23 May 2011

THE IMPACT OF THE JOINTLY OWNED PROPERTY LAW ON HOTELS AND BRANDED OPERATORS IN DUBAI - UPDATE

Authored by: Brent Baldwin

THE IMPACT OF THE JOINTLY OWNED PROPERTY LAW ON HOTELS AND BRANDED OPERATORS IN DUBAI - UPDATE

Brent Baldwin explains the practical implications of the Dubai JOP Law on hotel developers and branded property operators.

In brief

  • The manner in which the Jointly Owned Property Law and the Directions impact on hotel mixed-use developments is a particularly topical issue for Dubai considering the number of such developments here and because there can be a number of competing interests in such developments.
  • Although a hotel owner may have a very large individual entitlement due to the size of the hotel for example, the residential owners may collectively have more entitlements than the hotel owner.
  • If control of common areas is handed over to an Owners’ Association with no interest in meeting the contractually agreed standards, the owner of the branded component may be required to pay additional charges on top of any service charges levied by the Owners’ Association in order to maintain such standards.

This article is also published in the Travel Law Quarterly.

In little over 10 years, Dubai has grown from a relatively unknown fishing and trading port to arguably one of the world’s (or at least the Middle East’s) most sophisticated cities. Despite recent stories in the media about the “downfall of Dubai”, it appears no one has told the people living here. From the personal experience of the writer of walking around the malls, beaches and hotels here it seems Dubai remains an extremely attractive destination for holiday makers, those looking to establish a commercial presence in the Middle East or North Africa region and people wishing to settle here.

It is well known that over the past decade fortunes have been won and lost through property speculation in Dubai. Easily available credit, huge investment in world-class infrastructure and the construction of high profile developments such as the Palm Jumeirah combined to create a huge real estate boom. The purpose of this article is to consider some of the real estate laws that have been introduced to regulate the real estate market in Dubai, and in particular the “hotel mixed-use” developments that help make Dubai a prime holiday destination for its many thousands of visitors each year. Many of these developments include freehold apartments for residential living or which are placed back into a hotel letting pool or both, and it is interesting to consider the impact of recent legal developments on this segment of the Dubai hotel and leisure market.

Considering the amount of foreign investment in Dubai over the past decade, particularly in the residential apartment and villa sector, it may surprise some to know that it was only in 2006 that the government formally introduced regulations specifying areas in which foreigners could obtain title to freehold property. Although there was no specific restriction on this previously, it was customary practice that only UAE citizens and citizens from countries included in the Gulf Cooperation Council could be registered as owners of land in the UAE.

Although there had previously been a land registry in place, it was nowhere near as well-developed as one would find in some other jurisdictions that are popular for real estate investment. This led in 2007 to a new “Land Registration Law” being introduced that made provision for a more specialised land registry with jurisdiction over all Dubai land including “Designated Investment Areas for Foreigners”, and included a more formalised land registration process and rules supporting the concept of freehold property ownership. These laws were only a small part of a raft of property related legislation that was introduced within a relatively short space of time between 2007 and 2010.

A significant number of large scale residential, villa and mixed-use hotel/residential/commercial developments were being built at this time. Given the relatively undeveloped state of the real estate laws, there was always an element of uncertainty regarding who was responsible for managing the common parts of such developments. Although the laws made it clear for example, that investors could own a freehold unit in an apartment building, there was a need for further clarity regarding the rights and obligations investors had in relation to lifts, foyers, swimming pools, gyms, gardens and other “common” areas and facilities, and how owners could collectively be responsible for running and paying for them.

The usual mechanism to provide for this was for owners to enter into a contractual scheme, and for the developer to take responsibility for the related management and administrative matters and levy service charges on owners with in many cases, limited legal oversight for how this was done. This led to many claims from owners that developers were over-charging and making a profit from service charges, and based on anecdotal evidence it appears many developers had relied on their ability to run these developments and levy service charges with a profit component to help support their cash flow.

This occurred despite the fact that approximately five years ago, the Dubai authorities began considering an appropriate legal regime to apply to such developments and began consulting with advisers from overseas jurisdictions where jointly owned property (often known as “strata”) management regimes were commonplace. This ultimately led to the issuance of Law No.27 of 2007 concerning Ownership of Jointly Owned Properties in the Emirate of Dubai (JOP Law) in December 2007. The JOP Law was broadly based on the equivalent Australian legislation, and sought to put in place a statutory regime to level the playing field with respect to service charges and clarify issues relating to the ownership and management of jointly owned properties and the common areas and facilities that form part of them.

