Office politics: New stock coming onto the market is driving prices down

While Abu Dhabi experienced a shortage of office space and residences during the spell of rapid economic growth leading up to 2008, a number of commercial and residential projects have since come onto the market, bringing prices down to a level more comparable with those in neighbouring Dubai. This trend is expected to continue for the remainder of 2012, which will help consumers and businesses looking for office space, but for developers and landlords it will remain a challenging period. However, there remain some bright spots in the market, including industrial real estate, a segment that is benefitting from the government’s push for economic diversification. At the same time, state-led housing programmes for Emiratis are also providing opportunities for developers to stay busy during this relatively quiet period.

RESIDENTIAL: The main challenge for Abu Dhabi real estate, across both the residential and office segments, has been the large number of completed (or at least semi-completed) projects that came onto the market in 2011 and early 2012. These included Marina Square on Reem Island, a mixed-use community development with 13 high-rise residential towers. Also on Reem Island but part of Sorouh Real Estate’s Shams Abu Dhabi development are the 74-storey Sky Tower and the 65-storey Sun Tower, both of which started to hand over units in 2011. Other significant deliveries in 2011 included units Al Raha Beach’s Al Zeina and Al Muneera projects. Raha Beach is a development from Aldar Properties, the largest developer in Abu Dhabi and partially owned by the government. On Abu Dhabi Island, Etihad Towers, a mixed-use complex comprising five towers that range from 54 to 75 floors, was handed over in December 2011. On Saadiyat Island, the St. Regis Apartments, part of the St Regis Saadiyat Island Resort, came onto the market in November 2011 with 259 units.

For the remainder of 2012 additional units came onto the market from developments that have started to deliver, such as Reem Island, in addition to new projects that will be completed, including the Nation Towers project on the Corniche, the Al Bateen Park development and Rihan Heights. But even setting aside this influx of capacity, the market has already had to absorb a large increase in supply. According to real estate services firm Jones Lang Lasalle, 2700 units came onto the market in the fourth quarter of 2011, followed by 7900 in the first three quarters of 2012, bringing total stock in Abu Dhabi City to 208,000 units.

PRICES: Sales prices have accordingly come down with the influx of new supply and the lower cost of construction, although there is some variation in terms of location and type of residence. “There has been a decrease in the cost of construction as a result of the global financial crisis,” said Yousef Al Nowais, the managing director of Al Maabar. “This benefits developers who are continuing with their projects, and these construction cost savings will then be passed on to the end user.” In an April 2012 report from Cluttons, the real estate consultancy said that apartment values have come down more than those for villas, with the greatest declines for the former at Al Reem and Marina Square, falling 7.4% and 7.3% in the first quarter of 2012 compared to the third quarter of 2011. By comparison, the most notable declines for villas were at Al Raha Gardens, down by 4.8% on the third quarter of 2011, and at Al Reef Villas, showing a 2% decrease over the same period.

Stepping back and putting things in a broader perspective, prices in 2012 are far below those that prevailed at the height of the market. According to Jones Lang Lasalle, during the third quarter of 2012, the average residential sales price was around Dh10,200 ($2,779) per sq metre, down 53% from a peak of Dh21,500 ($5850) during the fourth quarter of 2008.

SALES TRENDS: Despite the continued drop in prices, sales have remained slow, and market participants have accordingly adjusted their behaviour. For example, banks are lowering mortgage rates in an attempt to encourage more buying. “The market for residential real estate in Abu Dhabi is increasingly active due to the improvements in confidence and the availability of attractive finance options,” Saeed K Al Mehairi, the CEO of Pivot Engineering & General Contracting, told OBG. “The majority of demand is for middle-income housing, but current housing stock caters primarily for upper-income segments of the market. Prices either need to adjust or additional middle-income housing units should be released to accommodate such high demand.”

Owners have also started to utilise some new techniques to encourage sales, as Sami Asad, the CEO of Aldar, told OBG. “Developers have adapted to the market to make homeownership easier. For example we have developed a rent-to-own scheme which helps facilitate our customers’ needs,” he said. Indeed, this programme, which was introduced by Aldar in September 2011, can be used to buy units at Al Zeina in the Raha Beach development. The scheme is structured such that a tenant enters into a two-year lease contract with Aldar, and the annual rental amount is fixed for the two-year period, with an option to purchase the property at any time during the lease. If this option is exercised at the end of the two years, the tenant will receive 100% of the first year’s rent and 90% of the second year’s rent in the form of credit towards the purchase price. Tenants are also free to walk away from the agreement at the end of two years and can moreover assign the accumulated credit to any other person. The only risk for participants in the plan is that rents and sales prices could go down, but they are not obligated to buy.

