Dubai: Is Commercial Realty Commercially Viable?

Unitas Consultancy (A GLOBAL CAPITAL PARTNERS GROUP COMPANY) Q1 2015

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• Commercial Prices have underperformed residential prices in the last two years; this has resulted in the latterbecoming top heavy as developers have announced a plethora of projects in this space. In the commercialspace, whilst vacancy rates still remain high, there appears to be a shortage in the “affordable” segment; thishas resulted in higher yields being offered in this segment.

• An overview of Dubai’s office supply, shows that it has a similar composition of grade A, B, C offices to that ofSingapore (Grade A – 30%; Grade B&C – 70%). This structure is conducive to nurture the growth of SME’s andstartups, as it offers affordable options. However, future supply that is expected to be rolled-out in the nextthree years is top heavy (Grade A – 56%; Grade B&C 44%), indicating a mismatch between demand andsupply dynamics.

• As tenants within the DED jurisdiction look for cheaper options for rents, they will be forced to look in areasalong the MBZ corridor, such as JVC, Motor City, and DIP. DED company formation has been growing at 7% onaverage per annum over the last 5 years, creating a sustainable pipeline of demand for office space.

• As demand for affordable commercial units begins to build up, especially in the DED space, developers willlook to land repositories such as JVC, Arjan and Majan to fill the supply gap. To date, there have been only afew developers that have started construction within the MBZ corridor in the commercial district; however, asdemand dynamics become more visible, the rollout of supply is expected to increase.

Executive Summary

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Table of Contents

A) An Overview of Residential Vs. Commercial Office Space 4

B) The Topography of Commercial Supply 8

C) In Search of Affordable Office Space 11

D) Mohammad Bin Zayed Road Supply Dynamics 15

A) Conclusions 20

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4

An Overview of Residential and Commercial Supply

“Sometimes an act of common sense is indistinguishable from an act of genius.”― Amit Kalantri

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Residential prices have substantially outperformed Commercial realty

JLT: YoY Increase Business Bay: YoY Increase

As the above graphs indicate, residential prices have substantially outperformed commercial realty over the past twoyears. It is important to note however, that in 2014, free zone and non free zone commercial realty appreciate byvirtually the same amount; moreover commercial non free zone offices (as represented by business bay)outperformed the residential component in the same district.

13%

5%

11%

29%

0%

5%

10%

15%

20%

25%

30%

35%

2014 2013

Business Bay (Commerical)

Business Bay (Residential)

12% 13%

22%

31%

0%

5%

10%

15%

20%

25%

30%

35%

2014 2013

JLT (Commerical)

JLT (Residential)

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6

0

10

20

30

40

50

60

70

0

0,2

0,4

0,6

0,8

1

1,2

1,4

2008 2009 2010 2011 2012 2013 2014

Office Space Supply (Sqm) 'MResidential Unit Supply '000

-80%

-60%

-40%

-20%

0%

20%

40%

60%

2009 2010 2011 2012 2013 2014

Residential

Office

Incremental Office Vs. Residential Supply (2008-2014) Incremental Office Vs. Residential YoY Supply (2008-2014)

Historical Supply Dynamics of the Commercial and Residential Space

A supply side analysis reveals that commercial realty space continued to be completed and handed over in themarket place at an annual average rate of 1m sq meters per annum during 2008-11, well after the market hadcollapsed following the bust in 2008. This overhang continues to linger in the marketplace today, accounting for arelatively high vacancy rate in aggregate (approx 30%). In the residential space, however, supply spigots adjustedrelatively quicker, allowing for higher absorption rates in this segment.

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Projected Supply Dynamics in 2015

Residential: YOY increase of Incremental Supply 2014-2015

19%

34%

47%

Prime High Mid69%

0%

10%

20%

30%

40%

50%

60%

70%

80%

Residential

Commercial: YOY increase of Incremental Supply 2014-2015

26%

0%

10%

20%

30%

40%

50%

60%

70%

80%

Commercial

56%

44%

Grade A Grade B & C

Break-Down of Supply 2015 Break-Down of Supply 2015

Given the relative underperformance of commercial realty in 2011-14, developers have adjusted to the price signalby offering greater supply in the residential space, with a move towards the high and the trophy segment. In thecommercial sector, whilst incremental supply is growing at a lower rate, there appears to be a greater degree ofbalance in product supply, between premium and other office categories.

