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How does Inflation impact the Real Estate Sector?

Inflation is touching new heights every day and has adversely impacted every sector and the global economy. The global economy was recovering from the catastrophic effects of Covid-19 and then it was badly hit by Russia’s invasion of Ukraine that started on February 24, this year. The Russia-Ukraine conflict has disrupted the energy supply and has led to a shortage of raw materials. There has been over a 20% rise in fuel prices in Dubai between April and June 2022. The suppliers are facing supply chain disruptions which are restraining them from coping with the rising demand and leading to an increase in prices. 

To overcome this situation, governments across the globe are injecting more money into the financial system and increasing their spending. Businesses are battling inflation and trying not to lose customers due to the exponential surge in prices. 

Why is Inflation Rising every day?

The inflation rates are climbing new heights.  According to the latest data by the Dubai Statistics Centre (DSC), Dubai’s Consumer Price Index (CPI) jumped by 5.84% year-on-year (YoY) to 105.35 points in June 2022. The exponential rise in the prices of fuel since the beginning of the Ukraine-Russia war has increased transportation costs several folds which have been the main reason behind the surge in the inflation rate. Experts’ forecasts inflation to touch 2-2.5 % in 2022 compared to 0.2 % in 2021. The UAE Central Bank has warned that the country is not insulated from a global inflation surge. In its Q1, 2022 economic review, the central bank stated, “soaring global inflation is a concern for open economies such as the UAE, where imported inflation would ultimately pass through to domestic prices and feed into headline inflation”.

According to Khatija Haque, Head of Research and Chief Economist at Emirates NBD, “the main driver of inflation in Dubai in recent months has been transportation costs, which were up 28.8 % year-on-year in April 2022, accounting for around half of headline inflation. Food prices (8.6% higher year-on-year) were the second biggest driver of inflation in April, followed by recreation and culture costs and restaurant and hotel prices.” The experts believe that Dubai’s high-end or luxury residential real estate will be least impacted by inflation compared to any other nation as the vast majority of elites from across the globe are buying expensive properties in Dubai due to its distinctive laws and business-friendly policies. According to Mr. Faisal Durrani Partner – Head of Middle East Research, Knight Frank, “the majority of residential deals at the high end of the price spectrum are cash purchases, largely due to the unrelenting inflow of ultra-high net worth capital that is targeting Dubai’s most expensive homes. Consequently, the housing market at present is not at risk, since cash remains king, he said.”

The Impact of Rising Inflation on Dubai’s Real estate

Inflation has a detrimental impact on every sector and the real estate sector is not an exception. Inflation results in an increase in the cost of construction as the prices of raw materials also rise which makes the houses more expensive. However, Dubai’s real estate will be less impacted compared to other nations. The vast amount of credit for this goes to the UAE for its diversified imports policy, high currency value in terms of US Dollar, lesser prices of luxury properties compared to several other major western cities, highest return on investment (ROI) on the property, ease of doing business, etc. Global Real estate investors don’t have better options than Dubai to invest, which is the major reason it will have a very minimal impact on the rising inflation rate. Furthermore, the Dubai government is cutting down its dependence on imports by following a diversified import policy to minimize the impact of imported inflation. 

With the launch of the Golden Visa program, Dubai Masterplan 2040, and District 2020, there will be a huge proliferation in the population and the number of businesses in Dubai this year and in coming years which will boost the demand for housing.  This is very evident from the latest report by Knight Frank which reveals that the Dubai residential market recorded AED 61.9 billion ($16.85 billion) worth of apartment and villa transactions as of May 2022 despite a record spike in inflation worldwide. 

Knight Frank believes the impact of global inflation on the UAE economy and Dubai’s residential market is likely to be limited for now due to effective government measures. However, despite its unparalleled performance compared to the rest of the world, it’s no secret that Dubai’s real estate sector will face the headwinds of rising inflation rates globally. 

