Saudi Real Estate sector - Poised for lift off

Saudi Real Estate Sector

Saudi Real Estate Sector – Poised
for lift off

By Jitendra Garg
MS (Finance), CFA

3rd April 2009 Page 1


Table of Contents

Overview ..............................................................................................................3

KSA Real-estate sector – changing times ahead................................................. 3

Growth Drivers of Saudi Real Estate Market...................................................... 4

Residential Sector- Middle income housing verge of a high growth rate .......... 8

Additional benefits to the Company ..................................................................11

Issues and Concerns .......................................................................................... 12

Outlook .............................................................................................................. 13



Overview
The Kingdom of Saudi Arabia (KSA) is by far the largest economy of the GCC
and occupies ¾ of the Arabian Peninsula and holds 25% of the world’s
confirmed oil reserves. The region has an oil-based economy, with oil-related
activities accounting for 35–40% of real GDP and 85-90% of total exports
revenue. Strong crude prices over the last five years have played a significant
role in boosting the economic growth of the region which has registered a real
GDP growth of more than 5% a year during the period 2003 to 2007 and same
is expected to increase by 4.2% in 2008. Massive oil export revenues are
funding high public spending in infrastructure and education and have helped
the economy in maintaining a current account surplus of more than 25% a year
between 2003 and 2007. However, after witnessing a super-spike period during
mid-2008, oil prices fell sharply towards the end of the year to trade at less than
US$35 per barrel and resulted in the collapse of five-years of bull-run in oil
prices, which climbed from US$29 a barrel in early 2003 to a peak of US$147 a
barrel in July 2008. It was the result of a growing realization that the global
economy will face a sharp slowdown in 2009, leading to a huge drop in demand
for oil.

KSA Real-estate sector – changing times ahead
The focus of the KSA government to diversify from reliance on hydrocarbon
sector; provided a direct impetus for the growth of real estate sector.
Compared to other GCC states, the Saudi real estate market is at an early stage
of development. It is however poised for lift-off, with demographic
fundamentals and massive infrastructure investment providing the basis for
growth and a positive outlook for most sectors of the real estate market.

Key features of Saudi Real-estate market
Ø Saudi Arabia is by far the largest real estate market in the Gulf, as well as
being one of its fastest growing. Benefiting from its new era of
leadership, the Saudi commercial real estate stock which includes office,
hotel and retail space, is expected to virtually double in size to stand at
nearly 30 million sq.m. by 2012.
Ø The residential sector offers the greatest potential. With an estimated
residential stock of 875 million sq.m. in 4 million dwellings, the Saudi
residential market is more than ten times larger than any other Gulf
market.
Ø Saudi Arabian real estate market continues to maintain its charm even in
times of global recession and declining property markets. The existence



of enduring demand fundamentals rather than mere speculation activity,
heavily favours the growth of Saudi real estate market.
Ø A key characteristic of the Saudi real estate market is that the
fundamental engine driving the demand is domestic population and
economic growth, unlike other GCC economies where growth has been
largely based on overseas residents and employers.
Ø A major opportunity arises in the provision of more affordable housing
for a rapidly growing and youthful population. The current shortfall is
estimated to be as high as 500,000 dwellings, which could rise to one
million by 2012.
Ø Demand for office space has been rising in recent years with a large
number of commercial projects initiated by the Government.
Historically, villas were used as commercial space in top metros. The
Government has since prohibited businesses from locating out of villas
– provides further potential for increase in demand for office space.
Ø The retailing sector is also booming in the Kingdom. Given an official
ban on cinema halls, retail malls are a key source of entertainment. The
population visit malls for the purpose of, fun activities, socializing, and
shopping. Additionally, a large young population has led to the modern
retail trend finding faster adoption (i.e. higher brand consciousness and
international awareness). In fact, given the harsh weather and land-
locked cities like Riyadh, shopping is a key leisure activity.
Ø Saudi Arabia has by far the largest industrial market in the region,
presenting significant opportunities, particularly in the logistics sector.
This sector is currently underdeveloped but is expected to see rapid
growth, with the creation of specialist logistics parks over the next five
years. This will result in major opportunities for foreign developers and
investors.

