estate Woes Not Just a Question of Supply Part 2: ‘Malthus in the Desert’

Dr. Christopher Payne | February 2020

POPULATION CHANGE PROVIDES THE DIRECT LINK BETWEEN DOMESTIC ECONOMIC PERFORMANCE AND REAL ESTATE PRICES In our first briefing, we established that there had been too much focus on supply in explaining falling real estate prices in the GCC. In the UAE, these debates have become increasingly rancorous, with one major developer criticising another on Bloomberg TV for dumping properties on the market, claiming that Dubai faces a “disaster” from overbuilding.1 The Government of Dubai has also, in trying to allay general concern about supply, established a new council to address excess supply additions and coordinate agreement among developers to limit construction. While we whole-heatedly support measures to control Dubai’s future development, especially in the residential sector, we also think it’s worth reiterating and further explaining our viewpoint: that stronger aggregate demand in the economy will be key to market stabilization and that, to this extent, supply addition cutbacks, while helpful, are not sufficient cause, on their own, for a recovery in prices. Using data published by Dubai Land Department, this briefing will provide further evidence to support our demand thesis. Then, using population and workforce data from Abu Dhabi and Dubai, we will show just how and why non-oil GDP is so connected to real estate prices. In doing this we will invoke the spirit of Thomas Malthus, the first person in England (in the early 19th Century) to hold a professorship in Economics; a man who thought deeply about the connections between the economic cycle and population.

DUBAI’S REAL ESTATE MARKET AS AN EXAMPLE OF A DEMAND AND SUPPLY MODEL Market prices are, at any point in time, an outcome of the convergence of buyers’ demand and sellers’ supply. For example, if prices are falling, then we can either say that there is excess supply or insufficient demand; they are two sides of the same coin. But pointing out either (excess supply or insufficient demand) is decidedly not the same as attributing falling prices to either over-building or falling demand. Let’s take a closer look at the ‘supply addition’ hypothesis. In any normal market, if we assume that consumers’ preferences haven’t changed, what would be the normal effect of increasing supply? The answer: lower prices and higher transaction volumes. We know this intuitively: if the price of something we like goes down, we tend to buy more of it. Following this logic, if prices and transaction volumes fall, this can only be a result of demand falling by proportionately more than supply is increasing. For those who want to re-live their ECON 101 class, we have demonstrated this in the classic graphic formulation in Chart 1 below. In the chart, you’ll see supply increasing from S1 to S2. However, transaction volumes fall only because demand has shifted down by a greater amount, from D1 to D2. Overall, prices fall from P1 to P2 and transaction volumes from Q2 to Q1.



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Chart 2: Dubai villa and apartment units, number of

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Chart 3: Dubai villa and apartment value of transactions,

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Chart 1: Real estate demand and supply

Both Prices and Volume Fall

Does the model apply to Dubai? Chart 2 below, using data from Dubai Land Department, shows very clearly that transaction volumes have fallen: to be exact, volumes were 43% lower in 2018 than in 2013. Chart 3 shows that the total value of transactions has fallen by a greater proportion than volumes, confirming what we already know, that both prices and volumes have declined since 2014. So yes, the evidence does support the demand and supply model in Chart 1 above. Unless Dubai residential real estate has some very strange and unique characteristics (which, by the way, we are pretty sure it does not), the only explanation for what we see is that weaker demand is a greater driving force behind lower prices than additional supply.

Source: Dubai Land Department



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REAL ESTATE AND STOCK MARKETS None of this, to be sure, implies that supply additions aren’t important; after all, the demand and supply model clearly shows that additional supply has exacerbated price declines, even if the main driver has been weak demand. Nor are we disputing that there have indeed been significant additions to residential stock over the past few years. Indeed, the charts above show that sales of new build property have taken a greater proportion of market transaction volume in recent years, as a large number of new projects have come to market. But what matters is overall volumes, not just the volumes of new additions; taken together the trend is clear, even if sellers of pre-existing real estate have potentially borne more of the brunt of lower demand than developers. Perhaps, therefore, it is the increasing sales volume of new builds that has given the (false) impression that supply additions are the predominant problem; after all, a failure to consider transaction volumes of existing real estate might lead one to assume that while supply has increased, demand has remained stable, leading to price declines and volume increases. A comparison of Dubai’s real estate and stock markets is helpful here. Chart 4 of the Dubai General Market Index below exhibits a remarkably similar trend to real estate: both prices and volumes have declined since the start of 2014 as a result of the slowdown in demand. Interestingly, though, of the nine IPOs in Dubai since the start of 2014, five took place in 2014 when the index was rising to its cyclical peak and when transaction volumes were high. In other words, new equity supply in the form of IPOs, rather than depressing prices, were easily absorbed by buoyant demand.

