Bubbles
Many people are interested in investments, either in Dubai, or worldwide. Specifically, people are wondering if Dubai property is a good investment at current prices, or is a bubble. Which, of course, raises the question of, ‘What is a bubble?,’ the classic examples being the Tulip Craze and the South Sea Bubble.
In short, investors only invest in the hopes of making a profit. Secular investors therefore try to invest in whatever investments promise the greatest profit, while Islamic investors must invest in whatever halal investments promise the greatest profit.
The theory says that all investments carry some degree of risk (zero being a degree, in the case of government guaranteed investments), and that the return of investments of equal risk should be equal, since investors holding an investment with a low return should sell it, driving the price down and the return up, and buy investments with a higher return, driving the price up and the return down, until the returns on investments with identical risk are identical.
The return on an investment consists of the dividends paid plus the appreciation of the underlying investment. This appreciation might be from retained earnings, in which case the investment has additional assets, so the appreciation is clearly justified, or it might be from new investors realizing that the asset has a high return, so they are buying in and increasing the price, which also increases the overall return for the existing investors.
The definition of a bubble is when this increase in price from new investors purchasing the asset is the primary return on the asset. This is, of course, a vicious circle, with the increasing price justified by nothing except the increasing price.
One easy way to spot a bubble is when everyone says ‘This is not a bubble.’ As long as most people are saying, ‘This asset is overpriced, and will soon go down,’ there cannot be a bubble.
There are theoretical ways to value stocks and property, to determine if the price is supported, or is just a bubble.
In the case of stocks, the theoretical price is determined by all future earnings of the underlying corporation. Sadly, prediction of anything is very difficult if one tries it with respect to the future.
Property is much easier: the price should be determined by rents. Even when most units are owned by the people living in them, these people are just renting from themselves, and the theoretical price is determined by the rents obtained by investors who buy to rent the properties. Simply, the investor should be expected to put down 25% of the value of the property, and should have a positive cash flow from the onset.
When property prices are rising so quickly that investors are willing to invest with negative cash flow, expecting that rising prices will soon enable them to sell at a profit, net of the losses during the time they held the property, there is a property bubble.
When lenders loan with initial payments that are less than the interest due, so there is an actual monthly deficit in spite of an apparent positive cash flow, there is a property bubble.
As of current date, none of this applies to Dubai property. There are no sub-prime loans available. And any investor putting down 25% will see a significant positive cash flow from the first month, given the current generous housing allowances being allotted to the most valued employees, of which there are more than enough to fill all the Emaar, Nakheel, and Dubai Holding properties. So, again as of current date, Dubai is not in the midst of a property bubble.
Of course, this could change, and the sign that it has changed is when everyone starts saying, ‘Dubai is not in the midst of a property bubble.’
In short, investors only invest in the hopes of making a profit. Secular investors therefore try to invest in whatever investments promise the greatest profit, while Islamic investors must invest in whatever halal investments promise the greatest profit.
The theory says that all investments carry some degree of risk (zero being a degree, in the case of government guaranteed investments), and that the return of investments of equal risk should be equal, since investors holding an investment with a low return should sell it, driving the price down and the return up, and buy investments with a higher return, driving the price up and the return down, until the returns on investments with identical risk are identical.
The return on an investment consists of the dividends paid plus the appreciation of the underlying investment. This appreciation might be from retained earnings, in which case the investment has additional assets, so the appreciation is clearly justified, or it might be from new investors realizing that the asset has a high return, so they are buying in and increasing the price, which also increases the overall return for the existing investors.
The definition of a bubble is when this increase in price from new investors purchasing the asset is the primary return on the asset. This is, of course, a vicious circle, with the increasing price justified by nothing except the increasing price.
One easy way to spot a bubble is when everyone says ‘This is not a bubble.’ As long as most people are saying, ‘This asset is overpriced, and will soon go down,’ there cannot be a bubble.
There are theoretical ways to value stocks and property, to determine if the price is supported, or is just a bubble.
In the case of stocks, the theoretical price is determined by all future earnings of the underlying corporation. Sadly, prediction of anything is very difficult if one tries it with respect to the future.
Property is much easier: the price should be determined by rents. Even when most units are owned by the people living in them, these people are just renting from themselves, and the theoretical price is determined by the rents obtained by investors who buy to rent the properties. Simply, the investor should be expected to put down 25% of the value of the property, and should have a positive cash flow from the onset.
When property prices are rising so quickly that investors are willing to invest with negative cash flow, expecting that rising prices will soon enable them to sell at a profit, net of the losses during the time they held the property, there is a property bubble.
When lenders loan with initial payments that are less than the interest due, so there is an actual monthly deficit in spite of an apparent positive cash flow, there is a property bubble.
As of current date, none of this applies to Dubai property. There are no sub-prime loans available. And any investor putting down 25% will see a significant positive cash flow from the first month, given the current generous housing allowances being allotted to the most valued employees, of which there are more than enough to fill all the Emaar, Nakheel, and Dubai Holding properties. So, again as of current date, Dubai is not in the midst of a property bubble.
Of course, this could change, and the sign that it has changed is when everyone starts saying, ‘Dubai is not in the midst of a property bubble.’
posted by Dubai@Random at 12:26 am
3 Comments:
That's kind of funny, I was always under the impression that Dubai IS in the midst of a property bubble. I based this on the fact that many properties have exchanged hands many times before being constructed. In retrospect though, anecdotal evidence is never as good as a detailed analysis, even if it does seem more convincing.
I guess I have to agree with you. Dubai is not in a bubble.
*Covers Mouth*
DAMN!
One needs to validate the property prices against property prices across some of similar 'new cities' thriving on services. At the current levels, Dubai property prices are significantly under priced. Hence even if the supply improves by 2010, the property prices over the medium term will not move south. As the supply increases by 2010, there might be a small correction as many inventors will clear out. However against a 4 -5 years horizon, investment in Dubai property will deliver higher returns that most other investment options.
DPS: which similar cities? list? Price of properties?
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