Growth Drivers of Saudi Real Estate Market
1. Demography is Destiny
Rapid growth in population
Social, economic and real estate developments in Saudi Arabia are being
strongly impacted by the dramatically changing demographic profile of the
Kingdom. Saudi Arabia is not only the largest of the GCC countries
(accounting for over 60% of the region’s population), it also continues to
experience one of the world’s steepest rises in population; increasing from 7.3
million in 1975 to over 25 million in 2008, and fast growth continues as the
total population recorded 8year CAGR (2000-08) of 2.4%.. Although an annual



growth rate of 4.1% during 1975-2004 is estimated to drop to 2.3% in the
period of 2004-2015, it is still expected to be higher than 2.0% growth in Arab
countries and 1.3% in developing countries over the period of 2004-2015. . By
2015, UN estimates Saudi’s total population to reach over 29mn (nearly double
its population in 1990). It is also generating enormous pressures on the
country’s residential market and open up the Kingdom for vast array of growth
opportunities in all segments of real estate.
Favourable Demographic structure
The Kingdom's The Kingdom's Population by Age and Nationality
population (In mid-2007) (in thousand)
breakdown by age Age Category Saudis Non-Saudis Total % of Total
groups in mid-2007 0-14 6597.1 1295.6 7892.7 32.6
indicates that children 15-39 7647.6 3523.2 11170.8 46.1
of age groups from 0 40-64 2836.8 1608.4 4504.2 18.6
to 14 years old 65 & above 609.9 124 674.9 2.8
accounted for 7.89 Total 3446.7 1732.4 24242.6 100.0
million, or 32.6
percent of the total Source: Annual Report 2007 SAMA
population, the youth (from 15 to 39 years) 11.17 million or 46.1 percent,
while the age groups of 40 years and over stood at 5.18 million, or 21.4 percent
of the total population. The population pyramid is highly skewed towards the
youth with over 78% of the population below the age of 40. Interestingly, Saudi
has the highest percentage of population below the age of 40 across the GCC.
A large number of young Saudi’s are now entering adulthood and setting up
families. This will have a major impact on the economy, and will boost demand
for modern retailing and residential units indicating superior prospects for the
real estate sector.

2. “10x10” Vision is taking Shape Reforms boosting Economic
Competitiveness
The government is proactively seeking to achieve rapid and sustainable
economic growth. A key objective is to become among the world’s 10 most
competitive nations by 2010 – its “10x10 Vision” – through opening up its
market, inviting inward investment, improving the business environment and
capitalizing on the Kingdom’s competitive strengths as the global capital of
energy with a youthful population. A massive investment in infrastructure &
industry is required to execute this vision which will boost the income level &
thus will again boost the consumption capacity indicates huge potential for
commercial, retail and housing sector growth.



Relaxing FI norms and increase in FDI
To achieve this goal, government access to the World Trade Organization
(WTO) and reduced the corporate tax on foreign-owned firms (down from
45% to 20%). Apart from it, Saudi Arabia also removed the minimum capital
investment requirements on foreign investors and a new government
procurement law was also passed under which 100% foreign-owned companies
could bid for government contracts. All these measures, has dramatically
increased foreign direct investment, which is increased almost ten-fold from
USD 183 million in 2000 to USD 17.5 billion in 2007 respectively,
accompanied by equally impressive growth in domestic investment. This huge
inflow will further boost the capital formation which again lead to higher
income & thus will boost the real estate sector.

3. Negative real interest rates scenario make real estate compelling
Interest rates in
Interest Rate Trend for 3-month Currency
the region are at Deposits
decreasing trend &
interest rates on 3- 4.5
Interest Rate (%)

saudi Riyal US Dollar
4
month SAR and 3.5
US dollar deposits 3
2.5
touched the four 2
years low of 1.45% 1.5
1
and 1.21%
Jan. 08

Feb. 08

Mar. 08

Jun. 08

Jan. 09
May.08

Jul. 08

Oct. 08

Dec. 08
Sep. 08
Aug. 08
Apr. 08

Nov. 08
respectively in Jan.
2009. Low interest
rates in the region
Source: Monthly Bulletin, SAMA
work as catalyst
for real estate
sector growth & provide an excellent opportunity to the genuine buyers to buy
a house or an office which they can ill afford. It will also benefit the real estate
developers by reducing the cost of financing and improving their margins.
Apart from it, inflation hit a 27-year high of 10.5% in April-08 as rents climbed
20.4% due to the lack of residential supply and individuals forced to rent.
General cost of living index in the region is still very much higher than the
prevailing nominal interest rates taking the real interest rates in the negative
zone. With negative real interest rates; consumers have less of an incentive to
save/deposit their funds and a greater incentive to invest in real estate to
benefit from attractive rental yields and gain though capital appreciation home
prices.