Aldar’s announcement followed the roll-out of a similar plan from Sorouh in July 2011 for its unsold units in Sun Tower on Reem Island. According to the terms of this programme, tenants enter into a three-year lease agreement, during which the rent is fixed. The tenant is given the option to buy the unit at the end of each year, at which point 90% of the rent paid to date can be converted into equity. The buy-out price for each year is established at the beginning of the contract, and the tenant can choose to exit the agreement without any penalty. These types of programmes can be useful for people who do not have access to sufficient funds for a down payment. If enough equity has been accumulated during the rent-to-own leasing period, it may entirely obviate the need for additional funds. As Sorouh noted in documents it prepared to explain the programme, it is possible to accumulate 15% of the purchase price during the lease period, which is sufficient for a down-payment for those who can qualify for an 85% loan-to-value mortgage.

Still, some market observers, including Jones Lang Lasalle, remain sceptical that these types of programmes will have a meaningful impact on the market. In its first quarter 2012 report, the real estate consultancy wrote, “Despite the introduction of rent-to-own schemes, the number of sales transactions happening in the market remained limited (in the first quarter of 2012) and were predominately from Emirati purchasers.”

NEW LAWS: On the other hand, another factor that could boost the residential sales market, although perhaps not as immediately or as obviously as pricing discounts and rent-to-own plans, would be the passage of real estate laws that have been in the works for several years. As it stands, non-Emiratis are allowed to buy property in so-called investment zones, according to a law passed in 2005. These investment zones include Reem Island, Raha Beach, Al Reef, Yas Island, Saadiyat Island and Al Maryah Island, among other areas. However, a system of property and real estate laws which do not currently compare as favourably to those of neighbouring Dubai – may discourage some foreign investors from purchasing a residence in Abu Dhabi.

This is set to change if new draft real estate laws that are currently under review are passed. The laws introduce a number of new features, including the regulation of both master- and sub-developers; a licensing regime for market participants such as brokers and surveyors; the requirement for certain contractual provisions in sale and purchase agreements; an escrow regime for off-plan sales similar to the one found in Dubai; and strata rules, including a formal process for establishing and registering a homeowners’ association.

In the meantime, even before the formal passage of the law, some developers, including Sorouh, have already started to implement features into their contracts that will be compliant with new regulations, including allowing for the establishment of homeowners associations. In a 2010 presentation to owners at the Sun and Sky Towers, Sorouh said that it would remain the owner of common areas until the new law is finalised, but once the new rules are in place, the homeowners association will take over control. This system will ensure that residential owners do not incur any costs related to the commercial or retail owners in a mixed-use development, officials from Sorouh said.

Developers are generally positive when it comes to the strata rules and the formation of homeowners associations, with Asad of Aldar telling OBG, “The finalisation of the strata law will help drive the residential market forward and manage some difficulties that developers face with respect to facility management.” Under the new law, the sale and purchase agreement will have certain statutory provisions that will address construction delays, such that statutory penalties will apply if they exceed a certain period.

RESIDENTIAL LEASING: The rental market presents a picture not dissimilar to that of the sales market, with supply rising and prices falling. In the rental segment tenants are looking to upgrade their apartments, sometimes without incurring an increase in cost.

According to Jones Lang Lasalle, annual rents for a prime two-bedroom apartment fell by 1% in the first quarter of 2012 to reach Dh120,000 ($32,700), with the year-on-year decline hitting 11%. The real estate services firm noted that the softening of rents was worse in Al Raha Beach and on Reem Island, due to the fact that these are rentals from individual unit owners rather than a single developer. The presence of multiple landlords in the same building or complex tends to push down prices, with individual owners competing to attract tenants. An April 2012 analysis provided by Cluttons came to conclusions broadly similar to those of Jones Lang Lasalle, although it noted that declines in rental prices were worse in suburban areas like Khalifa A, Al Raha Beach and Al Raha Gardens. According to Cluttons, as of the first quarter of 2012, the price for a studio rental in Khalifa A had hit Dh25,000 ($6800) per year, while 3-bedroom villas in Al Raha Gardens were being let at Dh155,000 ($42,000) per year. This represents a decline in rental values of 10% in these areas.

