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February 2013
Managing for Value
Operating Costs and Service Charges in the UAE Office Market
The average service charge for Grade A office buildings in Dubai is currently around AED 33 per sq ft per annum. There is a significant variation around this average, reflecting both different calculation methods and a wide range in quality of services being delivered.
Unlike more mature markets, there is little correlation between the actual costs of operating buildings and the amount the owner can recover in service charges in the Dubai market. As a result, many owners are experiencing a shortfall between the level of costs incurred and their ability to recover these costs from occupiers.
As the market matures, we expect to see the adoption of more transparent measures of operating costs and service charge arrangements. This represents a win : win situation that is attractive to tenants and provides landlords with an excellent opportunity to differentiate their buildings in an increasingly competitive market.
Key Findings
● Occupiers are paying increased attention to service charges as they seek to achieve savings on their total occupancy costs in the UAE as in other markets globally.
● Owners are paying increased attention to operating costs as they seek to maximise returns from their assets in the face of depressed market conditions.
● Global best practise suggests that service charges should reflect actual operating costs. In Dubai, service charges are driven by market forces rather than true operating costs. Often these are below actual operating costs, leaving owners facing an operational deficit; and in a few instances higher than actual, leaving tenants paying for a level of service that they do not receive.
● The majority of Grade A office buildings in Dubai are currently operated on a net model (net rent plus service charges), while many secondary buildings are still utilising a gross rental basis (a single charge including rent and service charges).
● A major attraction of the net rental model is that it triggers a sharper focus on operating costs. This provides greater transparency that can assist occupiers in reducing their total occupancy costs. Improved transparency is a win : win situation, offering benefits to both occupiers and building owners.
● There is a significant variation in the level of operating costs and service charges among Grade A buildings in the Dubai market, reflecting different calculation methods and a wide range in the quality of services being offered.
● The average service charge within Grade A office buildings in Dubai is around AED 33 per sq ft per annum. This compares relatively favourably with service charges in Grade A buildings in other leading global financial centres such as New York (AED 50), London (AED 59), Hong Kong (AED 68) and Tokyo (AED 90).
● Given that office rents in Dubai are much lower than in other major global cities, the ratio of service charges to net rent (25% in Dubai) is above that in New York (24%), London (11%), Hong Kong (13%) and Tokyo (18%).
● There is some difference between service charges for Grade A office buildings between Dubai and Abu Dhabi, with average in Dubai being 7–10% higher.
● Cost effective management and transparent service charge arrangements are attractive to tenants, and provide landlords with an excellent opportunity to differentiate their building over others.
● Further improvements in the transparency of how operating costs are calculated and recouped from tenants in the form of service charges are likely as office markets in the UAE mature over the next few years. This trend is to be welcomed by both occupiers and building owners.
2 On Point • Service Charge Report • February 2013
Increased Focus on Operating Costs and Service Charges
Relationship between Operating Costs and Service Charges There is no single definition of service charges applied in the Dubai market, but most would agree with the following generic definition from the UK’s Royal Institution of Chartered Surveyors (RICS).
Service charges are the means by which the operating costs of providing the common services to a property are recovered from the multiple users of those services. The total costs recovered should not be inflated for profit. Similarly, there should be no residual loss (assuming a fully-let property with no concessions on service costs to specific occupiers) left for the owner to pay.
On this basis, operating costs and service charges should equate to each other, with the owner neither deriving a profit nor incurring a loss. In reality, a combination of the difficulty of accurately quantifying operating costs in a relatively immature market and resistance among tenants to pay for high quality services, means this is rarely the case in Dubai. As a result, many owners are currently incurring a shortfall between the true cost of operating the common areas of their buildings and their ability to recoup this cost from occupiers through service charges.
Increased Importance of Service Charges to Occupiers While Dubai is on an economic recovery path, with real GDP growth of 4.5% in 2012, this has yet to result in increased demand for office space. The office market remains generally over supplied, vacancy rates in the CBD are in excess of 30% (with vacancies in strata title buildings outside of the CBD at much higher levels) and there is downward pressure on rentals for all but the most preferred buildings / locations.
During the previous market upswing, tenants had little choice but to accept the rental and service charge levels being demanded by owners. As the market has moved increasingly in their favour, occupiers have a much greater choice and enhanced negotiating power.
