Saudi Real Estate sector - Poised for lift off


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This report summarizes future prospects and hidden potential of Saudi Middle Income Housing Markets.

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Saudi Real Estate sector - Poised for lift off

  1. 1. Saudi Real Estate SectorSaudi Real Estate Sector – Poisedfor lift off By Jitendra Garg MS (Finance), CFA 3rd April 2009 Page 1
  2. 2. Saudi Real Estate Sector Table of ContentsOverview ..............................................................................................................3KSA Real-estate sector – changing times ahead................................................. 3Growth Drivers of Saudi Real Estate Market...................................................... 4Residential Sector- Middle income housing verge of a high growth rate .......... 8Additional benefits to the Company ..................................................................11Issues and Concerns .......................................................................................... 12Outlook .............................................................................................................. 133rd April 2009 Page 2
  3. 3. Saudi Real Estate SectorOverviewThe Kingdom of Saudi Arabia (KSA) is by far the largest economy of the GCCand occupies ¾ of the Arabian Peninsula and holds 25% of the world’sconfirmed oil reserves. The region has an oil-based economy, with oil-relatedactivities accounting for 35–40% of real GDP and 85-90% of total exportsrevenue. Strong crude prices over the last five years have played a significantrole in boosting the economic growth of the region which has registered a realGDP growth of more than 5% a year during the period 2003 to 2007 and sameis expected to increase by 4.2% in 2008. Massive oil export revenues arefunding high public spending in infrastructure and education and have helpedthe economy in maintaining a current account surplus of more than 25% a yearbetween 2003 and 2007. However, after witnessing a super-spike period duringmid-2008, oil prices fell sharply towards the end of the year to trade at less thanUS$35 per barrel and resulted in the collapse of five-years of bull-run in oilprices, which climbed from US$29 a barrel in early 2003 to a peak of US$147 abarrel in July 2008. It was the result of a growing realization that the globaleconomy will face a sharp slowdown in 2009, leading to a huge drop in demandfor oil.KSA Real-estate sector – changing times aheadThe focus of the KSA government to diversify from reliance on hydrocarbonsector; 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 stageof development. It is however poised for lift-off, with demographicfundamentals and massive infrastructure investment providing the basis forgrowth 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 existence3rd April 2009 Page 3
  4. 4. Saudi Real Estate Sector 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 Market1. Demography is Destiny Rapid growth in populationSocial, economic and real estate developments in Saudi Arabia are beingstrongly impacted by the dramatically changing demographic profile of theKingdom. Saudi Arabia is not only the largest of the GCC countries(accounting for over 60% of the region’s population), it also continues toexperience one of the world’s steepest rises in population; increasing from 7.3million in 1975 to over 25 million in 2008, and fast growth continues as thetotal population recorded 8year CAGR (2000-08) of 2.4%.. Although an annual3rd April 2009 Page 4
  5. 5. Saudi Real Estate Sectorgrowth rate of 4.1% during 1975-2004 is estimated to drop to 2.3% in theperiod of 2004-2015, it is still expected to be higher than 2.0% growth in Arabcountries and 1.3% in developing countries over the period of 2004-2015. . By2015, UN estimates Saudi’s total population to reach over 29mn (nearly doubleits population in 1990). It is also generating enormous pressures on thecountry’s residential market and open up the Kingdom for vast array of growthopportunities in all segments of real estate.Favourable Demographic structureThe Kingdoms The Kingdoms Population by Age and Nationalitypopulation (In mid-2007) (in thousand)breakdown by age Age Category Saudis Non-Saudis Total % of Totalgroups in mid-2007 0-14 6597.1 1295.6 7892.7 32.6indicates that children 15-39 7647.6 3523.2 11170.8 46.1of age groups from 0 40-64 2836.8 1608.4 4504.2 18.6to 14 years old 65 & above 609.9 124 674.9 2.8accounted for 7.89 Total 3446.7 1732.4 24242.6 100.0million, or 32.6percent of the total Source: Annual Report 2007 SAMApopulation, 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 percentof the total population. The population pyramid is highly skewed towards theyouth with over 78% of the population below the age of 40. Interestingly, Saudihas 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 