Reforms and housing investment feeding into Saudi real estate pipeline

 

Although growth in Saudi Arabia’s real estate sector has softened since 2016, government-led initiatives to increase access to affordable housing, in addition to wider economic diversification plans focused on tourism and industrial output, look set to turn fortunes around. All eyes have been on the impact of the government’s white land tax on unused plots, which was introduced in 2017, with early signs indicating that this reform is encouraging greater access to land for mixeduse real estate development. Government reforms and funding initiatives in the home loans sector are under way, with the aim of significantly increasing home ownership. However, going forward there are concerns that an oversupply in new real estate developments will drag down sales and rental prices.

Size & Performance of Sector

The real estate sector struggled in 2018. While the Knight Frank Global House Price Index recorded a global average increase of 4.7%, Saudi’s property market registered a 1.3% decrease in prices in the first six months of 2018, ranking it 55th out 57 countries surveyed. This followed on from a soft 2017, when sale prices and transaction volumes came under pressure due to the lack of market liquidity. In 2017 the value of the real estate index on the Saudi Stock Exchange (Tadawul) decreased by 6.4% as the economy came under pressure from weak oil revenues and a growing budget deficit. Despite pressure on real estate prices, however, the total value of the real estate sector still grew by 4% in 2017 and comprised around 5% of GDP, or $37.2bn. According to a report by Saudi financial services firm Falcom, total real estate transactions between September 2017 and February 2018 showed a 14% year-on-year increase to SR106.2bn ($28bn).

Structure & Oversight

The real estate sector underwent some significant structural changes in 2018. In September 2018 Cabinet approved the conversion of the State Property Department, the government entity which oversees the real estate sector, into a general authority now called the General Real Estate Authority (GREA). The change is aimed at enhancing efficiency, with GREA to oversee management of state property assets, formulate broader real estate policies, and promote business development with the private sector. Other prominent players in the sector include the Public Investment Fund (PIF), which is overseeing state funding for major construction projects in the country, including housing.

Regulations relevant to the real estate sector include the real estate mortgage and financing laws, which were introduced in late 2014. These laws comprise five separate pieces of legislation dealing with regulatory issues such as mortgage creation, oversight and default, which has ensured greater financial stability in this sector. In order to diversify the economy and further open the real estate market to smaller investors, the Capital Market Authority introduced new rules in 2016 allowing for the formation of real estate investment trusts (REITs) on the Tadawul. As of February 2018, the total capital value of listed REITs sat at approximately SR7.2bn ($1.9bn).

General Trends

Saudi’s real estate sector has undergone significant change since 2016 as the government has reigned in spending and increased taxes in the face of weaker oil revenues. This continues to weigh on consumer sentiment, and rents for residential and commercial space have largely remained flat since 2016, while property prices have decreased. Since 2017 the government has introduced several taxes for the real estate sector aimed at increasing state revenue and encouraging property development. The full effects of the introduction of a 5% value-added tax (VAT) charge on new commercial and residential property sales, which came into force January 1, 2018, are still unclear. The VAT applies to any real estate sales transaction but residential rents and first-time homebuyers up to a purchase value of SR850,000 ($227,000) are exempt. Real estate sales are expected to see an increase in price in the coming year as sellers are likely to simply add the tax to the value of the property rather than cover the cost themselves.

Major Developers

Saudi’s real estate sector and the wider construction industry have historically been dominated by large local conglomerates which often have strong relationships with the government and royal family. The country’s major real estate developers include Saudi Binladin Group, Al Akaria, Dar Al Arkan, Jabal Omar Real Estate, Makkah Construction and Development, and Kingdom Real Estate Development. The government has major stakes in most of the large real estate developers, including a 70% share in Al Akaria and 35% in Binladin Group. Most are publicly listed and have looked to initial public offerings (IPOs) in recent years to raise funds for expansion.

For example, in December 2017 Dar Al Arkan, the country’s largest publicly traded real estate developer, with assets worth SR2.7bn ($714m), announced that it would sell a 30% stake in its property management unit through an IPO. In 2018 there was a significant increase in profits for several of Saudi’s major developers off the back of a slew of sales linked to large-scale development projects. For example, Al Akaria posted a SR30.3m ($8.2m) profit in the second quarter of 2018, a 46.2% increase from the same period in 2017. Meanwhile, Dar Al Arkan’s net profits surged from SR10.9m ($2.9m) to SR108.6m ($28.9m) over the same period.

Residential

The government has plans to invest over $100bn in housing by 2023 as it seeks to build 1m homes and increase the home ownership ratio from 47% to 70% as part of its Vision 2030 strategy. Around $15.7bn in funding is expected to come from state coffers and the rest through public-private partnerships (PPPs). PPPs in the housing segment currently account for around 54% of the $42.9bn of PPPs, and are expected to drive growth in the coming years.