The weakness in demand can also be seen in other steps that landlords are taking to attract tenants, beyond reducing nominal prices. For example, as of December 2011 incentives to rent at the Shams development on Reem Island included 10% cash back or six weeks of free rent. Owners are also trying to accommodate potential tenants in ways beyond lower prices, for example by providing better facilities management. As Abdulla Saeed Al Qamzi, the managing director of Khidmah, told OBG, “With downward pressure on rents there is a lot of competition and so different landlords are using different methods to incentivise tenants. Professional facilities management is a very good draw in this regard.”

One factor that may ultimately slow the downward trend in pricing is the fact that the differential in pricing between Dubai and Abu Dhabi is narrowing. In the past, many people working in Abu Dhabi instead chose to live in Dubai, given that housing there was more plentiful and less expensive. In September 2012 the Secretariat General of the Abu Dhabi Executive Council announced that all government employees must live in the emirate within one year. This could provide some relief for landlords looking for tenants.

EMIRATI HOUSING: While the residential market at the high end is over-supplied, the middle- and lower-income segments of the market have not been served by the real estate industry, according to some developers. Another area that represents an alternative area of activity for developers is housing for UAE nationals. Since the formation of the UAE, the government of Abu Dhabi has placed a focus on planning and building modern homes for Emirati families, and the delivery of these housing communities forms a central part of Plan Abu Dhabi 2030. “The government is doing an excellent job in providing state-of-the-art infrastructure and thus enabling adequate housing for UAE nationals,” Al Nowais told OBG. “The population is young and growing, with significant household formation and a quest for a new lifestyle, so this is a priority area.” The government was developing housing projects at Al Falah, Yas Island and Watanti in mid-2012. The Al Falah development is on a 12.5m-sq-metre site east of Abu Dhabi International Airport and was designed by Aldar.

Upon completion, expected by the end of 2012, it will provide 5000 homes to Emiratis, as well as schools, mosques and other community facilities. The first phase of the second project – known as Yas Island Villas – will consist of 500 villas built over a 780,000-sq-metre site and is being carried out by local firm Royal Development Company. This self-contained community will also include commercial and retail facilities. Meanwhile, Sorouh will build more than 2600 villas as part of the Dh5.4bn ($1.5bn) Watani project. As of April 2012, the developer announced that it has nearly completed the first phase of the project, delivering nearly 1400 units.

For developers such as Aldar and Sorouh, building national housing may be less profitable than carrying out commercial projects, but it does provide a steady stream of revenue, an important factor during this period of limited growth in the market. Indeed, Aldar experienced some financial troubles during 2011, twice selling assets to the government. These included the Ferrari World theme park on Yas Island, the Central Market project on Abu Dhabi Island (subsequently renamed the World Trade Centre) and several hundred homes at Al Raha Beach. In total, the government pledged nearly Dh28bn ($7.6bn) to the developer. Additionally, Aldar announced in March 2012 that it was studying the possibility of a merger with Sorouh.

OFFICE: As in the residential segment, a number of key projects came onto the office market during 2011 and early 2012, including Etihad Towers, Sowwah Square and Al Khubair Tower (also known as Al Ain Tower). According to a report from Jones Lang Lasalle, the total office stock in Abu Dhabi City increased from 2.38m to 2.46m sq metres during the fourth quarter of 2011, rising to 2.73m sq metres as of the third quarter of 2012. The report also noted that office vacancy rates increased from 23% to 37% over this period.

While prices in 2012 are a far cry from the levels that prevailed in late 2008, the rate of decline since then seems to have slowed, with annual rent for grade-A office space decreasing from Dh1700 ($460) to Dh1540 ($420) per sq metre between the fourth quarter of 2011 and the third quarter of 2012, according to Jones Lang Lasalle. Cluttons has estimated higher prices for grade-A office space, at Dh1800 ($490) to Dh2000 ($540) per sq metre. However, both firms have overall similar conclusions when it comes to office rents, namely that prices for grade-A properties will continue to decline in 2012, but it will be a more gentle fall than in grade-B space, where the drop is expected to be severe. Some landlords have been under pressure in this environment, but there are bright spots, including Sowwah Square, according to Paula Walshe, the associate director at the Abu Dhabi office of Cluttons. The first of four towers at Sowwah Square, a development on Al Maryah Island, was delivered in March 2011, with three additional towers handed over during the first quarter of 2012. Tenants have already moved into the first tower, which has been more than 89% leased.

