The sheer speed of development in the UAE means that investors must be prepared to sacrifice the level of due diligence that they are accustomed to, as Tim Watkins reports
As the credit crunch hangs like a dark cloud over most of the rest of the world, so the sun continues to shine in the United Arab Emirates (UAE).
There are no signs at present that the global financial slowdown will significantly affect the blistering pace of development that has transformed the UAE's real estate market in recent years. Investors from Europe and the US, faced with a reduced range of viable investment opportunities at home, are looking more to the UAE as a market seemingly untouched by the creeping effects of current global economics.
The pace of construction and development in the UAE has not, however, been matched to the same extent by the passing of laws and regulations of a type that one might ordinarily expect to find in certain western jurisdictions.
The foundations of the current legislative framework were laid with the promulgation, in each of Abu Dhabi and Dubai Emirates in 2005 and 2006, respectively, of property ownership laws that first which served to identify those areas (and only those areas) in which non-UAE nationals and entities could have ownership rights.
These have recently been enhanced by the passing in Dubai (and, it is expected, shortly in Abu Dhabi) of Law No. 8 of 2007 (the ‘escrow' law) designed to regulate the way in which developers are permitted to receive payments from end user purchasers of projects under construction, by having payments held on escrow and released to the relevant developer only upon completion of certain construction milestones. In this way, the new law ensures that developers are under greater time and financial commitments to complete project developments on schedule and are less able simply to use payment receipts to fund the promotion of future projects.
New legislation has also recently been passed in Dubai to regulate strata ownership and management within condominiums. The establishment, in July 2007, of the Real Estate Regulatory Agency (RERA) in Dubai to regulate, manage and license various real estate activities and issues is also evidence of a move towards streamlining the local real estate market.
However, the existing suite of legislation can still benefit from further regulation. There are still a number of practices and customs that have become standard in any UAE property transaction as a result of the lack of a more sophisticated framework within such transactions. Investors seeking to acquire investments in UAE property should be aware of the following:
The need to make a quick payment
Construction of the vast majority of announced projects in the UAE has yet to be completed. As such, the majority of what is bought and sold comprises off-plan developments on the secondary market. Yet prices (and therefore returns) continue to rise between launch date and completion of construction because of the volume of speculative investment, with owners selling what they bought for a premium, most commonly in the earlier stages of the post-launch development period and before the next scheduled payment is due to the master developer.
For as long as this practice keeps prices rising, there will always be other interested purchasers (many of whom may be cash buyers from the region) ready with available funds. Invariably, this means there is a need to pay a holding deposit at the outset, sometimes supported by a brief contractual memorandum of understanding, to lock down the deal. Because of the speed with which prices move, once a holding deposit has been paid there is great pressure on purchasers to complete very quickly (usually within no more than four weeks) which gives the purchaser little time to begin, and complete, his enquiries and due diligence.
Searches and enquiries of the seller
Given the above, property due diligence in the UAE is never as extensively undertaken as might be the case in western jurisdictions. For example, in the UK it is a common part of any transaction that title in the interest being transferred has been properly verified, and that any and all searches have been carried out (which may include environmental or town planning searches) prior to the payment of any money or the entering into of any contractual documentation. The simple fact is that few, if any, of the Middle East jurisdictions currently experiencing a real estate boom are geared up for this level of enquiry.
As a result of the recent legislation referred to above permitting foreign ownership rights in land, the land registration departments of Dubai and Abu Dhabi have suddenly been faced with a significant rise in registration applications, which has caused them now to become many months behind in terms of registering property interests. Consequently, the process of enquiring about registered title can be time consuming.
Furthermore, given the nature of staged payment structures that apply to almost all real estate developments, invariably the named seller who is seeking to sell his interest on the secondary market will not be registered as title holder because land payments are outstanding while construction is ongoing. As such, what is actually acquired in many cases is an assignment of the possibility of the property interest, which will crystallise upon completion of construction and payment of the entire pre-agreed purchase price.
Limited scope for negotiation of contractual documentation
It is not uncommon for investors to purchase a property interest despite certain parts of the contractual documentation not having yet been drafted. When developments are launched, and prior to construction having been commenced, sale and purchase agreements will often make reference to, for example, a Master Community Declaration (a form of Estate Management Scheme) or the terms of a Condominium Association Constitution (under the new Dubai Condominium Law). Often these are to be drafted later and their applicability then inferred on all owners.
Effectively, therefore, the only terms that are usually negotiable at time of purchase are price and (in respect of purchases on the secondary market) the time scale for payment of any agreed premium.
For so long as the level of construction activity in the UAE remains high, and the market remains buoyant, all of these factors will continue to demonstrate how real estate investments here are dictated less by a need to own a particular type of property asset than by the potential for that asset to generate significant financial returns. Investors would be well advised to enter this market with a full appreciation of how and why things are not done here as they might be "at home". With the potential for great returns comes a need to step out of one's comfort zone in terms of how those returns might be achieved.
Tim Watkins is an associate at Reed Smith, Dubai