Income from the white land tax is reportedly already helping to fund some of the state’s ambitious residential construction projects, including the SR100m ($26.7m) Al Uyaynah Housing Project in Riyadh. Affordable financing is offered through partnerships between private companies and the state-owned domestic mortgage lender, the Real Estate Development Fund (REDF), which has $49bn in funding. This is also expected to help ease the cost of borrowing, which has been recognised as one of the major barriers facing first-time home buyers.

The residential supply market in Riyadh remained largely unchanged from 2017 to 2018, with 1.26m units in the market. Similarly, Jeddah’s residential supply is also largely unchanged at 813,000 units, Dammam at 347,000, and Makkah with 384,000. Residential sales prices and rentals softened in 2017 and 2018, decreasing by 3% and 4%, respectively, in Riyadh, for example. Further downward pressure is expected in 2019. Construction prices for villas range from SR1700 ($453) per sq metre for a low-asset class unit, up to SR6200 ($2107) per sq metre for a residential compound unit, according to a report by global real estate company Century 21. Apartments range from SR2000-4500 ($533-$1200) per sq metre. In encouraging signs for investors, 2018 saw the government start to contract foreign companies to undertake several major residential development projects. Mohammed Badat, chief commercial officer at Bidaya Home Finance, a Saudi home financing institution, told OBG, “Saudi’s Ministry of Housing (MoH) has done a fantastic job with launching and organising new housing projects, both off plan and already completed, across the Kingdom.” In October 2018 the government signed contracts worth $4.4bn with Chinese and Japanese firms, including deals to build over 18,500 houses and over 8000 apartments. A month later it had inked contracts to build an additional 19,000 homes.

Affordable Housing

Continued government focus on providing more affordable housing to drive up home ownership among Saudi nationals is set to boost the country’s wider real estate sector, particularly in the capital Riyadh. Around 1.6m Saudi nationals are currently on waiting lists for government housing programmes and the government wants to build 1m low-cost homes over the next five years.

In line with the National Transformation Programme, the MoH aims to increase home ownership for nationals from 47% to 52% by 2020 through boosting affordable residential supply. A continued focus on this sector of the market was evident in 2018, when the MoH secured eight new PPP agreements and distributed 105,174 affordable residential products by May, and was expected to reach its target of 300,000 residential products by the end of the year.

Mortgage Financing

A major shortage of affordable housing in Saudi is in part tied to limited competitive offerings in the home loans market, which remains small by international standards, sitting at around SR290bn ($77.3bn). The Kingdom’s mortgage penetration has previously been estimated at around 8% of non-oil GDP. However, the government expects the value of the home loans market to reach SR500bn ($133bn), or 15% of non-oil GDP, by 2030. As is the case across most of the region, mortgages in Saudi Arabia mainly come from commercial or state banks, and there is a limited number of private non-banking financial institutions (NBFIs), although this is expected to increase over the coming decade.

Home loan interest rates are often too high for low- to middle-income earning Saudis and the waiting list for government-backed interest-free loans is long. To deal with this issue the government established the Saudi Real Estate Refinance Company (SRC) in 2017. The SRC has been tasked with refinancing 20% of Saudi’s primary home loans market, and since its inception has signed memoranda of understanding to provide banks and home finance companies with slightly less than SR6bn ($1.6bn) of financing. Increasing the availability of long-term, fixed-rate residential mortgages (LTFRs) will be key to growing the home loans market and expanding access to mortgages and in August 2018 SRC began offering LTFRs of 15-20 years through banks and other financial institutions. With SRC’s intervention in the market, LTFRs could account for 50-60% of Saudi’s mortgage market, up from its current level of one-third.

Informal Housing

Informal housing accounts for large parts of cities such as Makkah and Jeddah. A 2012 UN report estimated that around 1m people in Jeddah live in 50 unplanned settlements across 16% of the city’s surface area. In Makkah there are around 16 unplanned settlements where 40% of the city’s population of 2.2m people live, according to another report.

Since at least 2007 the government has been focusing on upgrading informal settlements in Makkah, Jeddah and other cities across the Kingdom through redevelopment projects. The government has also partnered with the UN Human Settlement Programme to develop a sustainable urban development programme focused on quality of life, economic competitiveness and environmental protection.

Major development projects for informal housing areas include the Jabal Al Sharashef Redevelopment plan in Makkah, which consists of formal housing and commercial districts close to the city’s holy sites.