With many tenants facing pressures to reduce their total real estate operating costs, they are paying increased attention to not just the headline rental but also the on-going service charges of the different options they are considering. Prospective tenants today are often scrutinising the management of a building as closely as the quality of the office space itself, evaluating the cost of these services and benchmarking these closely between buildings.
In addition to their concern to understand and control their total occupancy cost (not just the level of rent), tenants are increasingly recognising that the quality of their working environment and the comfort, safety & well-being of staff and visitors to their offices is directly dependant on the quality of property management services provided by the owner or his agent. This is further increasing the weight they attach to how buildings are managed and how these costs are passed on to occupiers.
There has been much discussion of service charges in respect of the Dubai residential market during 2012 as developers have sought to recoup more of their operating costs from individual owners. While there has been less public debate, service charges have also become an increasingly important issue in respect of office projects across Dubai. This paper looks at the relationship between operating costs and service charges in respect of one part of this market, namely Grade A buildings in single ownership.
On Point • Service Charge Report • February 2013 3
Increased Importance of Operating Costs to Owners The rapid rise in office rents in Dubai between 2006 and 2008 masked the true cost of operating the increasingly sophisticated buildings being brought to the market. With rental rates now under pressure from cost conscious occupiers, landlords are compelled to focus on managing buildings in an optimum manner.
With many buildings opening with low levels of occupancy, a particular challenge facing owners is how to manage costs while at the same time providing a level of management service that retains existing tenants and attracts new ones.
A significant factor impacting operating costs for owners is the increased complexity and sophistication of office buildings in Dubai. The market has seen the completion of more mixed use buildings in recent years, with office space being combined with retail, residential and hotel uses in the same structure. This increases the amount of common areas, the costs of managing these areas and the complexity of allocating these costs fairly to different users of the building.
Faced with increased levels of competition and conditions of oversupply, landlords are beginning to recognise the role that sophisticated property management can play in creating a point of difference for their building and thereby attract tenants. In so doing, landlords need to manage the difficult balance between providing high levels of management and building operation, while at the same time keeping service charges to tenants at a competitive level.
Converting Operating Costs into Service Charges Service charges should be based on either a realistic budget of anticipated expenditure on the actual building, or by reference to specific operating costs incurred in an earlier financial period. In practice, service charges in Dubai are often based on rule-of-thumb calculations or a perception of what the market can bear, rather than a stringent budgeting process based on genuine cost discipline.
The RICS Code of Practice identifies major headings into which office operating costs can be allocated and these form the approach to operational cost accounting used by Jones Lang LaSalle in managing a portfolio of around 2.6 billion sq ft of office space worldwide:
● Management Costs ● Staffing Costs for Site Management Resources ● Utilities (for common areas) – Air-conditioning, Water,
Electricity ● Soft Services – Internal & External Cleaning, Façade
Cleaning, Waste Management, Security, Pest Control, Landscaping, Environmental
● Hard Services – Mechanical, Electrical and Plumbing Services
● Insurance ● Sinking and Reserve Funds
4 On Point • Service Charge Report • February 2013
19%
13%
1.5% 1.5%2%
12%
8%
8%
13%
Electricity22%
Site Management Resources 13%
MEP Services13%
Cleaning & Environment 12%
Security8%
Sinking & Reserve Funds 2%
Water1.5%
Management Costs 8%
Insurance1.5%
22%
Cooling19%
Given the harsh climatic conditions and the high costs of energy in Dubai, utilities typically form the largest component, accounting for around 40% of total operating costs. Measuring the consumption of utilities by individual tenants often creates a challenge, as many of the recent Grade A office developments in Dubai have been delivered with either only one water meter or chilled water meter, or multiple meters that do not correspond to the sub-division of the building into individual tenancies.
In these circumstances, there is no financial incentive for the tenant to use utilities judiciously, as their charges do not reflect actual consumption. The building is likely to be charged the maximum tariff rates as there is only one meter reflecting the entire consumption for the building.
This either drives the service charge higher for all tenants, even those who are responsible users or is absorbed as a non-recoverable cost by the landlord. It also works against the adoption of sustainability initiatives, which are increasingly a part of both government and corporate policy.
While utility costs form a more important component of total operating costs in Dubai than in many overseas markets, elements such as sinking funds are typically much less significant than in more mature markets. Long term, this is detrimental to the asset as lifecycle costs are not factored in for items that may need replacement over the life of the building eg: lifts and escalators.
