UAE Real Estate Trends and Developments

 

By Rani El Hajjar & Alejandra Esmoris, CVML Dubai

2023 was a phenomenal year for the real estate market in the United Arab Emirates (UAE), which saw an unprecedented growth in the volume and value of transactions. The real estate sector was supported by solid fundamentals and in-flow of foreign capital boosted by government policies, most notably, the easing of the requirements for the obtainment of long-term visas. Last year also saw the introduction of corporate tax in the UAE effective from 1 June 2023, which requires companies to pay a 9% corporate tax on income, including income derived from property investments. Whilst the strength in the real estate sector has generally been observed across all asset classes, specific trends have emerged in different pockets of the market. In the residential and hospitality sector, the demand for branded residences gained momentum. In the retail sector, the shift to omnichannel sales has prompted retailers to put more focus on online sales channels, whilst traditional brick and mortar retail also remained strong. Rents have soared across the board, putting rent cap regulations into focus. We explore in detail the current and evolving trends in the market and the legal framework governing these trends. We shall also emphasise that whilst general principles governing property ownership rights in UAE are set out under federal legislation, namely the civil transactions code (Law No (5) of 1985, as amended) and the constitution, specific property laws are enacted at the level of each Emirate. In this note, emphasis is placed on Dubai property legislation.

The Rise of Branded Residences

Branded residences are residential projects that are developed and managed in association with renowned international brands. Traditionally, most branded residences used to be associated with hotel operators. However, associations with non-hotel brands, such as fashion brands and car companies, are now more common, and are seen more frequently. The demand for branded residences in the UAE, particularly in Dubai, was very solid in the past year, prompting developers to associate with international brands and launch new branded residences developments. The increase in demand for luxury properties in Dubai has particularly boosted this segment.

Variants

Branded residences in the UAE involve a relatively complex legal structure which consists of interconnected agreements between multiple parties, namely (i) the developer, (ii) the operator or brand principal, (iii) the building management company, (iv) the investors or buyers, and (v) the tenants or occupants. There are different variants of the model, and the structure of the legal documentation between the parties involved can vary significantly. The variations are generally centred around the following.

• Location – branded residences can be part of a hotel, adjacent and connected to a hotel, or completely in a standalone building. When the branded residences are located within a hotel or adjacent to a hotel, certain services and facilities are shared with the hotel. The cost of providing the shared services and maintaining the shared facilities is also shared between the owner of the hotel and the owners of the branded residences.
• Brand principal – whilst the brand principal can be a hotel operator or a non-hotel brand, the role of the hotel operator is usually much broader than the role of a non-hotel partner. This is particularly the case regarding the supervisory role in managing the operations of the branded residences. A central part of the role of the hotel partner is to ensure that the branded residences are managed in accordance with its brand standards. The operator is also paid a supervisory fee for this role. On the contrary, a non-hospitality partner, that does not have the required expertise in managing hotels and branded residences, is not assigned such responsibilities.
• Rent pooling arrangement – some branded residences include a managed rental programme, whereby the operator will manage a rental scheme on behalf of the individual owners. When this is the case, it is done under an agreement between the operator and the individual owners.
• Retention of ownership – it is more common that branded residences are sold to individual investors. However, it is possible that the developer retains ownership of the branded residences to lease them out. The legal documentation for branded residences where the owner retains ownership is relatively simpler as it does not involve sales to third parties and does not need to cater for the issues that arise from the joint ownership of property.

Legal framework

Branded residence developments bring into play a mix of property legislation governing various aspects of the development. The following legislation applicable in Dubai are of paramount importance in this context:

• Real estate development law – the sale of branded residences to individual investors is subject to the laws regulating off-plan sales. Off-plan sales in Dubai are governed by a number of local legislations including law No 8 of 2007 Concerning Escrow Accounts for Real property Development and law No 13 of 2008 Regulating Initial Property Registration, as amended.
• Jointly owned property law – the involvement of the operator in the management of the residences, the availability of certain facilities shared with the hotel (when applicable), and the incremental service charges resulting from the management of the building as branded residences, all raise legal questions pertaining to joint ownership of property, and compliance with the applicable laws, in particular law No (6) of 2019 Concerning Ownership of Jointly Owned Real Property in the Emirate of Dubai.
• Tenancy law – the occupancy agreements with the occupants of the branded residences should be compliant with the applicable tenancy laws and regulations, namely law number 26 of 2007 Regulating the Relationship between Landlords and Tenants in the Emirate of Dubai, as amended by law 33 of 2008, and the rules and regulations set by the Department of Economy and Tourism for short term rental.

Buyers’ rights and obligations

Whilst the brand principal initially contracts with the developer, key conditions agreed between the brand principal and developer are often passed to the individual buyer under the sale and purchase agreement between the developer and the buyer and under the building management statement. Among those key conditions are the following.

