In the investing universe, whole worlds burst forth at times from just a few observations, even though the emphasis has always been on the multifarious.
The hottest housing markets in 2021-22 had two themes in common: 1) The majority of deals transacted were done from Russians and 2) a significant percentage of deals transpired in cash (which therefore explains the surge in luxury markets). There was a third overlooked variable, which was the fact that in all cases, international buyers outbid residents (in some cases by much as 50 per cent where data is available, and therefore skewed the values towards the luxury space).
And where markets have caught up, there has been a shrinking of demand as interest rates have worked their ways through the economy. From Canada to Australia to Seattle and Fort Lauderdale, despite the high percentage of cash deals, prices have now started falling (between 8-17 per cent from their respective peaks achieved only months ago).
A rush to launch
Demand has been highest for gated luxury communities and, in most cases, developers have raced to offer new supply only to meet with price resistance. The narrative has now shifted to the opening up of China, which may or may not lead to a fresh wave of foreign purchases as the Chinese economy regains momentum with the lockdowns being removed. (Ignored in this analysis is the fact that domestic Chinese real estate is trading at significantly below replacement values in many cases).
Meantime, the mid-income space remain well below their pre-Covid pandemic peaks, and both bids on new contracts as well as asking prices in the secondary markets have dropped. Sellers often overlook signs of shrinking demand until well after the fact, and as servicing debt levels continue to rise, potential buyers are choosing to stay on the sidelines in many of these oft- commented ‘hot’ markets.
Find value in older buildings
How does this impact investors in Dubai? The temptation has always been to focus on a) new builds and b) chase price rises in hot markets. Yet, the replacement value has always been a variable ignored in most market commentary. The slowdown as a result of rising interest rates exert downward pressure on older buildings (which increases the attractiveness of purchasing such assets, despite the increasing costs associated with these).
This is reflected in the data of mid-income apartment complexes, which have not participated in the upsurge in prices. The gap between older and newer building prices in the same community by the same developer has widened to more than 40 per cent in Dubai Marina, JLT and JVC, and this does not account for the most recent launches in JLT and Greens, which only serves to widen it even further.
Price gap is widening
Whilst there has always been this price dislocation between new and old builds, in mid-income communities, the median gap has hovered at between 15-20 per cent ceterus paribus. This recent widening presents an arbitrage opportunity, something that we have started to see being capitalized upon in certain areas like the Greens, Marina and JVC.
In communities like the Greens and JLT, there has been an uptick in activity as end-users (and in some cases family offices) have started looking for larger spaces. Buyers have demonstrated more sophisticated ability to distinguish between better quality old builds and those that have decayed. In both cases, the demand is starting to rise as the dislocation has become too large to ignore.
In secondary markets, there will always be a challenge to have the same kind of liquidity you see in the primary launches. Especially in a market dominated and driven by the ‘suburbia’ effect. But transactions reveal buyers are willing to take this risk.
Analysts are more or less unanimous in their view of prices stabilizing this year after a record 2022. There is almost a sense of elevated flamboyance accompanying the commentary. This may or may not be true – the argument does seem to be somewhat betrayed by its tiresome repetition. More importantly, they appear to be missing an obvious trade: the tilt in transactions towards secondary markets as investors look to capitalize on communities and developments where prices remain close to their replacement values.
It is time for mean reversion to exert its gravitational pull again.