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Commercial Realty Offers Higher Yields!

7,20%

8,10%

6,60%

6,80%

7,00%

7,20%

7,40%

7,60%

7,80%

8,00%

8,20%

Residential Office

Yields: Residential vs Commercial

8% 8,4%

0%

5%

10%

Grade A Grade B & C

6%8,51%

0%

5%

10%

Prime High-Mid

Commercial Yield: Break Down

Residential Yield: Break Down

Investment in the commercial realty space offers a yield enhancement at current levels. This can be attributed to therelative underperformance of the sector as a whole in recent years. An attribution analysis further reveals that whenthe “Affordable” part of the market is examined, yields jump by a further 40bps and equates to the yields beinggenerated in the mid income space in the residential sector. This jump is largely due to the relative scarcity of supplyin this space.

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Topography of Commercial Supply

“Small business is the backbone of our economy. I'm for big business, too. But small business is where the jobs are generated”- Michele Bachmann

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Singapore

International Microstructure Analysis of Commercial Realty

Source: www.mapletreecommercialtrust.com

30%

70%

Grade A

Grade B & C

New York

53%

47% Grade A

Grade B & C

Source: www.alvarezandmarsal.com

The above graph highlights the topography of commercial supply in two metropolitan cities Singapore and New York.Singapore represents the microstructure of most markets, with a skewness towards the SME sector, whereasManhattan, representing a concentration of larger companies, given its status as a money center city has a greaterweightage towards Grade A offices.

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30%

70%

Grade A

Grade B & C

Current Commercial Supply

56%

44%Grade A

Grade B & C

Upcoming Commercial Supply

Dubai Mirroring New York: Potentially “Top Heavy”?

Whilst Dubai has historically been mirroring Singapore's microstructure, upcoming supply suggests that the supply ofpremium offices will largely predominate; partly reflecting Dubai’s growing status as a regional money center;however this has also raised concerns of potential oversupply at the top end given its historical reliance on the SMEsector; a concern that has been already expressed in the residential space.

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In Search of Affordable Office Space

“The budget is not just a collection of numbers, but an expression of our values and aspirations” -Jacob Lew

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Free Zone Flexibility

Sheikh Zayed Road

Dubai Airport Free Zone Low

Dubai Healthcare City Low

Dubai Internet City Low

DIFC Low

Dubai Knowledge Village Low

Dubai Media City Low

Dubai Gold and Diamond Park Low

DMCC Low

Jebel Ali Free Zone Low

JLT Free Zone Mid

Muhammad bin Zayed Road

DUCAMZ Low

DIAC Low

Dubai Silicon Oasis (DSO) Mid

IMPZ Low

DWC Mid

The ‘Stickiness’ of The Free zones

As Dubai gravitates towards a surplus ofGrade A offices, we expect their to be amigration of tenants in search ofaffordable SME’s. The majority of thesetenants will be from the DED jurisdictioncompared to free zones.

The regulations and activities of freezones reduces the flexibility of migrationfor tenants to other free zones or underthe DED jurisdiction, allowing for ahigher rental paradigm in the formerwhen compared to the latter. Given theproliferation of free zones, the lack ofmobility is expected to accentuate,leading to company growth in the DEDjurisdiction having limited choices in theaffordable segment given the projectedsupply dynamics.

0

20

40

60

80

100

120

140

160

180

0 2 4 6 8 10 12 14

Min

Max

14

Deira Al WaslTrade Cente

r

Al Safa

Barsha Mirdif Business bay

DIP

Muhammad Bin Zayed RoadSheikh Zayed Road

Al Quoz

MarinaArjan JVC

Motor City

Commercial Rents Trend Cheaper on MBZ Road for DED Office Space

A rental comparison between Muhammad bin Zayed Road and Sheikh Zayed road, shows a clearpremium for offices along the latter corridor. As pent up demand from SME’s enter the market,driven by sectors such as real estate, banking, legal, and tourism (that require a DED license)demand for such space is expected to ratchet progressively higher. Office space along theMuhammad bin Zayed road will be the main repository for this incremental demand.