Commercial

The commercial real estate market in major cities such as Riyadh, Dammam, Jeddah and Makkah has remained largely steady since 2017. According to JLL, the supply of commercial real estate space in Riyadh was flat in 2018, at 3.9m sq metres of gross leasable area (GLA). Jeddah also remained largely unchanged at 1m sq metres of GLA, Dammam at 870,000 sq metres, and Makkah at 264,000. Nevertheless, vacancy rates in some cities, particularly Riyadh, decreased in 2018. In the capital, vacancy rates for commercial property halved from 16% to 8% between the second quarters of 2017 and 2018. Rents for commercial property remained broadly the same in 2018, sitting at SR1289 ($343) per sq metre in Riyadh, compared to around SR988 ($263) in Jeddah, SR1014 ($270) in Dammam, and SR551 ($147) in Makkah. However, rent prices are expected to decrease slightly in 2019 as supply increases. JLL estimates that total commercial real estate space will increase to over 4m sq metres in Riyadh, off the back of construction projects such as the Business Front on Airport Road, the Majdoul tower on King Fahad Road, among others.

Leisure & Retail

In contrast to commercial real estate space, the retail segment has witnessed strong growth since 2017, particularly in Riyadh and Dammam. The hotel segment, meanwhile, showed little change in the number of rooms in 2018, while occupancy rates edged up slightly and prices per night remained largely flat. Around 250,000 sq metres of retail GLA space entered the market in Riyadh and 77,000 sq metres in Damman in 2017, up from 100,000 sq metres and 25,500 sq metres, respectively, in 2016. In Riyadh another 250,000 sq metres is estimated to have entered the market in 2018, with a further 415,000 sq metres in the pipeline for 2019.

Total retail GLA in Riyadh is forecast to hit 2.4m sq metres by 2020, up from around 1.7m sq metres in 2018. Current retail GLA in Damman is around 1.1m sq metres and could rise to above 1.2m sq metres by 2020. Retail space is being boosted by a strong pipeline of large projects, particularly in Riyadh where the Jood Commercial Centre, Granada Centre Extension and the Al Maather Square Extension, among others, will add nearly 180,000 sq metres in floor space.

According to JLL, demand for retail space from the food and beverage segment — including international brands like the Cheesecake Factory and P.F. Chang’s — are driving a lot of this growth. However, JLL has raised an alarm about the possibility of oversupply in the market, which is already having an impact on vacancy rates, which have seen an increase from 9% to 12% in Riyadh between the second quarter of 2017 and the second quarter of 2018. Oversupply has also affected rental rates, which decreased by between 1-9% in shopping malls over the same period.

Industrial

The government’s push to increase industrial contribution to GDP to 20% by 2020 is paving the way for growth in warehouse, factory and manufacturing space. As of the end of 2015, the last year for which the Ministry of Commerce and Investment has complete data, there were 7036 factories in the country, a significant increase from 5814 in 2010. In 2015 around 43% of factories were in Riyadh and industrial space in the city totalled around 25.2m sq metres. The government forecast that industrial space would increase to 35.4m sq metres by 2018, rising at a compound annual growth rate of 8.8%. Occupancy rates, at least in Riyadh, have historically been high, hovering around 92-100%. In terms of construction costs for industrial real estate space, warehouse costs can range SR1500-2500 ($400-$667) for warehouses and SR1500-3800 ($400-$1013) for manufacturing space, according to a 2018 report by Century 21.

Development

The government is targeting 7% annual growth in the real estate sector, and is aiming for real estate and construction to eventually contribute 10% of GDP as part of its Vision 2030 development programme. The real estate sector is set to be a major focus of Vision 2030, which sets out ambitious plans to launch real estate projects of all kinds, from residential to commercial and entertainment.

Apart from increasing access to housing, which is set to be a major government focus over the next decade, real estate linked to tourism is also set to undergo major expansion. Construction of hotels and other leisure-related real estate is one of the key aims of the Vision 2030 programme as the government is seeking to increase capacity for Muslim pilgrims in the country’s holy cities from 8m to 30m visitors by 2030.

Land

The introduction of a white land tax in March 2017 is already increasing the availability of land for development in Saudi. The law requires the owners of undeveloped lands that were allocated for residential or commercial usage to pay a 2.5% tax if they do not begin developing it within 12 months.

The tax has already prompted some landowners to sell major tracts of land to the government. For example, in October 2018 the PIF purchased a $578.6m land plot in northern Riyadh, the largest real estate transaction in the country’s history. The 434,000-sq-metre plot of land is located at a prime spot in northern Riyadh, opposite the King Abdullah Financial District, which is itself still under development.

Outlook

Looking ahead, a strong housing development pipeline is likely to be the primary driver of the country’s real estate sector in 2019. This will be underpinned by greater access to mortgages as more private debt providers enter the market to meet strong demand, particularly for cheaper housing options developed through government PPP initiatives. The industrial real estate segment also looks to be a safe bet as the government continues to focus on diversifying its economic output base. Although it might still be too early to assess the impact of the 5% VAT on some commercial and residential properties, any associated increases in property prices due to this tax are likely to be cancelled out by increased competition in the market as a slew of developments come into play.

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The Report: Saudi Arabia 2019

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