Although the JOP Law created ripples in the market (for example it led to a number of owners’ association management companies setting themselves up in Dubai), the JOP Law was subject to implementing Directions without which it had no real impact. It was not until early 2010 that a number of Directions (Directions) were issued to effect the implementation of the JOP Law.

The manner in which the JOP Law and the Directions impact on hotel mixed-use developments is a particularly topical issue for Dubai considering the number of such developments here and because there can be a number of competing interests in such developments. Owners of residential units may not have the same desire to see common areas maintained to the high standards required by a hotel for example. Yet for hotels, the overall presentation of the development is an important aspect in attracting and retaining patrons. In addition (and depending upon any contractual restrictions), hotels may wish to regulate permanent residents’ use of common areas in a number of ways, such as by charging for the use of swimming pools and gyms, or putting rules and procedures in place for the use of foyers, valet and concierge facilities.

The JOP Law and Directions place responsibility for the management of the common areas onto owners through the creation of a registered Owners’ Association and an elected Board, with voting rights determined by each owners “entitlement”. Although a hotel owner may have a very large individual entitlement due to the size of the hotel for example, the residential owners may collectively have more entitlements than the hotel owner. This means that owners of apartments in hotel mixed-use developments may find themselves with a degree of control over a commercial hotel owner or operator.

There are a number of possible consequences of this, including potential impact on the valuation of the hotel, making the hotel less marketable to an institutional investor and a hotel management company or a lender not receiving the certainty they require that their investment will not be subject to the dictates of an “outside” group of owners, whose interests may not be the same.

The JOP Law and Directions have sufficient flexibility to regulate these matters, but developers need to consider the boundaries of what is acceptable to the Dubai Real Estate Regulatory Authority (RERA), which is the authority responsible for implementing the JOP Law. It is RERA’s stated policy that everyone is assumed to have the same rights under the JOP Law, and RERA has stated it is unlikely to accept (no matter how justifiable it may be) one particular owner in a development having a greater degree of control of common areas and facilities than others, for example by artificially adjusting voting rights.

Developers and owners who have an interest in promoting a hotel or serviced apartment brand will need to carefully consider how these issues are dealt with in the governing constitutional documentation for the building. If for example, a hotel or other brand is not maintained to its historical standard, it is possible the brand may suffer or the brand owner may terminate rights of use. Developers need to work closely with RERA in these matters to be mindful of what was and was not promised in the sales documentation and what the buyer bought into. Owners that bought in with the expectation of the development being maintained to a very high standard as part of a distinct brand may not object to those standards being reflected in the governing constitutional documentation.

There may however, be developments where residential owners do not share these concerns and who may object to such high standards being enforced and consequently reflected in their service charges. Once a developer completes an assessment of these issues, the manner of enforcing the particular standard needs to be carefully considered and appropriately reflected in the governing constitutional documentation. This creates a need for creative thinking by lawyers and others advising developers in this area.

Developers also need to consider the basis on which they have contracted with a hotel or other branded operator. If control of common areas is handed over to an Owners’ Association with no interest in meeting the contractually agreed standards, the owner of the branded component may be required to pay additional charges on top of any service charges levied by the Owners’ Association in order to maintain such standards. This could have a detrimental effect on profits. Developers also need to consider what services or facilities were contractually agreed to be provided for owners and whether hotels or other branded operators can charge owners for the benefit of those services or facilities.

It is important that these issues are properly considered by a developer and reflected in the governing constitutional documentation. Owners have rights to amend significant parts of the constitutional documentation by a two thirds majority vote, so proper consideration of these issues on the basis of achieving fairness and equity between the different interests in a mixed use development will reduce the chances of unfavorable changes being sought by owners later.

Dubai has very quickly grown from a quiet backwater to a sophisticated city and in many cases its laws (and in particular the JOP Law and Directions) have gone from being simple (or non-existent) to very comprehensive and technical by UAE standards. Many market participants may find issues associated with the application of these laws to be complex to grapple with, and there remain many questions regarding how the JOP Law and Directions are going to impact the market in the medium and long term.