The GCC has emerged as one of the most attractive destinations for commercial property investors. But whether to go for buying or leasing commercial space is the question of the day. Sunil Kumar Singh guides you through some of the pros and cons of buying or leasing.
The vigorous pace at which the GCC's commercial property market is expanding has taken everyone by surprise, not least the prospective investors scouting for an office address in the booming economies of the region.
The demand for high-quality office space has outstripped supply in the region's economic hubs such as Dubai, Riyadh, Jeddah, Doha and Bahrain, that has had a spiralling impact on the prices as well as the rentals of commercial properties.
Consider this according to property firm Asteco, office rental rates in Dubai have virtually tripled over the past two years due to the high influx of multinational firms and the expansion of existing businesses. Rates in 2005 averaged around Dhs100 per sq ft but prices have jumped to around Dhs 280 per sq ft. According to John Allen, Director, Research Valuation and Consultancy at Asteco, rates will remain high until 2009 due to construction delays.
In Abu Dhabi too, the office market remains the most lucrative, with prices and rents increasing by 35 per cent and 43 per cent, respectively, as per the two recent studies by HSBC and Dubai-based Damac Capital International.
A report from Better Homes, Dubai's leading property management firm, also notes that commercial office rental rates in Dubai have remained high and continue to rise at remarkable rates even when compared to more mature international markets.
But with the valuations of commercial properties in the region skyrocketing day by day - a trend which is projected to continue over the coming years - many potential investors are in a quandary as to whether to go for leasing the commercial space or buying it. The answer to lease or buy office space is purely contextual and it depends on the requirements as well as the size of the company looking for commercial properties.
As market analysts advise, investors should always weigh the pros and cons when evaluating whether buying office space would be better than continuing to lease it. As Nick Axford, Executive Director, Head of Research & Consulting - (Europe, Middle East and Africa), CB Richard Ellis Limited, one of the world's leading commercial real estate services companies, says, the decision to go for leasing or buying of commercial properties depends on the structure of the company and its growth phase.
If the company is in a high growth mode or is a start-up, it prefers to lease property because it can adjust itself better and respond to the periodical changes in the business. This flexibility would be absent if it went for buying the property. On the other hand, if the company has a specific requirement of space or if it is more likely to stay for long in a market where property value is expected to rise in the future, then it makes good sense to buy.
There are major considerations on both sides of the buy or lease equation. Real estate experts point out the following pros and cons to purchasing compared to continuing to lease commercial space.
Advantages of buying commercial space:
Fixed vs. variable cost: When a business owner buys office space, the person has a good idea what his or her costs will be over the long term. This is especially true if the person has a long-term fixed rate mortgage. However, if an investor leases office space, the market will dictate what he will end up paying for rent over the long run.
Appreciation: One of the primary goals of buying office space is to generate long-term increase in value through market appreciation. This is a good investment decision in a healthy market and is usually successful over the long term.
Additional income: Owning an office can offer the advantage of renting out extra office space, adding another source of income.
Tax deductions: The associated costs of owning and running a commercial space can provide expense deductions in the form of mortgage interest, property taxes and other items.
Disadvantages of buying commercial space:
Lack of flexibility: A new or growing business may experience unexpected needs in the future. If a business continues growing, your owned office space may become inadequate forcing a sale of the property.
Upfront costs: Buying commercial space will initially cost far more upfront. There are property, appraisal and maintenance costs, along with a large down payment and possible property improvement costs.
Advantages of commercial space leasing
Prime property: A leasing office space option provides a business with the chance to rent in an area with a good location and high image. If a small business is dependent on location and image, such as retail or restaurants, the leasing option is much more affordable.
Free-up working capital: The greatest attraction of leasing, perhaps, is that it is much more affordable in the short term than buying. This frees up working capital, providing funds for an investor's business to respond to opportunities in the market. And, the business owner can focus more on running his business without the distraction of owning the land and building he occupies.
More time: Any type of ownership comes with headaches. A leasing option affords the time to focus solely on running the business.
Disadvantages of commercial space leasing
Variable costs: With a leasing option, a business owner may be subject to annual rent increases and higher costs at the time when the lease expires.
No equity: While leasing an investor will be funding someone else's retirement with his lease payments. However, owning requires the investor to get involved in the property management business.
Analysts believe, given the growing economy of GCC countries, favourable government measures regarding foreign investments, and freehold law, the commercial real estate market in the region is expected to gain further momentum in the short to medium term. In this scenario, they feel buying a commercial property would be a better choice than leasing it. As Niraj Masand, Director of Commercial Advisory, Better Homes says, "In Dubai, the commercial property market is yet to deliver to the growing demand, a trend which is here to stay for at least two-three years. Hence, most of the investors are opting to buy commercial properties, while end-users prefer to lease." This is because of different positive factors.
First, businesses can look forward to good long-term prospects in the GCC as the region is awash with liquidity and there is a faint possibility of any forthcoming slump in the future. Secondly, prospective buyers of commercial property can look forward to easy access to credit provided by banks and lending institutions and, thirdly, commercial property rents are going through the roof, in which case, it's good business sense to buy property and let it appreciate. The fact that, in Dubai, rents are paid in advance -- sometimes up to one year in advance -- is surely a motivating factor for those considering a buy-to-let property in Dubai.
However, on the downside, service charges on new developments can be high and may be requested by the developer upfront. In most cases, buying will give an investor cheaper property in the long run because the cost will not include the landlord's built-in profit.
Also, experts point out that, an investor should buy, not lease, if he wants to stay in the same location forever. An investor can ill-afford to lose a prime location because of a rent escalation or a landlord's desire to take the property back. To put it differently, buying a commercial property proves a good decision if the property is in an area of appreciating land values. Otherwise, the investor/occupier will face continuing rent raises. If an investor buys the property, the growing land values work in his favour.
These are some of the reasons for owning a property, which analysts put forward. However, buying a commercial property is a long-term decision, and therefore an investor better make sure he can live with it. Neighbourhood and community stability is another key concern. In the UAE, which accounts for more than 60 per cent of the region's real estate development, there are a few grey areas that need attention in order to attract the flow of more international investments in the commercial real estate. As Nicholas Maclean, Managing Director, CB Richard Ellis Limited (Middle East), says, when an investor buys a commercial property, the greatest problem he comes across is regarding the estate management. At present in the UAE, there is still no legislative framework clearly defining the jurisdictions between the commercial property's owner/landlord, and the investor/occupier.
That said, there are no real right answers to whether to buy or lease commercial property. An investor's buy/lease decision hinges on financial, tax and personal issues as well as the sales and profits forecast for his business, and of course on the market. Whatever the case, an investor should not make decision precipitously and should consult legal experts, financial consultants, real estate analysts, and insurance agents before making a decision.
© Gulf Business 2008