4. Gross Fixed Capital formation – KSA early on the curve
Gross fixed
capital formation Trend of GFC/GDP & Growth in GFCF
(GFCF) as a
percentage of GFCF/GDP Growth Rate in GFCF
GDP refers as a 24.00
barometer of the %
14.00
level of
development in 4.00
an economy. In 2003 2004 2005 2006 2007
KSA, just 20% of
the Kingdom’s Source: Annual Report 2007, SAMA
GDP in 2007 was
channeled into fixed capital formation. This is the lower in the region with
regional peers ranging from Kuwait (19.7%) to Qatar (35.5%). Historically,
developed countries such as the US and UK have had their GFCFs as a
percentage of GDP steady at the 16%-19% levels. The EU and OECD
countries were marginally higher at 20.8% and 21.8% in 2005. China and India
on the other hand have witnessed a sharp increase in their GFCF from 36.5%
and 22.3% of GDP in 2000 to 43.8% (2004) and 33.8% (2005) respectively.
This rapid growth reflects the significant infrastructural development initiatives
underway in the two largest emerging economies. The ratio in the kingdom
tends to be skewed lower due to the buoyant oil prices that are driving GDP.
However, reality is that the remainder 80% is available to be channeled into real
estate and infrastructure development and there in lies the opportunity. This
shows that KSA is at the nascent stages of development and there is huge
potential for the real estate sector in the Kingdom. With hydrocarbon led
revenues continuing to dominate the Saudi GDP (estimated at 54.1% of GDP
in 2007) there are significant opportunities for growth in the sector as the
Government’s plan to diversify the economy away from hydrocarbon revenues,
and huge construction projects gets rolled out. Saudi Arabia has showed an
encouraging increase during 2005-07. The government’s continued investment
focus on prioritized areas of economy (real estate expected to be amongst the
list) indicates the growth in real estate sector to sustain even in times of global
recession.

5. Commercial real estate still has upside
Commercial rentals in the region have registered a high growth of 15.2% p.a.
over the last 5 years. However, absolute rentals remain comparatively low with
rentals for prime office space in Doha and Dubai at a steep premium of 190%
and 168% respectively to Riyadh. It indicates that prices are among the lowest



in the region; suggesting that the recent history of significant price rises should
not, in isolation, give cause for concern and still there is a potential for real
estate prices in commercial sector to go upside.

Residential Sector- Middle income housing verge of a high
growth rate
Housing sector accounts for more than 70% of real estate activity. It is
currently estimated that there are over 4 million units in the Kingdom.
According to the eighth National Development Plan (2005-2009), the real
estate sector is expected to grow at an annual rate of 6.3% and the demand for
housing is expected to increase at an average of 200,000 units per year.
Saudi Arabia has a fast growing and relatively young population, along with a
declining average household size. These factors are driving demand for
additional residential dwellings in all major urban areas. A major opportunity
arises in the provision of affordable housing for the fast growing middle
income segments of the market. Some of the factors which will ensures better
opportunity in middle income housing are as follows:

Active City Building and Rapid Urbanisation
The majority of the Kingdom’s population is city dwellers, and the country
contains four out of the five largest cities in the GCC region. Its urban
population has grown by over nine million between 1990 and 2008 as Saudi
cities continue to accommodate more than ½ million new urban dwellers a
year. Most urban growth is occurring in Riyadh, the capital, and in urban
clusters along the Red Sea Coast (Jeddah, Makkah and Madinah) and Eastern
Province (Dammam/Al-Khobar).
Trend of Urban Population
Year (Period) Saudi Arabia Arab Countries Developing Countries The world
1975 58.3 41.8 26.5 37.2
2005 81 55.1 42.7 48.6
2015 83.2 58.8 47.9 52.8
Source: Annual Report 2007, SAMA

According to Table, there has occurred a continuous increase in the ratio of the
Kingdom's urban population to total population. It rose from 58.3 percent in
1975 (against the world average of 37.2 percent) to 81.0 percent of the total
population in 2005 (against the world average of 48.6 percent). It is estimated
that the ratio of cities’ inhabitants to total population will reach 83.2 percent in
2015, which is considered high compared to the world average of 52.8 percent.



The continued rise in the ratio is suggestive of the expected expansion in the
demand for public utility services and housing in the Kingdom's cities during
the coming period. Thus, continuing urbanisation will be a major driver of real
estate growth. As well the rapid expansion of its existing cities (notably Riyadh
and Jeddah), six Special Economic Cities (SEC’s) are being developed, which
by 2020 are expected to account for up to 30% of the Saudi economy and
house 4–5 million people. This shows the high potential for growth of
residential market & huge demand for middle income housing sector in the
region.

