Recasting the rent-to-own model

Recasting the rent-to-own modelThe Greens / Image Credit: Archives,

Following a decline in residential sales across Dubai in the past quarter, analysts believe property values are likely to remain depressed over the near term as a large number of new units are scheduled for delivery over the next few years.

According to a report by JLL, residential transactions registered with the Dubai Land Department show a 45 per cent decline in aggregate value and a 47 per cent decline in the number of trans actions in the first half of the year compared with the same period last year. However, the influx of expats continues to fuel housing demand, especially in the mid-income segment, creating a gap in the affordable housing range.

''With house prices falling more than rentals in the Dubai market over the past year, more renters are currently looking to purchase for the first time,'' says Craig Plumb, Head of Research at JLL Middle East and North Africa.

Against this backdrop, developers would need to structure deals that appeal to a wider base of house-hunters. Reintroducing the rent to-own (RTO) model could offer a lucrative way to do so.

What is rent-to-own?

In an RTO arrangement, a portion of the rent paid by tenants is set aside as down payment. After a set period of around two to three years, the tenant will have the option to buy the property at a price agreed upon by both parties during the signing of the contract. Given the flexibility of the scheme, RTO properties tend to have slightly higher rental prices than the market price.

''The tenant undertakes a commitment to purchase with a medium to long-term view by paying a premium that goes into a bond or escrow account. The actual sale price needs to be agreed upon before commencement of the contract,'' explains Faisal Durrani, Head of Research at Cluttons. ''The developer will build in a profit to cover development costs and ensure security of payment.''

In addition to helping manage finances in a structured manner, this scheme also gives tenants a taste of the community and maintenance level of the property, alongside utility charges, owner association details, etc. ''It would benefit landlords who want to convert capital into maximum income over a long period. From a tenant's point of view, it allows [one to buy property] in cases where conventional mortgage is not an option,'' says Yolande Barnes, Director at Savills.

Barnes says an RTO arrangement could also be seen as a more secure form of renting because the lease would be long term and the landlord will have an interest in keeping tenants for more than a year or two.

''So it might particularly suit families with school-age children, for example,'' says Barnes. ''It would also suit highly mobile tenants who need to move town/country a lot. It would allow them to take an equity stake in a property without all the costs of trading [such as agent fees and stamp duty].''

RTO in other countries

Countries such as the US, UK and Spain have experimented with RTO schemes with leases tending to be anywhere between five and 25 years. In the UK the government has set targets for affordable housing to entice first-time buyers by providing them access to homeownership options. Developers have benefited by being able to offset the costs of developing affordable housing against tax breaks offered. Versions of an RTO model have met with varied success in the country.

''[The RTO model] can absolve some of the affordability constraints, but is not a panacea,'' points out Adam Challis, Head of UK Residential Research at JLL. ''It requires strengthening of structures around security, transparency for market participants and ease of application when it comes to entering such an agreement.''

In London, like in Dubai, ownership is cost prohibitive and even shared ownership models are often expensive. Challis warns the fine print of such programmes is often too complex for both buyers and sellers to pore over and delve into.

Dubai scenario

This could be one of the reasons why the uptake of the model in Dubai has remained restricted. Emaar Group was among those that successfully structured an RTO model during the launch of The Greens. It allowed expats to enter into property ownership in a phased manner with a three to five-year lease period. Harbor Real Estate also structured a similar payment scheme for the Skycourt Towers in Dubailand.

Another development currently offering this scheme is Emirates Living, which is being promoted by SPF Realty. One property listed under the scheme is a 2,700-sq-ft apartment with ''conventional rent'' at Dh235,000. The property's sales price under an RTO arrangement is Dh4.2 mil lion, with annual rent of Dh245,000. This model is also available for retail space in the same community with the conventional and RTO rents differing by 9 per cent.

The fine print

The success of RTO schemes lies in how the deal is structured and the resulting financial terms (the rate at which rental payments are offset against future price). The main hurdle in this model is the uncertainty faced by the seller, says Robin Teh, Country Manager of Chestertons UAE. ''Under a typical rent-to-own model the seller cannot sell the property to another buyer during a certain period, while the buyer can still opt not to buy the property at the end of the period. Therefore, the seller bears more risk in this arrangement as compared to the buyer, which is why the arrangement is not popular with sellers.''

Entering into an RTO scheme requires a keen look at the fine print and contract clauses. Experts advise buyers to ensure that the sale price is predetermined as a protection against market volatility, while any hidden charges, exit clauses or mortgage options for the scheme should be looked into.

Tenants should also ensure that the rent contract is renewable should they decide not to buy. Mortgage options after the contract tenure and the percentage of rent converted into equity are some of the other elements to look into.

Future viability

While the introduction of mortgage caps has controlled speculation in the market, it is impacting the ability of the average household to own property given the large down payment requirement. RTO schemes could be a way to ease the ability of households to commit to home ownership. But experts agree a wider application of this model is unlikely without federal-level intervention.

''Developers so far have been reliant on the pre-sale model to fund developments in Dubai. Any deferral of income damages viability,'' says Adam Wisher, Head of Development Advisory and Real Estate Research at Cavendish Maxwell. ''The developer would still require an entity to bulk purchase units and then implement a rent to-own model.

''There would be limited appetite in the private sector for this and it would need government support.''

However, for Dubai to maintain its competitive edge in the global market, all income-brackets need to be represented in the emirate's property market.

''For rent-to-own schemes in particular, regulation is needed around escrow accounts for the rent premium, making it secure and accessible later,'' says Durrani.

Developers too stand to benefit from building an asset base that is income generating and freeing up additional capital for use in other projects. ''They are also increasingly recognizing the benefits of selling to end users rather than investors and once this realization becomes more widespread, developers will increasingly see the attraction of schemes such as rent-to-own, which help convert tenants into long-term owners of real estate,'' says Plumb.

With checks and balances in place and lessons learned from other markets, analysts believe RTO schemes could help drive out some of the affordability constraints in the Dubai property market and cater to a previously untapped segment.

Get tips on building a successful property portfolio

Source: Manika Dhama, Special to Property Weekly


For Rent


View more properties

For Sale


View more properties