Buy-to-live or rent in Dubai?

Hani Zaitoun.

Gathering with friends the topic of real estate in Dubai always pops up, and with it confusion. Various questions immediately arise; shall we invest or shall we not? If yes, then why should we invest? Is it because we intend to save on rent or to make money?

Throughout this conversation, opinions start falling in your lap and you end up pretty confused. One of the ways to see it clearly is to do your homework, make the calculations and see for yourself from your own perspective how much money you have and how much you are presently paying in rent.

As a banker who understands returns and costs, I decided to make a few calculations. If I was to buy a one bedroom apartment in Dubai at a price of 1 million dirhams would I be saving or losing on rent?

The comparison I made included the costs of financing and other operational costs for a one-bedroom apartment. As many banks require a 20% down payment, this will lead to 800,000 dirhams in financing at an interest rate of 8.5% amortized.

With equal monthly repayments, my interest cost amounted to 396,000 dirhams over a 10 year period. With an additional 120,000 dirhams to be paid in service fees (12,000 dirhams per year per 1,000 square foot), my total expense for the life of the mortgage would be 516,000 dirhams. If I divide that by 10 years, my annual expense on this mortgage would be about 52,000 dirhams per year.

Hence if I can rent a one bedroom flat in Dubai for less than 52,000 dirhams, it is better to rent it than go and buy an apartment. At the very least, I am saving equity in the property. Well, that's true or not true depending on certain factors which I will focus on later.

On the other hand, would I make money by investing in a readily-available one bedroom apartment if I was either stay in my current place and pay off the mortgage using the rental income or forego that and actually live in it? Buy-to rent or buy-to-live?

Buying in cash

Let us consider if the same one bedroom apartment was bought in cash for 1 million dirhams. The anticipated rental income would be about 90,000 dirhams per year, minus service fees of 12,000 dirhams, giving a net rental income of 78,000 dirhams per year. This would be a return of 7.8% which increase by 7 percent every third year.

Three hundred basis points above the yearly CD (certificate of deposits) rate of 4.8% for the risk I am taking and the potential of appreciation in property prices sounds good. I would consider living in it only if I am presently paying more than 78,000 dirhams in rent.

If I do not live there and I re-invest the rental income in a fixed deposit renewed annually at 4.8% then my returns will be even higher. Investing 78,000 dirhams for 10 years with interest compounded annually will yield a bank balance of 1.018 million dirhams other than the value of the property. Hence, your money has doubled and you make more if the property appreciates in value. Given the rental increases over a ten year period the possible value of the property would be about 1.358 million dirhams, so I can exit the real estate market with 2.376 million dirhams.

If only I had a million! What if I want to take a mortgage and finance my purchase?

Taking a mortgage

Here the situation becomes complicated with evaluating actual cash flows of the investment.

Assuming the same 20% down payment and 800,000 dirhams in finance with an interest cost of 8.5% amortized rate, I would be required to pay 120,000 dirhams per year per annum and I will be receiving net rental income of 78,000 dirhams, hence a negative cash flow of 42,000 dirhams per year. In addition, the scenario adds the 7% increase in rental every third year (two consecutive years of same rental income).

As time moves forward, your cash deficit decreases. Hence, with a negative cash flow am I making any money? Yes, given a 7% cap on rental increase, you can expect your property value to increase - assuming return on assets (ROA) remains at 7.8% - to a value of 1.358 million dirhams. You would be 396,000 dirhams richer at the 4.8% discount rate. In terms of the internal rate of return (IRR), this returned 13.8%. Not bad.

On the other hand, if you were to sell in year five given return on assets of 7.8%, you would have been able to increase rental income to 91,000 dirhams net, the value would be 1.167 million dirhams. With a 16.7% increase in property value, what would be the return and the net present value of your investment? The net present value would be 155,000 at a discount rate of 4.8% and an internal rate of return of 15.9% - even better. Actually, the best return you can achieve is in year five.

The previous results highlight the importance of interest rates. If interest rates are reduced your return, will be higher but if interest rates go up, you should be careful that the total interest expense for the first year in your amortized schedule does not exceed your net rental income i.e. make sure your interest costs are not lower than your total rental income.

Deciding whether you should move into the property or not will depend on how much you currently pay in rent. If your rental expense per year is less than 78,000 dirhams, then you should stay where you are and forego moving in. If you moved in, that means your annual cash outflow increased by another X amount (being the difference). Similarly, if rental expense is more than your possible rental income then you should move in, because by moving in you have improved your annual cash flow by the difference.

How big money is made

So how are people making big money in real estate in Dubai then? As I have come to see it, the money is in entering early and buying at the time of launch. This generates the maximum return on your investment over a two year period and thereafter if a mortgage needs to be taken then we go by the same sequence above.

At time of launch, you are required to make a booking which usually is about 10% which is then followed by another payment and over a 2 year period, you usually end up paying between 40% to 60% and the balance on delivery.

As an example assume the launch price was 750 dirhams per square foot, and you paid 20% in year 1 and 20% in year 2 and, just prior to delivery by 1 month, you decide to sell. On a 1,100 square foot one bedroom apartment, the price would be about 825,000 dirhams and your cash payments till year 2 would total 330,000 dirhams.

If the same amount was placed in a bank deposit at 4.7% per year, your balance at year 2 would be 352,000 dirhams (compounded interest). On the other hand, if the property appreciates by 20%, the amount that gets into your pocket would be about 495,000 dirhams, deducting the broker's commission. That is 165,000 dirhams in profits being 50% return or 141,000 dirhams above the bank deposit. Not bad.

Finally investing in real estate in Dubai or any market for that matter depends on the status and circumstances of each investor or buyer. Now since interest rates are declining the cost of borrowing will be reduced resulting in higher returns.

Now I know what to do.


Hani Zaitoun is a corporate banker at Dubai Bank.

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READERS' COMMENTS

why invest it in UAE?
Posted by OMB, dubai, UAE on Tuesday 2 October 2007 at 08:00 UAE time

To re-invest the rental income in a fixed deposit renewed annually at 4.8% ? Why not reinvest outside the UAE? A fixed deposit of 8+% in India? Changes the equation considerably.

Buy - to live or rent
Posted by Raj, Duba, UAE on Monday 1 October 2007 at 17:00 UAE time


I agree, You cant keep tab on costs - EMaar introduced Chilled Water fees of 7 AED per sqft. Come on .........

Buy to live or rent in Dubai?
Posted by Rodger, Dubai, UAE on Thursday 27 September 2007 at 16:00 UAE time

Using the author's logic (which may or may not be appropriate depending on your circumstances) you would actually live in the apartment yourself only if you were currently paying rent in excess of AED 90,000. The AED 12,000 service charges are irrelevant as you pay them anyway whether you live in the apartment or rent it out.

cautions
Posted by Aust, London, UK on Wednesday 26 September 2007 at 18:00 UAE time


Excellent article but it only seems to worry about interest rate changes. There are other things that may change. Maintenance charges can be hiked and a property tax could be introduced. Either of these could push the equation down to the break-even level so people need to be aware that there is no long term guarantee of profit in property. The nominal rate of return in all things in life reflects the risk of losing your money. High rates of return always equate to high risks.

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