Low penetration in house ownership and increasing supply shortages
The housing market in Saudi Arabia faces an acute supply shortage, especially
of affordable housing for those on middle incomes. The total stock of
residential units across Saudi Arabia was approximately 3.95 million (as at the
beginning of 2008). This represents a significant under-supply in relation to the
current demand with this under-supply estimated to be as high as 500,000
dwellings. The current housing shortage looks set to worsen over the next few
years. The small amount of stock (380,000) set to enter the market between
2008 and 2012, compares to an estimated growth in the number of households
across the Kingdom of circa one million over the same period. In addition to
the growth of the population, according to the eighth National Development
Plan, home ownership fell from 65% to 55% from 2000-2004. Presently, it is
estimated that home ownership has further declined significantly and 40% of
total households and only less than 10% of the overall population owning their
own home. The government has taken this issue seriously and realized the
importance / need for housing and has implemented a vision for it. The
Governmental housing plan is reflected in KSA’s Eighth Development Plan
(2005-09) which targets the construction of one million housing units and the
new housing strategy aims at increase the house ownership from currently 40
percent to 80 percent by 2020. The Government’s development plan
encompasses 280mn sqm of residential land plots to be provided in urban areas
and the private sector constructing about 875,000 residential units (of which
225,000 units will be supported by the Government). It indicates that there is a
huge potential in the middle income housing sector in the upcoming years.

Decreasing size of household
Size of the average household is changing and there is a gradual trend towards
the western family life style of smaller (nuclear) family units. This is one of the
by-products of urban migration. Furthermore, the young population would
marry and form new households. The current average household size in KSA is
estimated to be 5.62 and it is estimated, the total household size to decline to



5.2 by 2015 and if the expatriate non-Saudi household size to remain constant
at 4.1, the household size of Saudi families would decline from approximately 6
at present to 5.8 by 2015. The declining household size will fuel demand for
housing, creating demand for a large number of household units.
Simultaneously the lower average household size and an improved affordability
factor will also accelerate the growth within the apartment segment. Apart from
it, to address the short term short fall serious efforts will need to be made to
accelerate the development of residential dwellings within some of the major
projects (particularly in the Special Economic Cities).

Increasing Per Capita Income
The income growth is
Trend of Per Capita Income & its Growth
a critical determinant
Per Capita Income Riyals Growth Rate (%)
factor for affordability
70000 25.00
of houses. An
60000
increasing trend in the 20.00
50000
Saudi per capita
R iy a ls

40000 15.00
Income has been seen

%
30000 10.00
since 2004. The per
20000
capita GDP in KSA 5.00
10000
has grown at a CAGR
0 0.00
of 12% for the period 2004 2005 2006 2007
2003-07. Annual per
capita income in the Source: Annual report 2007, SAMA
Kingdom rose by 4.6
percent to Rls 59,016 in 2007 against an increase of 10.2 percent in the
preceding year. This growth
is expected to continue in double digits with CAGR of 11% forecasted for
2007-10E according to IMF estimates. The past four years have shown a
continuous increase in the per capita income. Although GDP per capita is not a
perfect measure, it does in part reflect the earning power of an economy, which
in turn affects the asset prices including real estate and changes in the life style
of the people. The income growth will, increase the quality of life, expand the
housing ownership (new and exciting) and make positive impact on
affordability of houses by middle income people.

Low penetration in Mortgage Financing and Improved Housing Finance
Schemes
The mortgage finance market may prove a major driver for real estate demand
in the Kingdom. Globally, mortgage to GDP ratios vary from 100% in
Denmark to 5% in UAE. Comparatively KSA mortgage to GDP stands at



approximately around 1%. The high contribution of hydrocarbon revenues
(due to buoyant oil prices) distorts the mortgage to GDP ratios. Accordingly,
KSA also present below the mortgage per capita for the region. Note that KSA
remains highly under-leveraged compared to regional peers. According to the
Arabian News Property Survey 2008, nearly 80% of investors would opt for a
mortgage while purchasing a property in the Middle East. The constraining
factor in KSA housing market has been the lack of a well-defined mortgage
law. A much awaited new legislation is expected to be released very shortly and
it is expected that the draft proposal is currently being reviewed by the
Government. It is expected that the Government will expedite the proposed
mortgage law soon, which will unlock significant demand. The law is designed
to allow much wider access to property ownership in a country where currently
43% of the population owns their own home.
The new law is expected to result in:
● Entry of new players into the market, increasing the range of funding options
available to purchasers of residential dwellings
● The establishment of new standards for home finances
● Introduce new capital market instruments
● Stimulate further Islamic financing through new Shariah compliant products
● Provide large companies with ability to offer tradable financing bonds
● Encourage the regulation and greater transparency in the brokerage sector
● Introduce securitized mortgage products
● Create a secondary mortgage market
Apart from it, Saudi banks and financing companies have introduced housing
Shariah-compliant loan programs to finance home purchases that extend up to
25 years in advance of the approval of the mortgage law. This will again
expected to boost the demand in housing sector in upcoming period.

