Saturday, Nov 15, 2008

Gulf News

The panic of the real estate slowdown took a heavy toll in the GCC market last week and the US subprime symptom is now clearly visible.

Buying real estate as an investment without having stable income and leveraged by bank loans at a comparatively high interest rate (the subprime rate) followed by the industrial slowdown, job losses, failure to repay bank loans, banking foreclosures, the housing market downturn, a low recovery from the underlying assets and resultant banking losses is the year-old recessionary story from the US.

UAE banks are concerned about job losses in the vulnerable financial services and realty sectors and are reportedly increasing the eligibility norm for credit delivery. The Dubai Land DepartmentDubai Land Department has taken the timely proactive measure of imposing a 30 per cent cancellation charge that will act as an exit barrier. However, these preventive measures will invite a further slowdown rather than curing it: the Government has to take proactive investment measures to save the economy from the liquidity crisis.

The UAE (and the GCC) cannot afford a slow down in the realty sector despite the expected low return on investment. The real estate market should at this juncture project a low return of 5.5 to 7.5 per cent keeping growth and employment unaffected. For this the liquidity-strap-ped real estate developers need an innovative financing vehicle which could be a sovereign realty Special Purpose Vehicle (SPV).

The government should constitute a Realty SPV immediately for dealing in realty so that developers have the alternative to offload completed or under-construction property to the SPV. This SPV (a government company) is to be backed by government funding as its initial corpus. This will ease the liquidity crisis in the realty sector.

Overwhelming response likely

Banks will be comfortable to participate in the pass-through securities (PTS) of the Realty SPV. Unlike US mortgage-backed securities, the PTS should be a five year deep discount inflation-adjusted bond - say issued at 7 per cent yield but adjusted to inflation on maturity. As investors lost confidence in equities, gold and currency futures, and realty is in its downturn, there should be an overwhelming response to this product that will provide continuous liquidity to the proposed Realty SPV and thereby to the realty companies.

Before creating the realty SPV, it is necessary to check how the US government is using Freddie Mac or Fannie Mae for the reconstruction of the housing industry. A strong system of corporate governance at the top management level of the SPV will help it to adopt a stable policy framework: a thirty-year mortgage ARM at 6.20 per cent and 15-year AR at 5.88 per cent. Setting this as international benchmark, the SPV may set a UAE investment rate which may be in the range of 5.5-7.5 per cent. Job cuts in the realty sector should be avoided at any cost.

The Realty SPV should plan to provide a two to three year liquidity cushion against a slowdown in the realty sector.

- The writer is professor at Institute of Management Technology in Dubai.

© Gulf News 2008. All rights reserved.

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