Chart 4: Dubai Financial Market General Index: Prices and Volumes Decline in Tandem: 2014 to 2019

Source: World Federation of Exchanges

POPULATION FLUCTUATIONS This brings us back to considering in more detail why there is such a strong connection between non-oil GDP growth and real estate demand. Part of the explanation is entirely intuitive: because GDP (i.e. output) gets distributed between labour (as wages), capital (as profits) and land (as rent), an increase in GDP results in higher household incomes, dividends and rent. All other things being equal, faster income growth is likely to spur demand to upgrade one’s accommodation, whether one is renting or owning. Our focus on non-oil GDP growth is, in part therefore, just a proxy for household income growth.

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Volumes and Prices decline in tandem on Dubai's Financial Market, 2014 to 2019

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Chart 6: Dubai: Change in relevant workers, real GDP

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Chart 5: Abu Dhabi non-oil GDP growth and population change

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However, in the Gulf there is a further and much more direct connection between non-oil GDP growth and real estate demand: population fluctuations. Take, for instance, Charts 5 & 6 below. Both, and particularly the one relating to Abu Dhabi, demonstrate an incredibly high correlation between annual non-oil GDP growth and annual changes in the population.

Sources: Statistics Centre of Abu Dhabi, Dubai Statistics Center, Peninsula Research

Think for a moment about the UK or France or any developed country. None of them have freed themselves from the economic cycle or, for that matter, from long periods of government austerity (just ask anyone in the UK about that if you are unsure). But when the economy slows there is no expectation that the population will shrink; people lose their job, yes, but only a very small number of immigrants consider ‘going home’ as a result. This is clearly not the case in the Gulf. According to data from the World Bank, expats make up 50% of the population in the GCC; in Abu Dhabi and Dubai, they make up 81% and 92% of the population respectively.2 This compares to a global average of 0.77%, according to the estimates of Finaccord,3 a consulting firm which is part of the Aon group. Given that expats only have a limited time to remain in the GCC if they lose their job, it is little wonder that the population shrinks when the economy slows. In Abu Dhabi’s case, the sharp slowdown in population growth is both very clear and highly correlated with non-oil GDP growth. For the past two years, for instance, while Abu Dhabi’s non-oil economy has sharply slowed, its population has actually shrunk. In 2018, it fell by 3.6%. In Dubai’s case, the correlation is less easy to validate, as we only have worker numbers, which have continued to rise as a result of the construction sector and Expo 2020. Instead, we have looked at the correlation between GDP growth and the change in the number of workers working in sectors where the average salary is above 100,000 Dhs per year. By lagging worker numbers by one year, we arrived at a correlation coefficient of 0.8. Of course, short-term fluctuations in the population of the Gulf are not a new phenomenon. Indeed, we need to remember that in the past 20 years, the phenomenal economic growth story in the GCC has been predicated on the growth of the population. Between 2000 and 2018, for instance, the UAE’s population tripled, rising each year, on average, by 6.4%. These growth rates put a one-year decline of 3.6% in its proper perspective.

MALTHUS IN THE DESERT Annual changes in the GCC population are a key factor in determining short term changes in real estate demand. Put another way, there is a clear and direct relationship between non-oil GDP growth and real estate prices, via the flow of expats in and out the region.