• Restrictions on use – the operator may impose restrictions on the length of any occupancy agreements. When the branded residences are located as part of a hotel complex, the operator may typically put a restriction on short-term rental, to ensure that the individual owners of the branded residences will not compete with the hotel.
• Brand acknowledgment – a licence to use the brand is provided by the brand principal to the developer with certain strict limitations and guidelines. These limitations are passed to the buyers (and occupants), who are required to acknowledge that they shall adhere to the brand use guidelines.
• Shared facilities – in the event the branded residences are part of a hotel complex and certain facilities are shared with the hotel, the sale and purchase agreement and the building management statement will specify the facilities that are available for use by the occupants of the branded residences.
• Shared services – in the event the branded residences are part of a hotel complex, the sale and purchase agreement may specify that certain services are provided from the hotel, including services that are available a-la-carte, for a fee.
• Incremental service charge– the incremental costs associated with managing the building as branded residences are passed to the owners in the form of increased service charges. The annual service charge budget is subject to approval by the Real Estate Regulatory Authority (RERA), which ensures that the service charges are levied in accordance with the applicable laws and regulations.
• Re-branding – the sale and purchase agreement may specify that the agreement with the brand principal may be terminated, and the branded residences may be re-branded in certain circumstances, without triggering an event of default under the sale and purchase agreement.

In summary, branded residences often involve a relatively complex legal structure due to a number of interdependencies between contractual relationships among multiple parties. Whilst there are different variants of the development model of branded residences in the UAE market and the parties are free to decide how to structure their contractual relationships, the law plays a key role in shaping the legal landscape for branded residences’ developments.

The Shift to Omnichannel Retail in the UAE and its Impact on Lease Contracts

Shopping mall operators in the UAE often include in their lease contracts a percentage rent clause that requires tenants to pay them a percentage of gross sales, subject to a minimum payment as base rent. A percentage rent clause can only work efficiently if the landlord is able to obtain accurate sales data from the tenants. Over the years, mall operators relied on the tenants’ periodic reporting of sales, and on an audited sales report, submitted on an annual basis. With the advancement of technology, new reporting tools became available and are now used by mall operators in the UAE. These range from the submission of automated daily sales reports generated by the tenants’ systems to complete integration of the tenants’ point of sales with the landlord’s systems, enabling the landlord to have real time access to the tenants’ sales data.

Recent trends

Whilst brick-and-mortar continues to dominate the UAE retail market, retailers are now moving to an omnichannel model in which online sales also play a key role. This transformation was driven by the advancement of technology and a shift in customers’ behaviour, which accelerated during the COVID-19 pandemic. The shift to an omnichannel model is creating multiple situations in which certain transactions conducted by a retailer can have a partial connection to a physical shop, posing a question of whether such limited connection justifies the inclusion of the transaction in the gross sales for the purpose of computing the percentage rent. This is creating an area of tension between landlords and tenants which is yet to be resolved. For illustration purposes, the following transactions conducted by a retailer engaged in fashion or apparel trading, can be considered:

• a customer purchases a product online from the retailer’s website and takes delivery of the product at one of the retailer’s physical shops;
• a customer purchases a product online from the retailer’s website and takes delivery of the products at one of the retailer’s physical shops. Subsequently the product is returned or exchanged by the customer at another physical shop located in another mall;
• a customer orders a product using a tablet available at the retailer’s physical shop and takes delivery of the product at home; and
• a customer visits a store to purchase a specific product and is directed by the staff to order the product online due to the non-availability of stock.

The following transactions conducted by a restaurant operator can also be considered:

• a customer orders food on a delivery platform and the order is prepared in the kitchen of the restaurant situated in a shopping mall; and
• a customer orders food on a delivery platform from a restaurant located in a shopping mall, but the food is prepared in a central kitchen located outside the shopping mall.

Lease agreements

Most of the shopping mall operators in the UAE, particularly the key players, have managed to include in their lease contracts a very wide definition of gross sales, which allows the capture of all the transactions that have a limited connection to a physical shop in the turnover of such shop. Sophisticated retailers are now more frequently trying to challenge such wide definitions and attempting to agree on a narrower definition by adding certain exclusions. Negotiation of the definition of gross sales between sophisticated landlords and tenants can be intense as it affects the economics of the deal. The result of such negotiation is often an agreement based on middle ground, however the agreement on the contractual terms does not necessarily warrant final resolution of this matter, as often issues also arise whilst implementing the agreed contractual arrangement.

Practical challenges

The reality is that landlords do not possess tools that allow them to track all the transactions that have some connection to a physical shop if these are not processed through the point of sales of such shop. Consequently, landlords are not able to ensure that they are receiving accurate sales reports that reflect what has been contractually agreed. In most instances, landlords should rely on the tenants’ willingness to voluntarily share such data, which is an unsatisfactory position for the landlords. Moreover, the complexity of the possible scenarios often leads to different interpretations of what is contractually agreed. As a result, the likelihood that the report data will match what is stipulated in the lease will in most circumstances be near to zero.

