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How will rising US interest rates impact on Dubai property?

June 3, 2004 1:35 pm

Low US interest rates have been a major factor propelling housing markets upwards around the world. Yet capital markets now anticipate an end to cheap money, with the first up-tick in US rates as early as next month.

To step back a moment, it is instructive to look at how US interest rates are linked to UAE mortgage borrowing. It is true that the local base rate is a direct consequence of the level of US rates. But local lenders do have quite a lot of leeway in deciding the mortgage spread, or the premium above these rates that they actually charge borrowers.

For example, we have a base rate of 1% for US Federal funds today, while Amlak Finance charges 6.5% to mortgage borrowers in Dubai. Thus even if US interest rates rise Amlak Finance could choose to take some of this pain – in the interest of keeping its business growing – rather than pass it on immediately to borrowers.

We also have to consider how fast an upturn in US interest rates is likely to be. In market terms will the Fed go for an aggressive or progressive tightening of the interest rate? There is some historical precedent here; in four out of the past six recoveries the rate hike has been aggressive and in two moderate.

An aggressive tightening would mean a shift towards 4-5% within 18 months, and moderate advances would mean 2-3% over a longer period.

Now from the Dubai property perspective, it could be argued that an aggressive rate tightening would dampen the market, whereas a moderate increase might be partly absorbed by lower mortgage spreads and cause little damage.

There is another important point to consider. Dubai property prices are very low in global terms and to date the vast majority of buyers have been cash buyers. Thus mortgage rate changes will not impact on this market in anything like the same way as in the United States, for example.

However, in the Dubai property market higher interest rates would start to make property rental yields less attractive to investors, and this would be a dampener on the market.

But if US interest rates are rising due to worries about inflation due to a very high oil price, and $40 per barrel was breached last week for the first time in 13 years, then this region is going to be awash with cash and this high liquidity will surely feed into higher real estate prices.

Then we come back to the argument about whether Dubai property is cheap on fundamentals, i.e. relative to other investment opportunities. And so long as rental yields hold at present levels there is not much doubt about that.

Overall, this article is trying to balance up a number of countervailing economic factors that determine the strength of a property market. Higher interest rates are just one aspect of this equation and should not be overstressed in the particular case of Dubai which is rather different to more mature markets.

More complex is the analysis of future demand and supply in the Dubai property market which has been, and will be the subject of many more articles.