Question

Mismatch of Demand and Supply in UAE Property Market and the introduction of VAT

Chances of a major drop in Dubai’s home rentals are receding by the quarter — much of the new stock coming through is catering to the premium end of the rental market. And even if there is some softening in their asking rates, these properties are still way out of reach for budget-conscious tenants.

Phidar Advisory in its latest update on Dubai property trends offers numbers that show why. Two-thirds of the 6,000 apartments and 1,500 town houses and villas scheduled for completion during the second-half of this year are already available for leasing. Of this, villas and town houses make up a fifth, and carry rents of a minimum of Dh120,000 a year. These are generally affordable for households earning at least Dh360,000 per year, according to the consultancy.

But a sizeable number command Dh200,000 and over, and only accessible for those earning at least Dh500,000 a year and much more. “Thus, the new supply delivered is not the supply that is needed,” states the report.

Weak demand combined with moderate supply growth will lead to further rent and price atrophy, likely into and possibly through 2018,” said Downs

How VAT has affected Dubai real estate businesses, so far

It has been nearly two months since value-added tax (VAT) was introduced in the UAE and various industries are feeling its effects in different ways and varied intensity. While residential property is generally free from VAT, some Dubai real estate developers and brokers are feeling the pressure because other business expenses often incur VAT. To get a better view of the impact on real estate-related businesses in the early days of VAT, we talked to executives in the industry on the following two factors about their insights and how they are coping with the new tax regime. Their responses are noted below.

Cost-conscious developments

VAT is making the construction and real estate community more cost-conscious. As a developer, we do not charge the 5 per cent VAT to our customers. However, there is VAT impact on all the outgoings like contractors, sub-contractors, consultant, and broker commission and supplier payments. For example, on a Dh100-million construction, we would be paying Dh5 million VAT on contractor bills from January 1. The additional cost makes everyone cost-conscious and going forward I assume the contractors will try to carry out the same volume of work at lower cost by being more efficient. In a way, VAT will make every business more careful and responsible about their expenses.

Competitive pricing

If a contractor passes on VAT-related costs to the developer, it is likely to have an impact on a developer’s selling price. However, with consumers becoming more price sensitive, keeping prices competitive is critical for developers. Hence, a sudden spike in launch prices, however small, could affect demand. As such, residential off-plan sales have been exempted from any VAT, but any future inflation in construction costs could impact sales prices. The first supply of residential property is zero-rated within three years of completion, which allows developers to recover VAT on the construction of residential properties, including elements on architectural design, consulting, contracting and materials used. However, real estate developers should consider the complexities arising from mixed developments involving commercial and residential leasing and the need to assign VAT recovery.

No burden on buyers

VAT has an impact on the developer, as it cannot pass on [the tax burden] to the buyer of residential property. Building material suppliers of our residential projects send us invoices with VAT, which we the developer absorb without burdening the buyers. Therefore, the burden stops at the developer level. This will have an impact on profits of the developer. In commercial properties, the developer can pass on VAT to the buyer, but the market is not conducive to increase prices.

Minimal effect on cost

Residential property is free of VAT, so neither the developer nor the buyer is affected by its implementation as developers can be reimbursed for VAT when the first supply is in the market. Therefore, the VAT expense effect comes down to be minimal, which should not bring any difference to the prices. Practically, the implementation of VAT will increase by 1.5-2.5 per cent the general expenses of any business in the UAE, since the companies are not paying VAT on all of its transactions.

Buyers defer purchase

It is probably too early to say with any degree of accuracy exactly how VAT has affected the cost of selling within the secondary market. I did, however, state last year that the sentiment would be affected by the introduction of this tax. Some buyers will defer the purchase of property, preferring to take a wait-and-see approach before taking the plunge. This potentially has already happened, as sales of off-plan units did slowdown in January. If buyers are cautious, fewer sales will take place, putting pressure on an already challenging market. This, in turn, could lead to more softening of prices.

Questions for Discussion : : Please Do not copy and Paste and answer in Details

1-   Model the situation mentioned in the above scenario in the context of market equilibrium of Commercial property market given the introduction of VAT by the UAE government?  

2-   What impact do you anticipate on the demand of/supply for residential apartments from developer, seller and buyer point of view? Will there be excess demand/ excess supply eventually? Graphical illustration is required  

3- How the listed factors can influence (If any) the demand, supply and pricing of UAE commercial and residential property. Show your work through graphical illustrations  

Answer 1

Solution

1 - Unlike in the case of residential properties ,in the case of commercial properties,the developers can pass on the VAT to the buyer but the market is not ready to take the increased prices.The impact of VAT on the real estate and construction commmunity is not direct but it is indirect in nature which I would describe in the following questions.

In the case of commercial property market,VAT is seen as a burden on the developers.Eventhough the developers need not pay VAT on their transactions with the customers,but they incur additional cost because VAT is imposed on the other services they receive like architect ,design,contracting,building materials,etc.,.But they cannot pass on this burden to the thier customers as they are not ready to accept the increased prices.

Now in general all business experience a rise of 1.5% - 2.5 % in their expenses,the market is not ready to accept increased prices.So supply is stable ;demand is stable but weak as it is sensitive to price rise presently.

2 - Residential apartments

There is moderate supply growth and weak demand growth

Developers - As said in the article,presently the supply is catering only the premium segment within the residential space.So going forward, the future developers will be more focussing on developing more mid-level and lower-level segments.Also the developers are largely not impacted by the VAT as they can claim back the VAT they incurred on the business services if the properties development is completed within 3 years.

Sellers: Are also not impacted due to VAT as there is no VAT on transactions

Buyers Are also not impacted due to VAT as there is no VAT on transactions

There would be excess supply in the future as more developers would be concentrating on the mid-level and low-level segments

From consumers point of view,price is constant,supply is increasing ,so demand will increase.

3.The listed factors can infuence if the demand , supply and pricing of the properties:

Cost-conscious developments : As the suppliers become more price conscious and they can get their VAT costs re-imbursed,there may be price reduction (in case of residential but not in commercial) in future if other factors remain constant.Supply and demand will increase in case of residential properties but remain stable in case of commercial space.

Competitive pricing : There will not be much competitive pricing in the entire sector

Minimal effect on cost : In case of residential space,there can be price drop if demand drops.supply may increase in future.VAT impositon will not lead to price rise.In case of commercial,price is stable;demand is weak;supply is stable.We can observe the equilibrium price "Pe" is constant specially in case of residential space.

Buyers defer purchase : In case of residential properties ,Demand from buyers will decrease ;supply will remain constant , price will decrease.In case of commercial properties prices will not decrease mostly,supply and demand is stable.

Hope that this solution helps!!