Property Costs Climbing

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While property in Abu Dhabi looks to be a good investment this year due to steeply rising costs, increasing demand and ongoing supply constraints are leading the government to look at measures to lessen the squeeze on tenants.

A recently published report by HSBC suggested that higher commodity and labour costs, coupled with the falling dirham and interest rate cuts, will drive up property prices in the emirate by 25% this year. According to the bank, year-on-year property price inflation hit 30% in January. In the second half of last year, average rent increased 22%, while residential property prices rose by 18%.

In addition, not enough of the projects in the pipeline will come on stream this year; insiders estimate an overall shortfall of between 20,000 and 50,000 units for 2008.

High prices for steel and cement are contributing to the upward pressure on property costs and to overall inflation, and costs for both are expected to rise by nearly 20% this year on the back of China's continued construction boom and high transport fees. Meanwhile, currency depreciation and higher food prices caused by global factors such as droughts, flooding and a shift away from cereals to animal feed and biofuels have put upward pressure on wages, leading to increasing construction overheads.

The dirham's peg to the dollar is contributing to both supply shock and demand pull. On one hand, as the dollar falls, the Emirati currency does as well, increasing the relative cost of imports - including building materials and food. On the other, it effectively obliges the Central Bank of the United Arab Emirates to mirror the interest rates of the US Federal Reserve (Fed). The Fed is currently cutting rates aggressively in an attempt to stave off a recession in America and ease the constrictions in its banking system. So, just at a time when monetary policy could be tightened to help choke off inflation, it is being eased, cheapening money and encouraging liquidity onto the market. In short, this means more money chasing scarcer resources.

Further demand pull factors come from the emirate's growing population. A large proportion of nationals are young and will soon be seeking housing of their own, while the fast-growing economy is drawing in increasing numbers of expatriates. As Abu Dhabi's development strategy includes bringing in highly trained professionals from abroad, these pressures seem set to remain.

However, as HSBC notes, to some extent galloping property prices represent a natural positive correction in the market, as for many years they have remained relatively low compared to other affluent cities. In terms of GDP per capita, Abu Dhabi is one of the richest cities in the world, and prices are rising to reflect this fact.

Controlling property costs is difficult with the relative absence of monetary policy levers and an understandable reluctance to impose tighter fiscal policy, given the emirate's reputation as an income tax-free haven and the need for large investments in health, education and infrastructure.

In an effort to ease the pinch on citizens' pockets, the government has chosen to ease import duties on cement and steel, in anticipation of the price rises expected this year. Additionally, Abu Dhabi has lowered its rent cap from 7% to 5%, reducing the amount by which landlords can hike up rents each year. This move may be somewhat more problematic, however, and there has been some concern that unscrupulous landlords may increase prices by more than the legal margin, or force out tenants at the end of the year in order to impose higher rents.

Perhaps more serious over the medium to long term, some analysts have suggested that setting rent caps below inflation could disincentivise property ownership, therefore weakening the market for the new buildings that are needed to accommodate Abu Dhabi's growing population and ease inflationary pressures.

Until more housing comes onto the market, commuting from Dubai may become a more common phenomenon. This is a short-term solution however, as the shortage of property currently extends to office and hotel space, affecting businesses as well as home renters.

Abu Dhabi has a range of large projects in every sector due to come on stream over the coming years, which should help meet the high demand caused by rapid growth. But for the time being, prices look set to continue their steep upward trend.

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