Soaring inflation could deter commercial investors from buying larger office spaces in Dubai despite property experts believing returns on investments will be higher compared to Europe and Asia.

"Because of rising inflation, we will see fewer companies setting up commercial headquarters in Dubai," said Robert Mckinnon, Managing Director, Equity Research, Al Mal Capital.

"Instead, they will prefer to set up representative offices that need lower investments in terms of staff, salaries and office space".

He believed that the emirate could be on the verge of an over-supply, adding: "Delayed handovers are fuelling demand for offices space."

According to Jones Lang LaSalle, the current stock of office space in Dubai is 19.1 million square feet. "We expect an additional supply of 75.8 million square feet to enter the office space market in Dubai between 2008 and 2012," said Matthew Hammond, Director and Head of Agency Mena, for Jones Lang LaSalle. However, Philippe Dauba-Pantanacce, Senior Economist, Middle East & North Africa, Global Markets, Standard Chartered Bank is of the view that inflation implies risk at the macro level for all sectors of the economy, but if not reined sooner, the real estate sector will be the worst hit.

"Inflation in Dubai was 11.3 per cent at the end of 2007. The cost of rent and related housing items rose by 17.5 per cent and accounts for 36 per cent of the headline inflation in 2007.

"Already we see a steep rise in construction material prices which are jeopardising many projects. In the future, this will lead to an asset price bubble, followed by a bust."

Standard Chartered Bank predicts inflation to touch 12 per cent in the UAE by 2009 and woes could increase.



Expensive location

According to reports, Dubai is the sixth most expensive office location in the world after London, Moscow, Hong Kong, Tokyo and Mumbai, from both rental and price perspectives. Dubai International Financial Centre (DIFC), Business Bay and the Burj Dubai Downtown are among the top three office districts. These prime areas have seen a year-on-year appreciation of 35 per cent.

The current price at DIFC is Dh4,250 a square foot and at the Burj Dubai Downtown as much as Dh4810 a square foot. Business Bay commands an average asking price of Dh2,500 a square foot. According to James Knowles, Director Sales and Leasing, Asteco Property Management, in other areas such as Emaar Business Square, the asking prices are in the region of as much as Dh6,000 to Dh7,500 a square foot.

"Dubai has seen huge growth in capital values in the past three years over 100 to 150 per cent," he added.

Colliers International said recently that Dubai and Abu Dhabi have the lowest vacancy rates of two per cent, with Jones Lang Laselle reporting rentals in Dubai having shot up by 30 per cent from end-2007 to second quarter of 2008 alone.

Prime rental areas in Dubai are Sheikh Zayed Road (non-freehold area), which currently commands an average of Dh400 to Dh450 per square foot, while average rentals in Downtown Burj Dubai average Dh450 to Dh500 per square foot. The DIFC rentals are in the range of Dh450 to Dh500 per square foot.

"In Dubai, currently, the office supply that is available is all off-plan. There are no office properties ready at the moment. Whatever is being added to the market is quickly being leased out," said Niraj Masand, Director Commercial Advisory, Better Homes.



Rentals moving north

Hammond of Jones Lang LaSalle anticipates office rents will continue to increase this year and even in the next year.

"Short-term rents are expected to continue to rise, albeit at slower rates. Vacancy levels will increase with release of new stock. We anticipate rents to stabilise as the market absorbs new supply from 2010 onwards," he said. Masand of Better Homes believes that commercial developers are riding the crest of a wave at the moment. They are aware of the kind of supply they are putting into the realty market in Dubai, yet the interest from investors is asking them to add more.

The big question for Dubai, however, is how sustainable this is for the city. Mckinnon of Al Mal Capital said: "The office market in Dubai has a number of factors that it can leverage, for example the retail market. Most often office developments come with retail amenities and that can help spread risk of the office market segment.

"Continued project delays will help stabilise office prices and rentals in the near term. We estimate a levelling-off period between 2009 and 2010 when supply should come into the market. We are looking in about a year or two for office prices and rentals to stabilise."

Regarding absorption, analysts think companies that are buying or leasing office spaces represent a cross section of the economy of the emirate: financial industries in areas such as DIFC, re-export companies, real estate and property related firms and industrial consortiums, among others.

Added Dauba-Pantanacce: "In the financial industry's case, Dubai has been making a lot of efforts to position itself on the global map. Government initiatives to develop a set of international-standard regulations for the DIFC have helped to attract many global players."

Further, the yields for a commercial property in Dubai currently is two to three times higher than global markets. Yields on Grade A office are averaging at net seven per cent, after deducting service charges and other expenses. Gross yields average in the region of nine to 11 per cent. In comparison to European or Asian markets, Dubai brings two to three times higher returns.

But Fitch Ratings said that strong gains in property prices in recent years have prompted concern that speculative real estate investment was increasing, which clearly adds to the risk profile of the sector.

"The magnitude of price corrections, should they occur, could be substantial given the emerging nature of the market and depending on the magnitude of inexperienced speculators, and/or short-term holders, in the property market," the report on Dubai real estate said.

Knowles said: "Capital values of the office market and rental growth will remain strong. In effect, although an oversupply will initially exist, it will eventually achieve stability as Dubai continues to thrive as a global business hub."