Here’s why your rental income is shrinking

Here’s why your rental income is shrinking

Introducing The Urban Times, a report featuring the latest insights and proprietary research for landlords across Dubai.

When it comes to investing in properties in Dubai, there’s no denying the impact and importance of service charges. This annual fee, imposed by the designated owner association or property manager, ensures that a building or community’s cleanliness, maintenance, security and general upkeep are taken care of. It also covers common area utility bills, including power bills that keep the elevators running, and the water supply that irrigates common landscaped areas and fills the community pool. In theory, the better the standard of common facilities and spaces, the higher the service fees, and correspondingly, the higher the potential rental income the property can generate. This however may not always hold true.

Significant differences exist in terms of annual billed service fees between comparable freehold buildings within the same areas in Dubai. The issue is exasperated by the decline in rental income experienced across Dubai’s residential communities over the last three years, which has caused a consistently larger portion of income to be eaten up by service fee expenses, which had not moved in the same direction. The issue has recently moved front and center in terms of regulation, with a task force set up to address the mounting burden of service fees on property investors, as well as the establishment of Mollak by the Real Estate Regulatory Authority of Dubai in order to approve and control the application of annual service fees.

But how much is too much? What makes sense as an investment opportunity when you’re spending a large percentage of your property’s rental income to cover service charges?

As part of our first edition of The Urban Times, we chose to shed some light on the impact of current service fees on investment income in some of Dubai’s most prominent freehold communities. We took 1-2 bedroom apartments from the most popular freehold buildings in six key neighborhoods in Dubai and compared their service charges in relation to average rental incomes, as well as average purchase prices over the last 12 months. We kept the focus on 1 and 2 bedroom units in order to make it a more comparable data set across all buildings, as well as to focus on the most common investment class of properties in Dubai. Here’s what we uncovered:

Based on the sample we looked at, there seems to be a clear difference in average service fee charges across different key freehold neighborhoods in Dubai, with the sample average charge per square foot in Dubai Marina coming in at more than double the rate in Silicon Oasis. However, adjusting the view to service fee charges as a percentage of rental income, the difference almost entirely disappears with both areas coming in at around 22%. Jumeirah Village Circle (JVC) comes in with the most favorable ratio of 20.4% while Business Bay comes in at the higher end with a ratio of 27.7%. This carries through to average net rental yields, as JVC tops the range at a yield (based on current-year property transactions) of 7.1% compared to Business Bay at the lower end with 5% flat.

This view is certainly not complete, and buildings within each neighborhood sometimes vary widely in terms of service fee rates, transaction price averages and net rental yields. The differences can be accounted for to some degree by the age of the developments, their location within the neighborhood and various other factors.

Below is a sample of five of the most in-demand buildings or developments in each neighborhood:

As we can see, there’s a substantial difference in service charges even with properties with the same rental income in the same neighborhoods. Marina Promenade services charges for example are double the amount of Marina Gate. The fact that Marina Gate units do not generate a higher yield though is due to very robust transaction prices in the popular development, which have kept property values in the development well above the neighborhood average.

There are many other factors to consider when assessing the long-term potential for investment returns on freehold properties, not least of which are the potential for capital appreciation, the longevity of the development and the long-term appeal to potential tenants.

But what also seems to be a fair conclusion is that service fee levels do have a meaningful impact. A reasonable level of service fees to rental income, ideally below 25%, seems to correlate well with higher net returns, while the highest yielding properties typically have a ratio of between 15% and 20%. There is however, a point where service fees are set too low, and that is when they are not enough to maintain the long-term value of the development, and cause a decline in the general service levels within it.

Our recommendation? Find that sweet spot between service fees and rental income. What does that look like? A range between 15-20% is ideal. That means you’ll make the most out of your investment while maintaining your homeowner duties and ensuring your tenants retain a sustained standard of living experience.

It’s also worth keeping in mind that beginning in 2021, developers and home-owner associations in Dubai would be required to use the new Mollak electronic system (rolled out by RERA) to invoice property service charges. This will create a new level of transparency and control that is sorely needed. We can’t wait!

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