Additional benefits to the Company
Product Diversification
Currently, company has strong presence in three sectors- Asset management,
Brokerage Services and Corporate Finance. Company decision to enter in real-
estate sector will provide a reasonable amount of diversification to the
company revenues; as cash flows of real estate sectors are not perfectly
correlated with the cash flows of existing business segments. In normal
scenario; it is also seen that in medium term stock prices not moves in tandem
with real estate prices; thus it may help company to maintain stability in cash
flows.



Increase in Cash Flows
In present scenario, world economy is facing a deep downturn. Due to suck
out of liquidity, dull performances of stock markets & decrease in demand for
goods and services have adversely affected the M & A activities and fund
raising activities. Apart from it, trading volumes have also come down. All
these have increased pressure on margins of the company and further
deterioration in economy may put downward pressure on revenues. Entry in
real-estate sector will increase the cash flows of the company.

Increase in market presence and liquidity
Entry in this business segment will reduce the volatility of cash flows and thus
will reduce the business risk of the company. Increase in business operations
will also increase the overall market share of the company and thus its market
presence. Increase in market presence would lead to increased liquidity and
marketability in company stock.

Decrease in cost of capital
Increase in business operations & cash flows will decrease the financial risk of
the company as company having greater cash flows is less susceptible to short-
term fluctuations as compare to company having lesser cash flows. This
decrease in financial risk would further lead to decrease in cost of debt and
equity and thus will reduce the cost of capital of the company.

Issues and Concerns
Despite Saudi Arabia’s significant growth potential, a number of challenges to
realizing its full potential remain. The government has recognized the
challenges and has made progress in tackling issues such as modest
transparency, delays in implementing legislative reforms and opportunities to
increase foreign ownership. The government is also tackling issues such as
bureaucracy and labour shortages which have resulted in extended delays in
developing real estate projects in the past. Some other factors that need to be
considered are:

Unsustainable Growth in Cost of land and housing prices
The price of raw land has abnormally gone up by 20-25% on an annual basis
over the past three years followed by more or less similar increase in housing
prices. It was due to increase in demand for land, ample liquidity and searching
for a safe heaven by investors following the collapse in Saudi stock market in
2006. Such growth in prices is unsustainable in long run and correction in
prices may take place in upcoming year as a result of the marked expansion in



construction of residential buildings by the public and private sectors in
addition to the potential decline of most of the economic activities affected by
the global economic crisis which is expected to alleviate the increasing demand.
This is supported by the cost of construction that is expected to continue
decreasing as a result of a decline in construction inputs such as steel and
cement, which recorded a marked decline recently in view of fierce competition
among local manufactures.

Unrelated business segment need high level of efforts
Currently, company deals in asset management of financial asset, brokerage
services and corporate finance. Entry in new business segments need higher
level of management commitment and competency & greater management
efforts to get success; as on failure of which may leave the desired result
unachievable.

Increase in Construction costs - labor
A problem facing the industry is the difficulty in getting adequate labor. Labor
costs would increase, given lack of skilled labor in certain sectors in the
Kingdom. Efficient human resources are often not willing to relocate to Saudi
for employment given the significant demand for similar skill sets both in the
region as also the traditional labor markets of the Indian subcontinent. This is
creating a shortage in talent, resulting in an increase in labor costs. This
bottleneck is being faced across industries. For example, research study reveal
that wages to drivers of cement trucks have risen over 100% in just a year in
certain parts of the Kingdom. This may put downward pressure on margins.

Outlook
The first half of 2008 that witnessed high oil prices and in turn windfall oil
revenues for the KSA is estimated to have experienced property prices rising in
the range of 40% to 80% in the Kingdom’s capital city of Riyadh. Besides the
strong domestic demand in the country, the heightened real estate activity was
further catalyzed by the participation of investors from other Gulf states. The
momentum of rising real estate prices during early 2008, started to slow down
as the year end approached and is expected to consolidate at relatively lower
levels in 2009. However, the residential segment is expected to continue to
present under supply situation for the near future. Saudi Arabia is witnessing an
escalating demand from young middle income group. Thus, if Saudi is to meet
such demand it will need to build 1.5mn new homes by 2015 and it will be up
to the financial institutions (both governmental and private sector) to provide
the finance that makes this expansion possible. Overall, the Kingdom’s real



estate sector is expected to continue its growth trajectory between an average
annual rate of 5% to 7% till 2012. The rising trend may slow down in near
future but will continue its upward journey.


Saudi Real Estate sector - Poised for lift off

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