|09 April, 2017

Dubai firms move to renegotiate commercial leases to cover VAT

Businesses in Dubai are attempting to renegotiate their commercial lease terms in anticipation of a rent spike

By Megha Merani

April 9 (TRPN) - Businesses in Dubai are attempting to renegotiate their commercial lease terms in anticipation of a rent spike following the introduction of value-added tax (VAT) in the Gulf Arab region next year, a real estate expert said.

Younis Al Khouri, under-secretary at the UAE's finance ministry, told Zawya, a Thomson Reuters company, in February that a 5 percent VAT is expected to be implemented across the six member states of the Gulf Cooperation Council (GCC) from January 1, 2018, as part of fiscal reforms to counteract the impact of the plunge in crude prices.

Firms in the UAE have been facing increased cost pressures amid the economic slowdown in Gulf Arab states following the decline in oil prices since mid-2014. A report published by property consultancy Cluttons last week said that global economic anxiety and a subsequent scaling back or delaying of short-term expansion plans, particularly amongst international firms, has begun to "impact the resilience" of office rents. Commercial rents have dipped across various locations in Dubai in 2016, it said.

"We've seen a number of tenants from that regard seek to have a clause in their lease outlining that if VAT is brought in and it causes an extra 5 percent cost on top of rental expenditure for a tenant... then the cost is either waived or the cost is paid for by the landlord," Murray Strang, head of Cluttons in Dubai, told Thomson Reuters Projects last week.

He added that a lack of clarity on how the new tax might affect commercial rents was causing "nervousness" amongst some existing tenants.

The finance ministry held its first workshop in March to educate UAE businesses on the proposed new tax law. Gurdeep Randhay, head of tax at international accountancy firm Grant Thornton, who was present at the workshop, told Thomson Reuters Projects that according to the ministry, rental of commercial property would be subject to VAT at standard rates of five percent.

David Godchaux, CEO of real estate consultancy firm Core Savills, told Thomson Reuters Projects that he expected an increase in rents due to VAT over the mid to long term.

"On the short-term, this will translate into higher rents of offices, although we expect this effect to be absorbed as the market adjusts," Godchaux said in an email last week.

According to tax experts, buyers or tenants of commercial property who are not VAT-registered would not be able to recover the tax charged.

Low margins could hamper office rentals market

Commercial landlords are also likely to feel the brunt of lower returns.

"If their margin is going to be affected by 5 percent VAT costs then it could become a very critical issue for a lot of commercial landlords out there," Strang said.

"In a lot of commercial property, rents have been softening over the last three years and it is increasingly difficult for commercial landlords to make the required return on investment or profit margins on these types of projects," he added.

Jumeirah Lake Towers (JLT) emerged as 2016's weakest performer, according to Cluttons, with lower and upper limit rents ending the year at between 60 UAE dirhams ($0.16) per square foot (sqft) and 140 dirhams per sqft, down from between 70 to 180 dirhams per sqft a year earlier.

Business Bay and Garhoud were the city's next weakest performing markets during 2016, the report said, where rents have dipped between 10 to 20 dirhams per sqft on average.

The Cluttons outlook said the prospect of further weakness in global economic conditions, which were already impacting the level of deal activity in the market, did not appear likely to subside in the near term.

Godchaux said some landlords may consider bearing the burden to retain existing tenants or attract new ones.

"In the short-term, pockets of opportunities will be created where landlords can absorb the extra costs, making their commercial property relatively attractive and competitive," he said. "This effect will eventually disappear."

A matter of location

While business occupiers are concerned about how to cover the potential liability of a rent hike as a result of VAT, Strang said the likelihood of landlords taking on the costs would depend on where the property was located.

The rate of overall input price inflation quickened in March, according to this month's Emirates NBD UAE Purchasing Managers' Index. However, companies registered no change in output prices. It said firms that raised charges passed on higher cost burdens to clients, while other firms reportedly offered discounts due to intense market competition.

Strang said "resilience" in areas such as Dubai Media City, Dubai International Financial Centre and TECOM, where there was "undersupply", was likely to persist although no growth in rents is forecast.

"We are yet to see whether any landlords are prepared to accept these types of clauses," he said. "In our experience, landlords are looking to avoid the introduction of VAT costs every bit as much as tenants."

Commercial projects in areas where there is oversupply are also slowing down as a result, he noted.

"On the flipside there are sectors such as JLT to an extent, which has seen supply drown demand to an extent and we've seen rents come down and supply increase at a rate that has made it definitely a tenants market in these types of areas where there is a lot more choice for tenants to move or negotiate on rents," he said.

"In these areas we've definitely seen the amount of development slowdown over the last year or two because there is a large amount of vacancy."

He added that it was still unclear whether firms operating within free zones would be let off from any potential VAT charges.

"However, it is our expectation that any new tax will be applied across the board to avoid an exponential rise in requirements for free zone office space," he said.

The UAE's Federal National Council approved a draft federal law regarding the introduction of taxation procedures at a meeting on March 15 - indicating that the state is in advanced stages of preparations to put its taxation system in place.

A source said earlier this month that UAE President Sheikh Khalifa bin Zayed Al Nahyan is expected to issue a law to introduce VAT on goods and services in the country within the next four months.

(Reporting by Megha Merani) ((megha.merani@thomsonreuters.com;))