Source: Jones Lang LaSalle, January 2013
Breakdown of Operating Costs for Grade A Offices in UAE
On Point • Service Charge Report • February 2013 5
Source: Jones Lang LaSalle, January 2013
Landlords Tenants
Net Rental Model
• Increased transparency provides better understanding of true cost of maintaining assets.
• Allows calculation of net yields / returns.• Strengthens negotiating position with service providers.• Avoids the danger of undercharging tenants – ‘you can’t charge for
what you can’t measure’.• Encourages more sustainable practices and reduction of energy
costs.• Transparency creates a more attractive asset, as potential investors
have more confidence in the performance of the property.
• Increased transparency allows better comparison between competing buildings.
• Assists with assessing the trade-off between service level expectations and occupancy costs.
• Increased incentives to operate space in a sustainable manner.• More equitable allocation of costs, ‘user pays’ principle.• Avoids dangers of excessive service charges being hidden in a gross
rental structure.• Good track record of service charges provides tenants with confidence
in the building and encourages long term occupancy of tenants.
Gross Rental Model
• Reduces costs in identifying allocating and collecting service charges.
• Lack of transparency may allow a mismatch between recoveries and incurred costs.
• Simpler to understand as a single figure determines total occupancy costs.
Service Charge Structures in Dubai Historically, the costs of servicing the common areas of office buildings in Dubai have been included within rental payments (gross rental model). This simplified the accounting for both owners and tenants of single-use developments. The Dubai market has subsequently matured into a net rental model basis (with tenants being charged a net rent plus an additional service charge). While some older secondary buildings still use a gross rental model, almost all of the Grade A office buildings in Dubai now adopt a net rental model.
With the construction of more complex mixed-use developments, overlapping uses have become more frequent, creating increased costs and added complexities in allocating these costs. Deriving an accurate service charge requires a greater understanding of how operating costs are comprised. The extra effort of maintaining accurate data, record-keeping and financial analysis is justified as this provides owners with a more accurate picture of the true return on their investment and allows them to calculate a net rental yield.
Greater transparency also provides owners with the opportunity to reduce operational costs through more efficient management of their assets and more knowledgeable negotiations with service providers. An additional benefit is that owners will be able to identify areas where their assets offer advantages to tenants over competing buildings.
Greater transparency of how operating costs are calculated and passed on as service charges will also benefit tenants, providing them with the opportunity to more accurately compare total occupancy costs between competing projects. This will ensure that landlords are unable to pass on excessive charges and provides tenants with the chance to evaluate their service level expectations against the additional costs incurred to receive those services.
Current Market Practices
Table 1: Benefits of Alternative Rental Models
6 On Point • Service Charge Report • February 2013
Level of Service ChargesThere are three main approaches to the recovery of service charges that have been used within the Dubai office market:
1. Fixed service charges that cannot be varied, regardless of the actual costs to the landlord.
2. Variable service charges based on the actual or estimated cost of the services that will vary from year to year.
3. Percentage of rent basis which leaves the recovery of the operating cost exposed to fluctuations in the rental market.
While certain costs vary with occupancy (eg: utilities) there are many operating costs which are fixed irrespective of occupancy (eg: salary of on-site building manager). If premises are to be maintained to a certain operational standard, a base level of cost will be incurred irrespective of changes in market rents or the ability to recover service charges.
There is a considerable variation in the level of service charges currently being levied between different Grade A buildings in the Dubai market, with these charges ranging from AED 60 per sq ft per annum for buildings within the DIFC, down to just AED 12 per sq ft per annum for Grade A towers within Jumeirah Lake Towers. The average across Grade A buildings is around AED 33 per sq ft per annum (as at the end of 2012).
Our survey of Grade A buildings reveals that service charges are typically between 20% and 35% of Gross Rentals.