Source: RERA / GCP

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DED Company Formation Continues to Grow Steadily

7690682085

87545

9655710033096983

104097111701

123590128012,5

0

20000

40000

60000

80000

100000

120000

140000

2010 2011 2012 2013 2014(e)

Commercial

Professional

Total

Over a 5 year horizon, DED company formation continues to expand 7% on average per year. Weexpect this trend to continue as Dubai rolls out the infrastructure to support the World Expo2020. This historical growth rate further highlights that there is a mismatch between the demandand supply dynamics for this jurisdiction.

Source: Dubai Statistics Centre

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Muhammad Bin Zayed Road: Commercial Supply

“As you know, low demand and high supply means a drop in value of anything, including the dollar” Robert Kiyosaki

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Land Bank for Commercial Space on MBZ

32%

68%

DED

Freezone

Land Bank DED

Community SQ(Km)

DIP 49.4

IMPZ 10

JV 4

Motor City 0

Arjan 2.75

City of Arabia 10

Majan 3.84

Liwan 1.625

IC 8.6

Total 81.615

Land Bank Freezone

Community SQ(Km)

DOZ 1.8

DIC 10

DWC 160

DSC 7.95

DSO 7.7

Biotech 2.2

Total 189.65

Land Bank DED vs Freezone

Due to the ‘stickiness’ of Free zones, tenants that require certain activities, will be bound by the internal dynamics ofthat particular area. However, as developers adjust to cater to the shortage in supply of affordable office space onMBZ Road for DED office space, we opine that Arjan, Majan, and JVC will be the major beneficiaries of thisconstruction wave.

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Commercial Buildings on MBZ that Offer DED Licenses Expected Completion next 12 Months

Majan

Arjan

DIP

Diamond Business Centre

Palazzo Venezia

Developer: Diamond DevelopersSQM: 10,196

Developer: Global Capital PartnersSQM: 2,600

Arneco Schon Business Park

Developer: SchonSQM: 35,000

Developer: ArencoSQM: 49,200

The visibility of supply of affordableoffice space on the MBZ corridor isunclear. There are only fewdevelopers that have startedconstruction with DED areas to caterto the shortage. In most cases, whencomplete, such projects have metwith overwhelming demand,indicating that such project offeringsare expected to ramp up over thenext 12-18months.

ConclusionsResidential Vs. Commercial Office Supply Topography of the Commercial Supply

In Search of Affordable Office Space MBZ: Commercial Supply

A rental comparison betweenMuhammad bin Zayed Roadand Sheikh Zayed road, showsa clear premium for officesalong the latter corridor

As Dubai’s evolves into thecenter of business growth forthe middle-east, it will need aflurry of affordable options tosupport the growth of SME’s

A paradigm shift is underway between residentialand office supply, where the latter has becomeunder-supplied, relative to historical levels

Both residential and commercial supply in thecoming years has become top heavy, movingaway from affordable options for tenants

A rental comparison between residential andcommercial reveals that office space offer greatervalue to an investor in terms of gross yield.

Research into the topography of Dubai’scommercial stock reveals that approximatelyone-third of the supply is in grade A office,whereas the balance is in grade B & C.

The current composition follows that to offSingapore, making it conducive to find affordableoptions for nurturing of SME’s and start-ups

However, the expected supply over the nextthree years mirrors the topography of New York

Since the new commercial supply is skewedtowards the high-end, tenants within the DEDjurisdiction will begin to search for affordableoptions.

The rental differential between SZR and MBZ,make the latter better suited to cater to theaffordable market (SME’s and Start-ups)

Freezones companies, on the other hand, due tojurisdiction’s structural rigidity are controlledmarkets, implying that there will be a lowermigratoon effect. This then insinuates that freezone prices will remain higher and take longer toadjust to market dynamics.

The visibility of commercial supply on the MBZcorridor over the next 3-5 years is low, Whereprivate sector developers have offered projects inthis space, they have received strong demand,indicating the lack of supply that is prevalent in thissegment.

As Dubai DED company formations continue togrow at 7% on average per year over the last 5years, we opine that a flurry of new projects withinthis segment will be released in the next 12months. The major beneficiaries of thisconstruction wave will be Majan, Arjan and JVC

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Our Aspiration and Motto

“No barrier can withstand the strength of purpose”HH General Sheikh Mohammed Bin Rashid Al MaktoumThe Ruler of Dubai and Prime Minister of UAE