Lending to the nation’s construction and real estate sector rose markedly in 2013, according to data from the Central Bank of the UAE (CBU). In December 2012 the total amount of outstanding credit to the sector stood at Dh129.2bn ($35.2bn) – comfortably within the range mandated in the wake of the global economic crisis and deterioration of real estate markets in Abu Dhabi and Dubai.
However, just one year later this figure had swelled to Dh180.9bn ($49.2bn) – the biggest rise since the jump from Dh66bn ($18bn) to Dh119bn ($32.4bn) between 2007 and 2008. Data from the CBU for June 2014 showed the upward trajectory continuing, with total outstanding credit to the sector at around Dh186bn ($50.6bn). This uptick in construction and real estate lending has caught the eye of industry observers, some of whom draw parallels with the overheated pre-2008 market.
From a banking perspective, concerns have arisen about lenders’ exposure to real estate developers and, at the other end of the industry, the risk of widespread mortgage defaults should the sector see a sharp correction as it did some years ago. However, there are important differences between the fundamental underpinnings of the two eras – both in terms of the factors driving growth and the manner in which the authorities are regulating it.
As the increased lending to these sectors would suggest, Abu Dhabi’s real estate market appears to have turned a corner over the last two years. Given the market’s vulnerability in the past, it is unsurprising that concerns regarding its current trajectory have arisen from some corners. According to the IMF’s most recent Article IV Consultation – the results of which were published in June 2014 – “Rapid price increases in some segments of the real estate market have prompted concerns about possible excessive risk-taking.”
However, while sale prices in some segments rose rapidly in 2013 and 2014 – the IMF notes that Dubai’s were up 27% year-on-year (y-o-y) in May 2014 – by September 2014 sale price growth in both Abu Dhabi and Dubai was down around the 15% mark. According to NBAD’s Economic Research Group, average listed property rents in Abu Dhabi are expected to show about a 10% y-o-y increase at the close of 2014. This is lower than some had predicted at the start of the year, when growth in sales prices was peaking (and the IMF was compiling data for its report).
Bankers in Abu Dhabi are quick to point out that the current backdrop to higher real estate prices and lending is very different than 2008. Before the financial crisis – which was first felt by the UAE in the third quarter of 2008 – a much less stable scenario prevailed. The system was made even more fragile by an excess of liquidity, an annual lending growth rate of more than 40% in 2007-08, mortgage loan-to-value ratios in excess of 95%, and a large amount of off-plan sales and financing activity. The current situation, by contrast, shows a more measured and sustainable increase in real estate lending. Banks are better capitalised, have healthier loan-todeposit ratios and are more closely governed than before the crisis. Moreover, the growth in real estate prices is underpinned by solid fundamentals.
In short, there are many good reasons why it now costs more to live in the UAE. In the context of regional instability, the country has emerged as a safe haven of sorts, attracting new residents and greater capital inflows. As its economic diversification strategy continues apace, growth in the non-hydrocarbons sector has drawn even more people to the country. As for the Abu Dhabi market, prices have been buoyed further by a new rule that came into effect in late 2013, requiring some 23,000 public sector employees to live in the emirate.
These factors have led ratings agencies to take a more sanguine view. In August 2014 Fitch said that rising residential real estate prices did not pose a serious threat to Abu Dhabi banks, as the industry is not reliant on leverage, but backed by stronger fundamentals. Fitch went on to point out the fact that the authorities today are also “more attuned to the risks from rising house prices”.
The authorities’ interest in the relationship between banks and real estate can be clearly discerned in the regulatory stance of the central bank. At the close of 2013 the CBU introduced a new set of rules on mortgage lending by banks, finance companies and other financial institutions that provide credit to national or expatriate home-buyers. For UAE nationals, the loan-to-property-value (LTV) ratio was capped at 80% for a first property, and at 70% for properties worth more than Dh5m ($1.4m). To reduce property speculation, each borrower is only entitled to one loan for one property at this rate. Should a second property be bought with a mortgage, the LTV limit is 65%. For non-UAE nationals, including citizens from elsewhere in the GCC, the criteria are more stringent: 75% for a first property, 65% for properties valued over Dh5m ($1.4m) and 60% for expatriates purchasing a second home or investment property.
The new regulations also seek to address the problem of off-plan property purchases, which were a major contributor to the pre-crash property boom. The maximum LTV for an off-plan transaction is now 50%, regardless of the purchaser’s nationality or whether or not they intend to be an owner-occupier. Lastly, the regulations place some restrictions on the provision of interest-only mortgages where the principal repayment is deferred.
Indeed, these were also salient features of mortgage markets around the world in the run-up to the global economic crisis, leading to uncomfortable levels of exposure for some borrowers that many were unable to sustain. Under the new regime, mortgages with deferred principal repayment may not allow for non-payment of the principal for more than five years from the first drawdown of the loan.
Other provisions address matters such as the maximum term of a mortgage (25 years); age limits for borrowers (70 years at the date of the last repayment for nationals and 65 for non-nationals); and procedural issues, including a requirement to have a list of independent appraisers in place for the purpose of property valuations. In general terms, the regulations aim to reduce the financial leverage that is available to buyers, thereby boosting the equity component in property investments.
This goal is reinforced by a requirement that mortgage providers develop a standard debt burden ratio (DBR), by which a borrower’s income and ability to repay the mortgage can be assessed. The DBR is capped at 50%, and the amount financed cannot exceed eight times the annual income for UAE nationals – or seven times that of non-nationals.
Despite fears that the new rules would create an insurmountable hurdle in a relatively undeveloped mortgage market, the CBU told OBG that the continued expansion in mortgage lending shows that the new regulations are in fact working. The reasonable controls placed on mortgage lending will certainly do much to encourage sustainable, long-term growth from the banks’ perspective, while borrowers now have the ability to shop around in a more competitive market, characterised by lower interest rates, discounts and special offers for potential homebuyers.
One interesting question with respect to the future of the mortgage market is the prospect and degree of future CBU intervention. Should it start to feel uncomfortable with the way the market is headed, a useful starting point for intervention is the current deposit demand level of 20%. Over the next year, industry observers will be keeping a close eye on mortgage lending rates, exposure to the real estate and construction sector, and retail prices. However, given the solid growth drivers and new regulatory regime, there is unlikely to be much need for significant market intervention in the short term.
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