Limiting risk: Measures have been taken to slow down the increases in prices

Residential real estate prices are rebounding strongly, prompting the IMF to warn in July 2013 that “action will need to be taken to prevent a bubble”. The government has since implemented a series of changes to regulations aimed at cooling the market and dampening the effects of speculation.

Registration Fees Increase

 On October 6, 2013, the Dubai Land Department (DLD), the emirate’s property regulation and management arm, doubled the registration fee charged on real estate transactions from 2% to 4%, although this is still relatively low compared to global industry standards.

The move was aimed at discouraging the practice of speculative property flipping, i.e. purchasing with a quick onward sale in mind, particularly in the residential segment. The phenomenon had been blamed for inflating house prices in the emirate in the years before the housing crash.

The fee hike – viewed by some as a “stealth tax” in the income-tax-free emirate – represents a welcome fiscal boost for the government in Dubai, which has recorded five consecutive budget deficits, and, together with state-linked enterprises, faces debt maturities of approximately $50bn over the next three years resulting from the 2008 property crash. “The measure kills two birds with one stone by partially addressing concerns about speculative activity and future overheating in the real estate market and raising revenue at the same time,” said Giyas Gökkent, the chief economist at National Bank of Abu Dhabi. Barring the possibility of an exclusion for warehouses and industrial property, the extra 2% fee would have netted the government around $839m in 2012. At the pace set in the first three quarters of 2013, when total sales came in at Dh162bn ($44.1bn), the sales tax could earn the government up to $1bn annually.

Though widely lauded by analysts as a much-needed measure to slow the pace of growth in the property market, the marginal fee hike is likely to have only a modest dampening effect on speculation. Profit margins of up to 10% are high enough to justify the additional 1% in sales registration fees for “fly-by” investors (assuming the 2% DLD hike is split between buyer and seller). There are also concerns that the move may burden the legitimate market during a fragile recovery by adding additional costs of around Dh50,000 ($13,610) on an Dh2.5m ($680,500) Dubai apartment or Dh120,000 ($32,664) on an Dh6m ($1.6m) villa.

“It is likely to be the consumer that will end up paying for this, as the seller will no doubt push prices up,” Mario Volpi, the managing director of Prestige Properties, a Dubai-based broker, said. “It’s a short-term fix for a long-term problem.”

In this reading, regulatory intervention could act as a red flag for some investors weighing up whether to enter the market. Indeed, according to the property broker Cluttons, average house prices in Dubai grew by 8% in the third quarter of 2013, a respite from the 23% increase the company reported for the second quarter of 2013. Cluttons’ findings show higher rises in property prices than comparable research by Jones Lang LaSalle, which reported an average gain of 6% for the third quarter. The slowdown also corresponds to new rules set by the Central Bank of the UAE that impose limits on the size of mortgage loans for housing.

Mortgage Regulation

Between 2006 and 2008, competition in the Dubai mortgage market was such that 90-95% financing became commonplace. Banks were permitted to lend 100% of a property’s value to home buyers, and there were no restrictions on the number of properties that a buyer could finance through mortgage transactions. More than 90% of these were for off-plan properties, which meant that banks did not even have proper collateral to fall back on.

When the financial crisis hit, prices plunged by more than 50% and thousands of mortgage holders were left in negative equity. Investors balked at making payouts on properties that had shed almost half their value, while banks got tough in enforcing the payments that were due to them. The UAE’s two biggest mortgage providers, Amlak and Tamweel, were forced to stop lending for almost two years as mortgage financing ground to a halt.

Mortgage Cap

Given the potential asset-quality issues that could crop up from another real estate boom, and recognising the need to reduce speculation and excessive liquidity, the Central Bank of the UAE imposed new maximum loan-to-value (LTV) limits for residential mortgages on October 28, 2013. The mortgage cap is a macro-prudential measure that defines the eligibility of various categories of borrowers based on LTV ratios.

For first-home properties valued at up to Dh5m ($1.4m), bank financing will be allowed to reach a maximum of 80% for UAE nationals and 75% for expatriates. In cases where the property value exceeds Dh5m ($1.4m), loan eligibility shall not exceed 70% of the value of the property for UAE nationals or 65% for expatriate borrowers.

For a second house or investment property, loan eligibility is capped at 65% of the value of the property for UAE nationals and 60% for expatriates. Under the revised rules, expatriates could not finance third or subsequent homes with mortgages; they would have to pay cash.

The maximum LTV for mortgages on property being purchased off-plan (that is, before construction) will be set at 50% regardless of the purpose or category of purchaser. Only two UAE banks currently lend to off-plan property buyers.

These measures are intended to act as a speed-break on buyers seeking to tap banking finance to acquire additional properties for quick onward sale. Credit ratings agency Standard & Poor’s (S&P) has also suggested that the new mortgage rules will boost the long-term credit risk profiles of UAE banks and property developers by forcing them to adopt more conservative lending practices.

“We believe the mortgage caps could help reduce market volatility and ultimately loan losses, and prevent another boom-and-bust cycle that was witnessed in the UAE property markets over the past decade,” said Tommy Trask, an S&P credit analyst.

The impact of the mortgage cap is likely to be limited by the fact that over 80% of residential transactions in Dubai are driven by cash buyers. The 20% of transactions driven by mortgage holders is down significantly on the 49% recorded in 2007, before the downturn in the property sector. Moreover, the regulations do nothing to prevent buyers from accessing capital in another market for use in speculative activity in Dubai. However, the consumer market is changing. According to a July 2013 report from the DLD, buyers using mortgages bought 6050 properties worth a total of Dh51.3bn ($14bn) – roughly double the number of purchases recorded in 2012 and a 67% increase in total value.

The report points to growing numbers of long-term buy-to-let investors from both the UAE and abroad, plus an increase in owner-occupiers, all fuelled by affordable mortgage rates of between 4% and 5%, down from an average of about 7% five years ago.

This has resulted in significant growth opportunities for mortgage brokerages and consultancies. Groups such as Home Matters, Independent Finance and InvestMe Financial Services have increased staff numbers and doubled or tripled business over the past two years, capitalising on demand for residents looking to cut their housing costs by buying property and existing home owners seeking to remortgage properties purchased at higher interest rates.

Other Schemes

Other regulatory measures proposed by sector experts aimed at speculative flipping include deposit requirements, a sliding capital gains tax based on the amount of time an asset is held and 90-day minimum holds for non-agent buyers in off-plan sales. The government is reportedly looking at measures to regulate the off-plan market segment with alternatives including point-of-sale or resale restrictions linked to the completion of a percentage of construction or payment schedule.

The requirement for 30% payment on a property before it can be sold on could be increased to 50%, for example. This could have a knock-on impact across the whole market given that most speculation is occurring in this segment.

Laws that took effect in 2013 already appear to have had an impact, with international real estate consultancy Cluttons reporting a slowdown in the growth of average house prices from 23% in the second quarter of 2013 to 8% in the third quarter.

Although it is uncertain what the long-term impact of initiatives such as the mortgage cap and doubled registration fee will be, the short-term indicators support the view that regulation will continue to play an important role in moderating players’ speculative behaviour and cooling an overheated market.