Part of the reason for the success at Sowwah Square has been the developer’s willingness to be flexible, Walshe told OBG. It will work with potential clients, for example by splitting floors or offering rent-free periods. The development’s facilities are also attractive, including ample parking and a retail facility (The Galleria at Sowwah Square) that is expected to open in August 2013. Sowwah Square has, accordingly, been able to attract high-quality international tenants, including law and finance companies. “For international corporate clients looking at Abu Dhabi, Sowwah Square is probably the first stop,” she said.

The types of incentives offered by Sowwah Square are not usual these days in Abu Dhabi, with many landlords offering rent-free periods and fit-out allowances. According to Jones Lang Lasalle, the use of such incentives increased during 2012. A challenge over the year ahead will be adapting to the addition of more stock on the market, with new space expected from Trust Tower (at Aldar’s World Trade Centre project), Nation Towers and International Tower at Capital Centre.

However, one factor that could help the market for office space is the 2011 decision by the Abu Dhabi Municipality and the Department of Economic Development to ban commercial operations in villas and other residential premises. Businesses were previously allowed to operate in residential villas, but complaints about traffic and parking prompted the new rules, according to public statements by officials from the municipality. The new regulation has gone into effect slowly, with existing firms required to move to purpose-built commercial space as a pre-requisite of renewing their trade licences. According to Hamad Abdulla Al Shamsi, the CEO of International Capital Trading, a real estate development company, the use of villas by businesses has had an impact on both the residential and office segments of the market. “Many businesses are located in villas rather than commercial buildings. This has pushed up residential prices by leading to a shortage of supply. I believe companies will begin to move into commercial towers which will free up this capacity and also utilise some of the available office space that has come online,” he told OBG. It is unclear what will happen to the villas used for commercial purposes, but it is possible there could be demand in the mid-range residential market for these dwellings.

AREAS OF GROWTH: With both the office and residential segments already quite saturated, two other areas of the real estate market – retail and industrial – remain relatively less developed, although both are expanding. According to Jones Lang Lasalle, as of the third quarter of 2012 Abu Dhabi had 1.67m sq metres of retail space, of which around half was accounted for by malls (see analysis). Rents at the emirate’s malls depend on location, with those located in outlying areas charging lower rates than on Abu Dhabi Island. Pricing in suburban areas has come under some pressure and owners are increasingly using incentives such as free periods to attract tenants. Market conditions on Abu Dhabi Island are better, although prices are expected to decline due to growing competition from new destination malls located off Abu Dhabi Island.

Indeed, mall space will increase by around 700,000 sq metres by 2015, according to global property specialists DTZ. This space will be a combination of dedicated malls – like Deerfield’s Townsquare – as well as retail space in mixed-use developments, such as the Boutik Mall at the Sun and Sky Towers on Reem Island. But by far the largest mall currently under development is the Yas Mall, which will have 235,000 sq metres of retail space and some 700 retail and food units. When it opens in 2013, Yas Mall will become the second-largest mall in the UAE behind Dubai Mall.

Industrial real estate is perhaps even more underdeveloped than the retail segment, with the potential for growth substantial given the government’s focus on establishing Abu Dhabi as a centre for industrial activity and transport (see analysis). Some warehouse and manufacturing space is currently available at industrial areas such as Mussafah and the newer Industrial City of Abu Dhabi (ICAD), but it is relatively limited. DTZ has reported that the total warehouse stock in Abu Dhabi stood at around 9.46m sq metres as of 2010, with only 6% of that total counting as high-quality product. Perhaps not surprisingly, given this relatively low supply and growing demand, new industrial real estate developments continue to come onto the market.

OUTLOOK: Challenging months may lie ahead for Abu Dhabi’s developers and landlords, particularly for residential and office space, as more stock comes onto the market, potentially further weakening rents and sales prices. Still, as pricing comes down, the emirate may start to appear more attractive compared with Dubai, which could mean more tenants, both residential and commercial. There are pockets of activity that look promising, including industrial and, to a lesser extent, retail. The anticipated passage of new real estate laws could also improve the situation in the longer term.