_The evolution of Free Zones and their impact on Dubai’s commercial real estate

Recently I have been approached by a range clients, both existing and new, who have asked me to provide some clarity as to whether their business needs match their real estate provisions, or if setting up, what the best solution would be for the business in varying circumstances. Given the host of proposed regulatory changes and the introduction of VAT, I thought it would be beneficial to provide an overview of the options available in Dubai’s occupier market. If you would like any further information on the real estate market in Free Zone, or would like to discuss, please do feel free to get in touch, my contact details are located below.

December 14, 2017

Origins of Free Zones

Historically built on trade, Dubai is known to the international business community and has successfully built a diversified economy by developing industries combining both local and foreign expertise.

To facilitate the process of doing business and attract foreign talent, the Dubai government created designated areas known as Free Zones that eliminate traditional trade barriers and minimise bureaucratic regulations, Jebel Ali Free Zone was the first of its kind, (9th February, 1985).

Over time, Free Zones in Dubai have evolved to symbolise strategic hubs for cooperation, learning and knowledge. Operationally, companies within a Free Zone are not required to have a local Emirati partner and can therefore control 100% of their own business.

Also, operating within a Free Zone exempts businesses from paying corporate tax and duties on exports to non-GCC countries. While the existing tax position is set to undergo some changes with the introduction of VAT on 1st January 2018, the implications of this Free Zone entities will need to be reviewed dependent on their business model and markets. Moreover, operating within a Free Zone allows for the repatriation of all capital and profits.

Impact on Commercial Real Estate

The impact of this on Dubai’s commercial real estate has been substantial. Large international corporates operating out of Dubai have been attracted to Free Zones, not just because of the ease and liberty of doing business, but also because of the attractive infrastructure they offer, including grade A quality built real estate, the majority of which are under single ownership and developed amenities (food and beverage, retail, gyms etc.).

This has resulted in a two-tier market where buildings within Free Zones charge a substantially higher premium (40%* on average in the year to Q3 2017) for rent on the back of strong demand.

Occupancy in some of the prime Free Zones such as DIFC and Dubai Media City are nearly 100% occupied within their core portfolio, where international corporate occupiers wish to be located, while rents [I assumed you meant rental performance] in buildings located in the onshore market have historically lagged (-6% on average in the year to Q3 2017*).

Dual Licencing

Free Zones do however have limitations, as companies who operate in them are unable to trade directly with the UAE home market, unless they establish an onshore operation. To bridge this gap and support a more flexible approach to investment, various Free Zones across the emirate are now offering dual licencing to companies that register within the Free Zones.

This relaxing of requirements will allow more flexibility for occupiers to (a) consolidate their operations and (b) locate the most suitable and cost effective real estate based on their business requirements rather than out of the need to be within a Free Zones. Examples of where this has occurred include the DIFC and Dubai World Trade Centre, which hope to leverage on the demand for dual licencing and the potential cost savings of operating a business. Overall companies should require less office space as they consolidate, however, this may be in a more expensive real estate option within the Free Zones.

Sponsorship Law

To further promote an internationally competitive and liberal business environment, a new law that is set to exempt foreign firms from giving local partners 51% of the company is expected to come into force next year (2018). Currently, organisations that undertake certain activities are exempt from the 51% requirement. These include companies involved in the oil and gas industry and foreign banks, in addition to companies established in Free Zones.

By adjusting the sponsorship law, this will allow for more corporates to set up their businesses onshore while avoiding the risks and hurdles of having a local partner. This will undeniably have an impact on the commercial real estate market as the take up for onshore real estate is expected to increase, particularly from smaller businesses setting up their operations in Dubai.

This will allow corporates to review what works best for their business in operating onshore and not necessarily following a dual licence option. In addition, this will also benefit grade B buildings which are secondary locations which may benefit from the increase demand in onshore activity.

Regional Competition

While Dubai continues to be the leading business hub for the region, there has been speculation over the impact the potential opening up of Saudi Arabia (The largest GCC economy) will have on Dubai’s commercial market.

Should this happen, it would allow for companies to have a more permanent and larger operation in the Kingdom rather than serving the market from Dubai on a fly-in-fly-out basis.

Naturally and in the long run this would impact demand and occupancy levels for commercial real estate in Dubai. However we assert that to operate successfully and liberally, businesses not only need an efficient physical environment, but also liberal rules and regulations that govern jurisdictions. This is particularly true of the Financial Services sector, which currently operates out of the Dubai International Financial Centre (DIFC) which follows English Common Law.

Looking Ahead

Many established companies in Dubai are expected to optimise their occupancy strategies mainly by consolidating their operations. The steps taken on behalf of Dubai’s government to facilitate this, whether by offering dual licencing or adjusting the sponsorship law, are enabling this environment. This is in addition to other initiatives to promote Dubai as more than a regional GCC hub, but one for Africa as well.

How this will play out in the commercial real estate market is yet to be seen, however we expect that Dubai’s status as an ‘open business field’ will continue to attract various industries and sectors, including medium-to-small scale enterprises (SME’s) who are likely to occupy space in onshore facilities that offer more competitive rental rates as noted in Knight Frank’s latest Dubai Office Market Review Q2 2017. This will eventually balance demand for office space between offshore and onshore real estate.

Matthew Dadd, Partner, Commercial and Leasing Agency

Email: matthew.dadd@me.knightfrank.com

Tel: +971 56 6146 087