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And this is where the reference to Thomas Malthus comes from. Malthus is infamous for his “Essay on Population”, first published in 1799, which appeared to predict inevitable trouble for humanity, such as war, disease, famine, because population growth (which increases geometrically, i.e 2, 4, 8, 16….) is always greater than the growth of food production (which increases arithmetically, i.e. 1, 2, 3, 4….). As civilisation has progressed, however, this ‘Malthusian trap’ has been overcome time and time again. It turned out, due to scientific discoveries and improvement in agricultural production and storage techniques, that agricultural output could be increased at a geometric rate after all. But what is less appreciated about Malthus was his genius as an economist, pulling together hundreds of years of data on the English population and corn prices to provide the world’s first quantitative analysis of the economic cycle. He may not have been able to predict the future, but he described the past rather well; and the importance of population changes in the determination of wages and economic growth. Essentially, his formulation of the economic cycle goes as follows: wages are high which enables labourers to bring up more children. As a result, the population grows, as does GDP (which benefits little from productivity growth as the economy has few capital goods and a low rate of innovation). However, as the population grows, wages start to fall, and resources get stretched; the ultimate outcome is trouble for all. One way or another – war, disease, or famine often resulting from the competition for scarce resources – the population ends up falling and the economy shrinking. Once the ‘recession’ is over, wages rise again as there is more competition among employers for labourers, wages rise and so the cycle repeats. Now, it goes without saying that the cycle that Malthus is describing is not the current economic cycle in the GCC. For a start, Malthus’ cycles were closer to 50 years in length! All the same, thinking about Malthus is useful in that it reminds us of the role that population plays in the economy as a determinant of demand; and that, in certain circumstances, it can be a key dynamic factor affecting the short-term pricing of assets, such as real estate. One might suggest that real estate market volatility in the Gulf is an illustration of short-term Malthusianism, in which population and the economic cycle are intricately bound; Malthus in the Gulf.

WHAT NEXT FOR GCC REAL ESTATE? Peninsula’s first two briefings have dealt comprehensively with the causes behind the decline in real estate prices in the region. Rather than focusing on supply addition as the key factor, the real culprit, falling demand, has been discussed in detail. To summarise, lower oil prices led to large government deficits, as GCC governments have been highly dependent on oil and gas for their revenue. Governments responded appropriately by cutting back spending and increasing non-oil revenue. Subsidies have been reduced and new taxes introduced, such as VAT. Both are key to the Gulf’s long-term future: ensuring better economic incentives and establishing new, efficient ways to raise government revenue. In the short term, these fiscal controls have lowered growth in GCC domestic non-oil economies. This has had a doubly negative impact on demand for real estate as income growth slowed and, more importantly, because of a decline in the expat population. With a clear sense of the causes of the downturn, our next briefing will focus on what the future holds for the Gulf’s real estate markets.



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ABOUT THE AUTHOR Dr Christopher Payne is Chief Economist at Peninsula Real Estate. Formerly, he was the chief economic advisor at the Dubai International Financial Centre; and head of research at the Kuwait Institute of Banking Studies. He has also worked at Bloomberg LP, JP Morgan and PriceWaterhouseCoopers (where he qualified as a Chartered Accountant). He has 25 years of experience covering developed and emerging markets, and holds a Bachelor’s degree from Cambridge University, England, and a Doctorate from the London School of Economics.

ABOUT PENINSULA REAL ESTATE Peninsula provides asset owners across the Middle East with an intelligent solution that addresses systemic challenges in the market. Peninsula is constructing a risk-weighted, diversified real estate portfolio across the Middle East; adhering to best regulatory and governance practices, and compliant with Shariah principals.

DISCLAIMER This report has been issued by Peninsula Real Estate Management Limited (“Peninsula”) for informational purposes only. It does not purport to be a complete analysis of the topics discussed, which are inherently unpredictable. It has been based on sources Peninsula believes to be reliable. Peninsula has not independently verified those sources and makes no guarantee, representation or warranty as to its accuracy or completeness. Peninsula accepts no responsibility or liability in respect thereof or for any reliance placed by any person on such information. All opinions and views expressed in the report reflect our judgment at this date and are subject to change without notice. Statements that are forward-looking involve known and unknown risks and uncertainties that may cause future realities to be materially different from those implied by such forward-looking statements. No investment or other business decisions should be made based on the views expressed in this report. This document may not be reproduced or circulated without the prior written consent of Peninsula.

Peninsula Real Estate Management Limited +971 2 671 1773 | [email protected] 8th Floor, Al Sila Tower, ADGM Square, Abu Dhabi, UAE

1 Bloomberg News, Dubai Faces a ‘Disaster’ from Overbuilding, Top Developer Says, https://www.bloomberg.com/news/articles/2019-10-27/dubai-faces-a-disaster-from-overbuilding-top-developer-says 2 The World Bank, Data, https://data.worldbank.org/indicator/sp.pop.totl 3 Finaccord, Global Expatriates: Size, Segmentation and Forecast for Worldwide Market, April 2018, http://finaccord.com/BlankSite/media/Catalog/Prospectus/report_prospectus_APG_GEP.pdf


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