Open questions

The above leaves the following open questions.

• From a tenant’s perspective – in an omnichannel world, where significant sums are spent in developing and promoting the online business, is it fair and appropriate to include online sales, which have a limited connection to a physical shop, in the gross sales of such shop? Do parties take into consideration the investment made by the tenant in promoting the online business when they negotiate the definition of gross sales and when they agree on the rate of percentage rent?
• From a landlord’s perspective – what tools can be used by landlords to ensure that they are receiving accurate sales data that reflect what has been contractually agreed? Will technology play a role in developing such tools?

In summary, the shift of retail towards omnichannel in the UAE creates legitimate questions for both landlords and tenants regarding the viability of the traditional percentage rent model. With online sales expected to continue growing over the coming years, landlords and tenants will inevitably have to face these questions. This will require an open and collaborative discussion between landlords and tenants with the aim of addressing both parties’ legitimate concerns. It can also be expected that technology will play a role in bridging this gap. At present, and until the gap is bridged, it is likely that the traditional model for computing rent in UAE retail leases based on percentage rent, will be under check.

Soaring Rents and Rental Disputes

Rents have soared in the UAE over the past year, putting rent cap regulations in the spotlight. Whilst each Emirate has adopted different rules regarding the rental market, Dubai has defined clear parameters that determine whether a landlord can request an increase in the annual rental and if applicable, the permitted percentage of increase. It has also defined certain notification requirements that a landlord should follow if it wishes to increase the rent at the time of renewal. If the landlord does not notify the tenant of the proposed increase in time, it may not be eligible to increase the rent.

Permitted rent increase

The cap on rent increase in Dubai is set out in decree 43 of 2013. The permitted increase depends on how low the rent of the property is at the time of renewal compared to the average similar rent, and is determined in accordance with the following:

• no increase if the difference between the rent of the property and the average similar rent is less than 10%;
• 5% if the difference between the rent of the property and the average similar rent is between 11% and 20%;
• 10% if the difference between the rent of the property and the average similar rent is between 21% and 30%;
• 15% if the difference between the rent of the property and the average similar rent is between 31% and 40%; and
• 20% if the difference between the rent of the property and the average similar rent is more than 40%.

Scope

The rent cap does not apply to hotel facilities. Pursuant to law No 26 of 2007 (as amended by law No 33 of 2008), hotel facilities in Dubai are not subject to rental law.

Determination of the average similar rent

The information used by RERA to establish the average rent is obtained from the Ejari system. The Dubai Land Department has on its website a rent increase calculator that allows one to check the permitted increase on the annual rent. The criteria used by RERA to determine the applicability and extent of the permitted increase includes the type of property, whether it is residential, commercial, industrial or staff accommodation, the location of the property, the number of bedrooms or the size in respect of commercial or industrial property.

Notification requirements

Pursuant to law No 26 of 2007 (as amended by law No 33 of 2008), in case either party to a lease contract desires to amend any of its terms and conditions, it shall notify the other party of same at least 90 days prior to the expiry of the lease term, unless otherwise agreed between the parties. The landlord should therefore notify the tenant at least 90 days prior to the expiry of the lease of any proposed rent increase. If the landlord does not notify the tenant of the proposed increase in time, it may not be eligible to increase the rent.

Income Tax and its Applicability to Property Investments

The introduction of corporate tax in 2023 is a major development in the UAE. Under federal decree (47) of 2022 on the Taxation of Corporations and Businesses (the “CT Law”), a corporate tax of 9% is levied on profits derived by individuals and companies engaged in commercial activities in the UAE for the financial years commencing on or after 1 June 2023. The corporate tax applies to the income earned from immovable properties in the UAE by local entities as well as foreign entities and non-resident juristic persons. For Free Zone Persons under the CT Law, the situation is more complex and various parameters must be taken into consideration. While income derived from non-commercial property is normally subject to the 9% corporate tax rate, income derived by a Free Zone Person from commercial real estate transactions with another Free Zone Person in respect of a commercial property located in a free zone will most likely benefit from the 0% corporate tax rate if all criteria of the Qualifying Free Zone Person regime are met. However, if the income received by the Free Zone Person derives from a commercial property transaction with a natural person, a mainland or foreign company or any other person that is not a Free Zone Person in respect of that property (whether the property is located in Free Zone or mainland UAE), the income will be most likely treated as taxable income, subject to the standard corporate tax rate.

Natural persons may be subject to corporate tax in respect of business activities conducted in the UAE if the total turnover exceeds AED1 million within a Gregorian calendar year. However, real estate investment income is not subject to corporate tax when derived by natural persons if it is related, directly or indirectly, to the selling, leasing, subleasing, and renting of land or real estate property in the UAE that is not through a licence nor requiring a licence from a licensing authority to carry out such activity.