Calculation of Service ChargesThere are two basic reasons for the wide variation in service charges between different Grade A buildings within the same market:
1. Different basis of Calculation. The lack of standard market practices means there are currently significant variations
Property Location Prime Office Rent AED sq ft / pa Q4 2012
Service Charge AED sq ft / pa Q4 2012
Service Charge to Rent Ratio
Net Rent + Service Charge
Building 1 DIFC 220 60 27% ü
Building 2 DIFC 220 60 27% ü
Building 3 Sheikh Zayed Road 150 50 33% ü
Building 4 Downtown 160 38 24% ü
Building 5 Jebel Ali 150 25 17% ü
Building 6 TECOM 130 Inclusive N/A Gross
Building 7 Marina 130 30 23% ü
Building 8 Silicon Oasis 120 35 29% ü
Building 9 Downtown 125 27 22% ü
Building 10 TECOM 120 25 21% ü
Building 11 Sheikh Zayed Road 115 25 22% ü
Building 12 Jumeirah Lake Towers 100 25 25% ü
Building 13 Jebel Ali 80 25 31% ü
Building 14 Business Bay 80 20 25% ü
Building 15 Jumeirah Lake Towers 50 12 24% ü
Average 130 33 25%
Table 2: Service Charges for Grade A Office Buildings in Dubai
Source: Jones Lang LaSalle, January 2013
On Point • Service Charge Report • February 2013 7
Property Location Prime Office Rent AED sq ft / pa Q4 2012
Service Charge AED sq ft / pa Q4 2012
Service Charge to Rent Ratio
Net Rent + Service Charge
Building 1 Al Nahyan 204 28 14% ü
Building 2 Khalidiya 195 28 14% ü
Building 3 Captal Gate District 185 33 18% ü
Building 4 Tourist Club Area 185 28 15% ü
Building 5 Al Maryah Island 180 42 23% ü
Building 6 Al Raha Beach 180 39 22% ü
Building 7 Captal Gate District 170 28 16% ü
Building 8 Khalidiya 140 28 20% ü
Average 178 29 18%
Table 3: Service Charges for Grade A Office Buildings in Abu Dhabi
Source: Jones Lang LaSalle, January 2013
Source: Sowwah Square, Al Maryah Island
between buildings in terms of the costs that are included within service charges. There are widely different treatments in respect of utilities (air-conditioning, power and water). The manner in which these costs are calculated (eg: on a metered or on an area basis) and the formula applied to apportion them to various stakeholders in a mixed use-development also make it complex to compare service charges on a like for like basis.
2. Different levels of Service. Apart from the vexed question of what is or is not included in the service charge, no two buildings are identical in the standards of service offered to tenants. Two separate properties within a short distance of each other may vary differently in terms of the hours of operation, the presence or otherwise of on-site staff, security systems and air-conditioning. The differing requirements and
expectations of landlords will also result in differing levels of service provision and therefore very different levels of operating costs between two relatively similar physical assets within the same market.
Is Abu Dhabi Different to Dubai?Service charges for Grade A office buildings in Abu Dhabi are more uniform than in Dubai, reflecting a range of between AED 25 and AED 45 per sq ft per annum, with an average of AED 29. The smaller variation in service charges in Abu Dhabi reflects the more similar age of Grade A buildings in Abu Dhabi, most of which have only been completed in 2011 / 2012, the lack of freezone status (which inflates the cost in some areas of Dubai) and in some instances a mirroring of wider market norms.
8 On Point • Service Charge Report • February 2013
Market Practice Overseas Globally, there are different approaches to recovering operating costs. In the US, the normal approach is to charge tenants a single figure (gross rent) which includes operating costs. In contrast, the UK and Europe typically operates on a net rent plus service charge approach. Both of these practices are prevalent across Asia Pacific.
Irrespective of the approach, the financial goal of the owner will be to maximise the Net Operating Income by a value driven approach to property management operations. The old axiom applies ‘one can’t manage without measurement’, there is a financial imperative to owners to better understand and quantify their operating costs in a manner that allows them to maximise the recovery of these costs from tenants in the form of service charges.
The UK leads the market in terms of understanding office operating costs. Jones Lang LaSalle has been publishing the Office Service Charge Analysis Report (OSCAR) in the UK for nearly 30 years and this provides owners with substantial amounts of data for quantifying operating costs and establishing service charges.
Levels of service charges in overseas markets Service charges vary significantly between major global office markets, from AED 90 sq ft in Tokyo to just AED 22 sq ft per annum in Frankfurt. A simple average of the 17 cities covered suggests a global average of around AED 43 sq ft per annum.
There are clearly challenges in calculating a global average office service charge, due to both differences in local market practice (what is included or excluded in the calculations), differences in rental rates between markets and substantial climatic / cost differences. It costs a lot more to operate office space in high labour cost markets such as Tokyo than it does in those with significantly lower labour costs (eg: Shanghai).