Here are the Top 6 Ways the Rising Inflation Rate will Impact Dubai’s Real estate sector –

1. The rise in the Cost of Raw Materials

There has been an over 25-30% rise in the prices of construction materials since 2021. The prices of all necessary materials like steel, wood, copper, glass, and concrete have increased up to 25% in the last year. The cost of labour and machinery used in the construction of the building has also increased several folds. This has put more pressure on the construction companies and developers to increase the prices of the property to manage the rising cost.  According to Faisal Durrani, house prices in Dubai are expected to grow around 5-7% this year for the mainstream market and 12-15% in the prime market. Dubai remains an excellent inflation hedge.” 

An increase in the prices of the property delays the buying decisions of several potential buyers and results in lower sales and poor occupancy rates for the developers.

2. Higher Interest on Home Loans

The rise in inflation is also forcing commercial banks to increase the interest rates on home loans to cover up the increase in their operational cost. The Interest rates increased by 0.50 % in May 2022. According to Mr. Michael Hunter, Co-founder of Holo, the online mortgage platform, the half-a-percentage hike on May 3 would reflect on mortgage rates by between 1-1.5 basis points across lenders. “This means, for every Dh500, 000 borrowed, it could cost an additional Dh5, 000 per year,”

An increase in inflation makes it more expensive for potential homebuyers to take home loans and they delay their decision until inflation and home loan rates come down. This has an adverse effect on property sales. Furthermore, a rise in inflation also devalues the currencies which forces many lenders to raise rates further. This makes the cost of debt expensive for the developers.

3. Increase in Rents

Surge in the prices of the property followed by higher interest rates on home loans charged by banks discouraged a vast number of buyers from buying the property and looking for rented accommodations. The substantial rise in the demand for rented accommodations allowed landlords to increase the rents which tenants have to accept with a ‘pinch of salt’ as paying increased rent is much cheaper for them than paying a higher mortgage. This has substantially increased the rental rates of the property in the first quarter of 2022. In Dubai, as many reports have shown this quarter, average rental rates increased by 13.1% in Q1, 2022 which is the highest rate of growth recorded since December 2014.

4. Increase in Resident Dissatisfaction

Inflation results in an increase in the operational cost of a community or a building as all items required to maintain and manage the building become expensive. In this scenario, property management firms are left with no choice than increasing the service charges to manage the cost of the community without compromising on resident welfare and safety. However, an increase in service charges often opens up a “pandora’s box” for the property management firms as it results in a surge in resident dissatisfaction, an increase in tenant turnover rate, poor occupancy, and a decline in revenues. The service charges in Dubai have increased between 10-25% since 2017. Furthermore, the Ukraine-Russia war has further aggravated the situation and has resulted in an exponential increase in the price of fuel, electricity, and other raw materials.

5. Payment Delays 

An increase in service charges also creates a problem of payment delays as it becomes expensive for several residents who were making timely payments of service charges. These residents either delay their service charge payments or move to more affordable communities. Non-payment of Service charges in Dubai dates back to 12 to 18 months. In both ways, it hurts the developers and property management firms in terms of revenues and Occupancy rates. The decline in revenues also limits the capabilities of the property management firms to launch initiatives for the betterment of the community. This results in a rise in overall resident dissatisfaction.

6. Adverse Impact on Vacation Rentals

The rise in inflation rates discourages tourists to plan their holidays or vacations. This is indeed bad news for vacation or short-term rental real estate which relies heavily on tourists and retirement communities.

7. Economic Crisis

Inflation often brings instability to the real estate sector and is an invitation to an economic crisis. The US and Spain are the best examples of how rapid house price inflation in the early 2000s has led to a credit bubble. The rise in property prices in the 2000s encouraged developers to come up with new construction and motivated banks to increase lending to a wider range of buyers. This credit bubble later proved unsustainable for the sector as well as for the economy and ultimately led to the credit crisis and economic failure.