Many investors say they remain puzzled about the applicability of Dubai's property rules, but most of all by the fact that Dubai's biggest property developers have little-known agreements with the Land Department exempting them from escrow law.
In 2007, Dubai's escrow law required all developers in Dubai to set up special accounts that limited the use of investors' funds to construction and other costs related to the projects into which investors had bought.
Analysts say it has long been clear that so-called master developers - companies that build roads, drainage systems and other basic infrastructure for their large-scale projects - did not have to comply with the law's requirements. Nakheel has disclosed its exemption in recent bond prospectuses. Emaar Properties, Dubai's largest developer, revealed its exemption in a prospectus for a convertible bond last week.
"We thought the money would be safe with a company like Nakheel, being semi-government or owned indirectly by the government," said Aarti Chana, an investor in the Palm Jebel Ali project. "Everybody trusted Nakheel and still trusts Nakheel, and we hope things will improve." Investors have been provided few details about their rights under the law, leaving many to assume that the master developers, would safeguard their investments. Since the financial crisis, property prices have halved in some parts of Dubai and led to a sweeping restructuring of Dubai World, Nakheel's parent company, prompting many investors to reconsider their assumptions.
Nakheel was one of the first companies to receive an exemption from escrow rules. About four months after the law's passage, Dubai World and all its subsidiaries signed a confidential agreement with the Dubai Land Department meant "to set forth their understanding and mutual obligations concerning the law", according to a copy of the document obtained by The National. The agreement said that Dubai World's commitment to finish projects in line with contracts "shall be accepted in lieu of bank account escrow arrangements for all developments to be undertaken by [Dubai World] entities, including developments undertaken pursuant to joint venture relationships".
Dubai World declined to comment. The Land Department could not be reached for comment. The exemption "is something that's not highly publicised, but it has always been the case", says Chet Riley, a property analyst at Nomura Securities in Dubai. "You'd assume as an investor that there's always been an escrow account in place." The exemptions that have been extended to Dubai World, Emaar and other big companies, allowed developers to spend the payments that investors made on new projects, helping the expansion and financing infrastructure for big developments. But they may also have compounded Dubai's property crash by fueling the growth during the bubble, analysts say.
"Pretty much everyone was using buyers' money to fund new projects and not putting the money in escrow to make sure the project was fully funded," says Nabil Ahmed, a property analyst at Deutsche Bank. "Three years ago, everyone was buying property, not even caring about construction and reselling three or four times while it was still on paper. Moving forward, if they want a more professional market, this is the basic kind of thing they have to address to make sure investors are comfortable."
But having to comply with escrow laws could be burdensome for developers such as Nakheel and Emaar because of their obligation to build expensive infrastructure in their master developments. Emaar said in its prospectus last week that if it had to comply with escrow laws, its "business model may be significantly impaired as it would only be able to finance the construction of projects with corresponding purchase price instalments once certain construction milestones are met".
"From an organisational perspective, cash inflows which could be redistributed to other parts of the business - other developers - gave some level of operational flexibility," Mr Riley says. "With the size and scope of developments for all of the master developers and the requirement to provide infrastructure to sub-developers, I actually do not think an escrow-type model could be applied. It would have necessitated a distinct change to the business model."
Despite the exemptions, Marwan bin Ghalita, the chief executive of the Real Estate Regulatory Agency, said last week there was nearly Dh7 billion (US$1.9bn) in Dubai's escrow accounts and that the system was still funding construction across the emirate.
Relaxed attitude paved the way
The Dubai escrow law, known as Dubai Law No. 8, was promulgated in 2007 to prevent purchasers’ money from being used for purposes other than the buildings in which they invested.
Early on, however, some private developers took advantage of loopholes that allowed them to use the money to pay for the land on which the buildings would be constructed as well as for marketing.
The developers of multiple projects in Dubai that are stalled spent money in this way, and now homeowners find that their investments were spentbut that the projects cannot continue without new funding.
"It could be argued there was a relaxed attitude towards the withdrawal of funds from escrow accounts by developers with limited sanctions imposed by Real Estate Regulatory Agency [RERA] and the escrow trustee," said a recent report from the law firm Hadef & Partners. "Some projects have run out of liquidity as monies in escrow had been
depleted either on non-project related expenditure or where released payments were greater than actual expenses."
Marwan bin Ghalita, the chief executive of RERA, said during an interview on October 3 that despite criticisms of the law, it had saved many projects by ring-fencing the finances. He said there was nearly Dh7 billion (US$1.9bn) in the escrow accounts of projects in Dubai.
* Bradley Hope
