No need for capital gains tax in Dubai property market

Posted on 29 July 2008 with no comments from readers

What are the free market economists of Standard Chartered Bank thinking of in suggesting a capital gains tax on the re-sale of Dubai properties within a year? This is exactly the sort of taxation Dubai has become famous for avoiding as a tax haven, quite apart from being the very worst sort of arbitrary intervention in a market that any government could make.

Surely the Dubai Government already has a strong enough control over the local market with its ownership and share holdings in the key development companies. There is no need to revert to capital gains taxation to bring the market under control. If oversupply threatened, the breaks could be applied to projects.

The normally wise members of the Standard Chartered economics team appear to have been worried by a 42 per cent surge in Dubai house prices over three months. This price hike is strong indeed but explicable in terms of low US interest rates, very high oil prices and the poor performance of local stock markets as an alternative investment.

Rather in the same way that speculation has become a feature of the oil market, and could create a sudden correction, Standard Chartered is concerned that speculation in local property is getting out of hand. Low deposit levels, in particular, encourage short-term price flipping on off-plan sales, although this has been more of a feature of the Abu Dhabi market than Dubai in recent months.

But to introduce capital gains tax for the first time ever in the history of the UAE would seem an over-reaction to some modest speculative activity in an economy that has never seen better times. What the government might consider, if it feels it necessary is forcing developers to take bigger deposits to discourage speculation.

However, any notion that the Dubai property market is in some kind of imminent danger of collapse is patently ridiculous. The very surge in recent prices is indicative of a healthy market with very high levels of demand, inadequate supply and a price risk biased to the upside.

Dubai real estate price levels are now much higher than a few years ago but still lag behind prices in cities of comparable per capita GDP, and rental yields are still high, suggesting that capital values have room for further appreciation.

Of course, the market is maturing and the recent sudden price hike could be followed by a flatter autumn. But I very much doubt it. More likely the quieter months of summer will be followed by another upward spike in prices, unless oil prices suffer a very serious retreat.

The supply of property, both residential and especially commercial, remains inadequate to meet the demands of the hub city of the booming Middle East. Moreover, the average project delay is two years, putting back the estimated arrival time for oversupply until 2010 or later.

Construction costs are another factor driving up prices, and may well be running ahead at an even higher rate. This is a fundamental and not a speculative reason for higher real estate prices. Developers have to pass these prices on or they will have to stop building.

Even the possibility of a global stock market crash which hangs over the UAE bourse like a storm waiting to break is not likely to cause any problem for local real estate. For one thing that would mean a cut in interest rates, and positive for real estate. And if local stocks fell then investors would go for property as a more solid alternative, as happened after the 2006 crash in the UAE.

Of course no boom continues forever. The 14-year UK housing boom finally went bust a year ago. But economists had been calling an end to this boom for almost a decade and it went on and on. Why should the experience of the UAE be any different?

In particular, I would argue that the Abu Dhabi construction boom is going to send Dubai real estate prices higher. It will not be until late next year that any new property is completed in the UAE capital and that means that all the staff involved in this massive development has to be either accommodated in Abu Dhabi or in neighbouring Dubai.

The vast majority of the $1.3 trillion of infrastructure spending in progress in the Gulf States is happening in the Emirates and while this immense investment is in progress it is hard, if not impossible to see any weakness in local real estate market. Economists ought to know better than to sound alarm far too early in this economic development cycle.

The real warning will come later down the road when the economists have fallen silent, having said too much too early and lost credibility, then a correction will occur as they always do in market economies. But we are probably five years away from a real downturn, and have yet to see the market flatten.