Rent-to-own: can it solve the Dubai real-estate conundrum?

In: Blog
By: Prabhakar Raghavendra
Date: May 26, 2019
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Rent-to-own: can it solve the Dubai real-estate conundrum?

Dubai is currently brimming with real estate inventory awaiting new ownership. At the same time, 70% of the expats in Dubai are living in rental properties – interested, but reluctant to own a property, due to hefty down-payments⁽¹⁾. Unable to reach a more organic market equilibrium, real estate supply in Dubai remains in excess of an elusive demand, which the market ironically does actually contain. For a property worth AED 5 million or less, a buyer has to bear 25% of the property value as down-payment and a further 8% in initial fees, inadvertently creating a demand-supply mismatch. This real-estate conundrum in Dubai is the bottleneck that has resulted in the emergence of rent-to-own (RTO) schemes, which seek to redress this imbalance.

The rent-to-own idea is not peculiar to Dubai. It was first launched in the early 2000s, but failed to garner mainstream attention until after the financial crisis of 2008. Owing to a real estate downturn and the destabilization of prices in 2018, RTO schemes have now gained substantial traction in the region. The buzz is strong enough to warrant attention from some of the most influential figures in the industry. Whether or not rent-to-own is a silver bullet for Dubai’s real estate conundrum hinges on some specifics that have both pros and cons. For starters, how does the market define an RTO scheme, in the context of Dubai’s real estate sector?

Rent-to-own

Each rent-to-own scheme is unique. In its rudimentary form, an RTO scheme is a conditional agreement between a developer and a buyer, comprising of a rental and future-sale obligation. The rent paid by the tenant, as a part of this agreement, culminates in equity conversion after a specific time frame and at a predetermined price. The rent amount is, in effect, a series of installments towards the purchase of the property. Sunil Gomes, CEO of Gemini Property Developers, believes that such agreements are an effective means to address many issues delaying the purchasing decision of a substantial number of buyers. In Sunil’s opinion RTO arrangements reconcile positive outcomes for the buyers in question as well as the developer community, creating a strong motivation for their adoption. While he concedes that rent amounts under such an arrangement tend to be higher than typical agreements, Sunil believes that eventual ownership of the property provides a rationale for this.

The terms of the agreement are the crucial differentiator, in a rent-to-own scheme. The tenant has to fulfill all the obligations listed within the clauses, to become the homeowner upon the maturation of the contract. An RTO scheme adheres to the regulatory guidelines set up by Dubai Land Department (DLD), and offers the same consumer protection available in mortgage and typical rental transactions. Besides the initial upfront payment of 2% of property value, some nominal fees and ensuing rents, RTO schemes have no strings attached, unless otherwise specified in the contract.

Pros

Sunil believes that, from a buyer’s standpoint, a rent-to-own scheme is as practical as it is economical. He points out that, for an unqualified loan borrower with a low credit score, an RTO scheme might as well be the last resort to own a home, given the currently available options in the market. It buys time to spread the cost of purchase over a predetermined time period and, in the event of a market upturn in the future, the buyer gets the advantage of a predetermined, predictable price. Such an arrangement also facilitates a hands-on experience of the property before purchase, eliminating unpleasant surprises. RTO schemes reinforce the tenants’ emotional connection with the property and eliminate the inconvenience of packing and moving repeatedly. Of course, replacing the pure cost aspect of rent with a process of contributing to the ongoing creation of equity within an asset, is perhaps a buyer’s foremost advantage.

From a seller’s standpoint, the primary objective is to offload a rising backlog of inventory. Once the agreement has commenced, sellers get a steady flow of rental income and become impervious to any future downturn in the market. Tenants tend to be more invested and attentive to a property they can own down the road, which is a positive for the seller from a maintenance perspective, in case the option to buy is not exercised.

Cons

RTO schemes entail long-term commitment from both sellers and buyers. The latter could lose money in case of inability to adhere to the agreement, as the rents are relatively higher to begin with. Complications may arise due to the precariousness of ownership during the tenure. Market downturn and upturn can hurt both parties due to predetermined prices. Sellers cannot expect an instant windfall through an RTO, after having invested massive capital in the construction, and have to settle for returns staggered over time. Also, the legal imperative cannot be downplayed here. The contract should detail multiple clauses and stipulations, in the event of various complications, under the watchful eye of a legal advisor who specializes in real estate matters.

Perspective of industry experts

John Stevens, Managing Director of Asteco, is exercising “cautious optimism” as the industry warms to RTO schemes⁽²⁾. On the other hand Firas Al Msaddi⁽³⁾, CEO of fäm Properties, believes that developers in Dubai have no option but to jump on the RTO bandwagon if the current oversupply persists. Rent-to-own finds more proponents in the likes of Farooq Syed, the Managing Director of Springfield Real Estate and Bayut CEO Haider Ali Khan⁽⁴⁾. Gemini Property Developers CEO Sunil Gomes is of an opinion that RTO schemes could hold the answer to the issue of accumulating inventories, in the Dubai real estate market, as well as addressing a growing housing need among the upper middle class and young millennials. However, Sunil cautions that optimal success of the strategy requires a revisit of regulations, to streamline the process and diminish associated risks.

Conclusion

Dubai’s real estate market is currently at a watershed moment, with foreign investors and brokerage firms swarming the market, hoping to leverage the long-standing global interest in its state-of-the-art real estate offerings. However, this alone will not suffice, just like the new 10-year residency visa policy will not solve the inventory issue in isolation. While the aforementioned reforms could facilitate a favourable environment at best, innovations like rent-to-own could deliver the much-needed impetus.

Developers have set the ball rolling for RTO schemes since 2018, but considering Dubai has added over 50,000 properties to the market since 2016 ⁽⁵⁾, the impact of RTO schemes will take a substantial time to manifest. Meanwhile, as Sunil suggests, a closer look at the options that rent-to-own schemes facilitate is certainly a good idea.