Average prime office rents in Dubai are 50% of the global average whereas average service charges are 75% of the global average. This reflects the low level of net rents in Dubai as well as the predominantly high rise and high spec nature of the office space, with many iconic buildings and mixed use developments that incur higher operating costs than more simple ‘plain vanilla’ office towers. In Dubai, climatic factors and fixed capacity charges for contracted cooling capacity also contribute to higher operating costs.
As an absolute figure, the market-wide service charge average of AED 33 in Dubai compares favourably to the global average of AED 43. The main reason for this is the relatively low wage rates in Dubai relative to other global office markets. The competitive nature of the Dubai market also restricts the ability of landlords to pass on the full cost of operating buildings to tenants who have a wide range of alternative properties from which to select.
Global Context
On Point • Service Charge Report • February 2013 9
City Prime Office Rent AED sq ft / pa Q4 2012
Service Charge AED sq ft / pa Q4 2012
Service Charge to Rent Ratio
Net Rent + Service Charge
EMEA
London 558 59 11% Net Rent
Paris 367 33 9% Net Rent
Stockholm 217 10 5% Net Rent
Frankfurt 180 22 12% Net Rent
Abu Dhabi 178 29 18% Net Rent
Dubai 130 32 25% Net Rent
Brussels 124 17 14% Net Rent
Americas
New York 213 50 24% Gross Rent
Los Angeles 156 51 33% Gross Rent
Boston 155 34 22% Gross Rent
San Francisco 139 55 39% Gross Rent
Chicago 131 61 47% Gross Rent
Washington DC 129 39 30% Gross Rent
Asia
Hong Kong 512 68 13% Both
Tokyo 494 90 18% Both
Sydney 269 51 19% Both
Singapore 258 39 15% Both
Shanghai 257 25 10% Both
Global Average 252 43 20%
Table 4: Global Office Service Charges
Source: Jones Lang LaSalle, January 2013Note: For cities in the U.S.A. – Read operating cost for service charge; Gross Rent = Prime Rent + Service Charge
10 On Point • Service Charge Report • February 2013
Continued Move to a Net Rental ModelA management environment in which budgetary calculations of the true operating costs of office premises are transparent, assists both tenants and building owners achieve their financial objectives. This win : win situation is most likely to be achieved through the more widespread use of the net rental model, which requires a greater level of disclosure of the operating costs for the common areas and allows these to be more equitably allocated to different users within the building. This meets the tenants objectives of better understanding and managing their total occupancy costs. At the same time, it benefits the landlord by increasing the marketability of an office building vis-a-vis other competing developments and also ensures that the asset is maintained at an optimum level, preserving its long term investment value.
Capped Service Charge Increases The current surplus in office space in Dubai makes it challenging to let vacant office space. This has brought an increasing focus on the level of service charge expenditure, which is regarded as an additional occupancy cost by prospective tenants. Some tenants are seeking to take advantage of their stronger bargaining position to negotiate “capped” service charges for the duration of their lease. This provides tenants with certainty concerning their future total occupancy costs, with building owners having to absorb any future increases in operating costs.
As building owners become responsible for any future shortfall between operating costs and service charges, it increases the imperative to manage a commercial property effectively. The owners objective is to drive best value from the service charge budget, while ensuring that services are delivered at a level that will retain existing tenants and attract new ones.
Improvement in Energy Efficiency The Dubai market currently has few sustainable or green office buildings. One of the reasons for this is the lack of incentives for either tenants or owners to achieve energy savings. With a greater understanding of operational costs and how these can be allocated to individual tenants over time, there will be an increased financial incentive to reduce energy costs and manage buildings more efficiently.
Closer Partnership between Building Owners and OccupiersA central principle of service charges and the basis for many of the disputes which currently arise between building owners and their tenants is that landlords are responsible for determining levels of operational standards and costs, while tenants are obliged to pay for these decisions through differing levels of service charges. There is also a common mismatch between the service expectations of occupiers and their willingness to pay a premium for these services. Improvements in the level of transparency about operational costs and how these are allocated to different tenants should help reduce such conflicts and enhance the long-term value of the asset.
Future Directions in UAE
On Point • Service Charge Report • February 2013 11
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