Since the enactment of the Dubai International Financial Centre`s (DIFC) pertinent REIT regulations in 2006 the DIFC has allowed the creation of REIT trusts or corporations within its perimeter. As DIFC-based property funds and REITs are now considerably gaining in investors` interest, it is time to take a closer look at the determining factors and available options.
Dubai`s DIFC has established itself as the region`s prime financial jurisdiction, offering a robust common law legal framework and thus becoming the domicile of choice for many property fund structures. As per the DIFC`s regulations, REIT entities are a subset of property funds, defined by the DFSA`s collective investment rules and characterised by the following features:
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Requirement to distribute 80% of the annual income
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Diversified real estate investment
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Closed-ended structure (no redemption)
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Property under development must not exceed 30% of the fund`s NAV
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Limited leverage (max 50% of Gross Asset Value)
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Mandatory listing
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Fund manager must be regulated by the DFSA (or equivalent)
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Usage of corporate or trust fund structure possible.
It is only recently that REITs have gained traction in the region, with „Emirates REIT“ being the first of its kind to go public on Dubai`s NASDAQ marketplace in 2014. In early 2017, EmiratesNBD bank listed its ENBD REIT, just as the former also domiciled in Dubai`s International Financial Centre (DIFC).
Taxes, Fees, Regulations
With the absence of withholding or corporate tax in the UAE, a property investment through a REIT is to be considered neutral compared to a direct investment. Regarding the newly adopted Value Added Tax (5%), levied on the sale of commercial properties and rents, individual and corporate investors alike have the option to distribute the VAT amount incurred on the property acquisition over the property`s lifespan (10 years) by off-setting it on a yearly basis against invoiced output VAT on commercial rents or other output VAT from applicable revenue streams.
A transfer of title bears a pricetag of 4% of the acquisition price within the Emirate of Dubai. In order to prevent charges to be levied a second time on shareholder level, the Dubai Land Department has signed an agreement with NASDAQ Dubai, effectively relieving DFSA-regulated or NASDAQ Dubai-listed property funds from the requirement to charge transfer fees on unit (share) transfer.
As per the local property laws, districts and comprised buildings are generally categorised into designated (freehold) and non-designated areas, whereas within the latter only GCC nationals are allowed to acquire properties. It is noteworthy that REITs can be relieved from this restriction, effectively opening the door for foreign (Non-GCC) investors to acquire property anywhere in Dubai and other Emirates.
Performance Measurement and other Challenges
Operating in a market environment which is known for fairly high fluctuations of asset valuations, it comes as no surprise that substantial parts of the earnings of UAE REITs stem from non-cash accounting entries associated with property revalutions. Combined with the obligation to distribute the majority of the fund`s profits, this can lead to a situation in which the fund de facto distributes equity back to its unit holders.
If the management`s performance fee is linked to the growth in NAV (often without a hurdle rate), substantial remunerations are paid to the management for unrealised profits. Given the long-lived property cycles, this appears to be somewhat problematic even assuming a high watermark clause has been adopted.
As REITs` and other property funds` earnings are greatly determined by non-cash positions for revaluation, depreciation and amortization, the property fund industry has widely adopted the performance ratio „Adjusted Funds from Operations“ (AFFO). Being a cash flow metric, AFFO measures the ability of a business to generate viable returns from its ongoing property operations. In eliminating revaluation gains however, the figures for some of the existing REITs boil down to AFFO yields of less than two percent at times, unmasking a problematic relation between revenues, overall costs and notably management remunerations.
Synopsis
With a competent management and appropriate fee structure, the proposition of a REIT as a liquid vehicle for investment into tangible, income-generating property assets is undeniably strong. Nevertheless, the UAE`s property market – exhibiting higher volatility in comparison to more mature regions – indispensably demands an appropriate timing strategy and diligent execution.
With the first local REIT listing on Dubai`s NASDAQ only in 2014, the sector for public real estate fund offerings is without any doubt still in a juvenile stage, therefore lacking sufficiently meaningful track records as well as competitive pressure. With a host of new REITs now incubating for a forthcoming market listing, it is highly likely that investment scope, quality and pricing of the available options will greatly diversify in the near future, ultimately spawning leaders for quality and price. Likewise, this trend will see sector specialists rise, implementing specified strategies to selectively invest into industries like education, hospitality, healthcare, student housing et cetera.
The advent of REITs in the UAE indicates a maturing of the property market while simultaneously nurturing its evolution, leading to increased liquidity especially in niche segments and for large, institutionals-dominated assets. I am convinced that the UAE`s market peculiarities, notably attractive rental yields and elevated volatility, represent a solid breeding ground for skilled managers, applying sound investment strategies and fair remuneration principles, to create highly attractive REIT structures. Those products, however, are yet to evolve.
This article was first published in the Spring 2018 issue of the Family Office Magazine.
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The author advises institutional investors about property transactions and handles property portfolios in Dubai since the year 2007. Should you have comments or inquiries, please contact the author on author@property-blog-dubai.com.
