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A successful enterprise depends as much on its location as its business model. Now that the UAE is on a renewed growth path, with small to medium-sized enterprises (SMEs) forming the backbone of the economy, commercial real estate is gaining traction.
The sector, which includes office space, industrial plots, retail stores, malls and warehouses, is seeing an unusually vibrant demand especially in prominent freehold areas. Recent trends and rising business prospects indicate that the self-employed, high-net-worth individuals (HNWIs) and corporates are beginning to invest in commercial property for end use, leasing or equity release.
In this new growth segment, access to financing is a crucial issue. Fortunately, banks have become sensitive to the demand and are stepping up their services to cater to enterprising investors. Commercial real estate investment remains an attractive proposition, however clients should weigh the myriad factors before opting for it. The market segment, upcoming locations, rents and pricing, as well as individual requirements and various financing aspects need to be assessed before taking the plunge.
State of the market
Until now, the UAE's commercial property segment has been relatively less developed than real estate. But over the past 15-18 months, freehold office space, especially in prominent business districts and primary areas classified as grade A has seen growing demand from SMEs. Entrepreneurs increasingly prefer to operate in their own premises rather than spend disproportionate amounts on rent. According to bank estimates, taking out commercial financing can work out to be about 40 per cent cheaper than renting.
Other structures such as warehouse areas, low-rise buildings for staff accommodation and retail spaces are also in demand.
A Dubai Economic Department Business Confidence survey indicates that 69 per cent of businesses will invest in expansion over the next 12 months. This view is endorsed by a number of surveys and reports brought out by prominent real estate companies, suggesting that the Dubai office market experienced healthy growth throughout last year's fourth quarter and the first quarter of this year.
The coming up of new start-ups and various business expansions has resulted in greater occupancy levels in prime office development areas. In fact, the current supply of space in the UAE's prominent business districts is low compared to the projected growth in demand. The purchase of commercial real estate can thus be a viable option for retail investors.
Location, rents, pricing
Over the past few months, there has been a surge in transactions for smaller office spaces ranging from 1,200-5,000 sq ft in size. Individual retail investors are buying smaller units to rent out, as yields can vary from 7-9 per cent depending on location and quality.
Despite rising rents, occupier demand is robust and the lack of premium office space is exerting an upward pressure on rents. This makes it a good idea to invest in commercial space. Given the slow supply in major business districts, secondary areas classified as grade B are also turning into attractive locations.
As per a recent market report, office rents remained steady in the last quarter of 2014. Rentals for prime office space increased by 14 per cent, while the secondary market saw a sound increase of 24 per cent last year.
Commercial property has faced some glitches in the past. In the pre-2008 era, a large number of freehold office space projects were launched, but most of them were off-plan and had to be halted during the downturn. Over the years construction was resumed in key areas including Business Bay, Jumeirah Lakes Towers, Dubai International Financial Centre and Tecom.
Maximum occupancy can be seen in plush areas such as Dubai Internet City, Dubai Media City and Dubai Airport Free Zone.
Industrial locations are not far behind. Rents in areas such as Al Quoz and Dubai Investments Park have increased by a whopping 43 per cent, especially on plots dedicated to distribution, fabrication and cold storage. Moreover, Dubai World Central has gained prominence with Ikea operating a 1.1-million-square-foot distribution hub.
As the commercial real estate market grows, banks too have stepped up their game. Financing of this segment has so far been under-served and SMEs have found it challenging to access funds. The situation, however, is set to change with financial institutions making efforts to address the lacuna.
Sales prices for office space
Noor Bank is one of the few institutions in the country that offers commercial property finance, where loans of up to Dh10 million can be availed for up to 15 years, with a maximum finance-to-value (FTV) ratio of 65 per cent.
This sort of financing is specially aimed at providing loans to the self-employed and HNWIs looking to purchase new office space. The bank usually finances ready commercial property such as offices and retail outlets in Dubai and Abu Dhabi. Clients can also transfer existing finance from other institutions to Noor Bank to avail of better profit rates and longer tenors.
Underwriting criteria may vary from institution to institution. Some of them underwrite commercial property under their corporate and SME finance criteria, and others under retail finance criteria. The underlying requirements for underwriting remain more or less the same, but banks are more cautious while funding this sector due to the higher risks involved.
For commercial property, FTVs range from 60-65 per cent with shorter tenors of up to 15 years, while financing for residential real estate can go up to 80 per cent with a 20-year tenor.
Profit rates and various fees are also relatively higher than residential financing schemes. Fortunately, the market is moving fast and we are likely to see more commercial offerings extended by banks.
Much of the criteria for commercial financing is similar to residential financing and banks provide it based on individual and company income. Documentation, credit assessment and verification methodologies also do not vary greatly (see box).
Existing clients of a bank may find the process swifter and they stand a better chance of negotiating terms and conditions compared to new ones. Since this is a slightly higher risk sector, banks place more safeguards and have valid reasons for rejecting applications.
Prospective customers must keep in mind that since the market is relatively new, there may be less space to negotiate fees and rates. Also, financing amounts for commercial projects are invariably heavy; banks are careful about vetting the ability of a client to pay. They're unwilling to place excessive burden on the self-employed as the amount of financing sought is sometimes disproportionate to the income.
Despite the rigours of the process, business owners need not balk at the prospect. Investing in commercial property with fixed-term financing protects entrepreneurs against the vagaries of rent hikes, adds to asset value and, importantly, is conducive to building equity.
• Company or personal bank statements and audited financials in case of large deals.
• Meeting the bank's debt burden policy
• Internal and external credit checks
• Telephone verification and references
Source: Pawan Dhawan, Special to Property Weekly
The writer is Head of Property Finance at Noor Bank. Opinions expressed here are his own and do not reflect that of the bank.