upfamilies. This will have a major impact on the economy, and will boost demandfor modern retailing and residential units indicating superior prospects for thereal estate sector.2. “10x10” Vision is taking Shape Reforms boosting EconomicCompetitivenessThe government is proactively seeking to achieve rapid and sustainableeconomic growth. A key objective is to become among the world’s 10 mostcompetitive nations by 2010 – its “10x10 Vision” – through opening up itsmarket, inviting inward investment, improving the business environment andcapitalizing on the Kingdom’s competitive strengths as the global capital ofenergy 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 forcommercial, retail and housing sector growth.3rd April 2009 Page 5
  6. 6. Saudi Real Estate SectorRelaxing FI norms and increase in FDITo achieve this goal, government access to the World Trade Organization(WTO) and reduced the corporate tax on foreign-owned firms (down from45% to 20%). Apart from it, Saudi Arabia also removed the minimum capitalinvestment requirements on foreign investors and a new governmentprocurement law was also passed under which 100% foreign-owned companiescould bid for government contracts. All these measures, has dramaticallyincreased foreign direct investment, which is increased almost ten-fold fromUSD 183 million in 2000 to USD 17.5 billion in 2007 respectively,accompanied by equally impressive growth in domestic investment. This hugeinflow will further boost the capital formation which again lead to higherincome & thus will boost the real estate sector.3. Negative real interest rates scenario make real estate compellingInterest rates in Interest Rate Trend for 3-month Currencythe region are at Depositsdecreasing trend &interest rates on 3- 4.5 Interest Rate (%) saudi Riyal US Dollar 4month SAR and 3.5US dollar deposits 3 2.5touched the four 2years low of 1.45% 1.5 1and 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. 08respectively in Jan.2009. Low interestrates in the region Source: Monthly Bulletin, SAMAwork as catalystfor real estatesector growth & provide an excellent opportunity to the genuine buyers to buya house or an office which they can ill afford. It will also benefit the real estatedevelopers 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 climbed20.4% 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 theprevailing nominal interest rates taking the real interest rates in the negativezone. With negative real interest rates; consumers have less of an incentive tosave/deposit their funds and a greater incentive to invest in real estate tobenefit from attractive rental yields and gain though capital appreciation homeprices.3rd April 2009 Page 6
  7. 7. Saudi Real Estate Sector4. Gross Fixed Capital formation – KSA early on the curveGross fixedcapital formation Trend of GFC/GDP & Growth in GFCF(GFCF) as apercentage of GFCF/GDP Growth Rate in GFCFGDP refers as a 24.00barometer of the % 14.00level ofdevelopment in 4.00an economy. In 2003 2004 2005 2006 2007KSA, just 20% ofthe Kingdom’s Source: Annual Report 2007, SAMAGDP in 2007 waschanneled into fixed capital formation. This is the lower in the region withregional peers ranging from Kuwait (19.7%) to Qatar (35.5%). Historically,developed countries such as the US and UK have had their GFCFs as apercentage of GDP steady at the 16%-19% levels. The EU and OECDcountries were marginally higher at 20.8% and 21.8% in 2005. China and Indiaon 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 initiativesunderway in the two largest emerging economies. The ratio in the kingdomtends 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 realestate and infrastructure development and there in lies the opportunity. Thisshows that KSA is at the nascent stages of development and there is hugepotential for the real estate sector in the Kingdom. With hydrocarbon ledrevenues continuing to dominate the Saudi GDP (estimated at 54.1% of GDPin 2007) there are significant opportunities for growth in the sector as theGovernment’s plan to diversify the economy away from hydrocarbon revenues,and huge construction projects gets rolled out. Saudi Arabia has showed anencouraging increase during 2005-07. The government’s continued investmentfocus on prioritized areas of economy (real estate expected to be amongst thelist) indicates the growth in real estate sector to sustain even in times of globalrecession.5. Commercial real estate still has upsideCommercial 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 withrentals 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 lowest3rd April 2009 Page 7
  8. 8. Saudi Real Estate Sectorin the region; suggesting that the recent history of significant price rises shouldnot, in isolation, give cause for concern and still there is a potential for realestate prices in commercial sector to go upside.Residential Sector- Middle income housing verge of a highgrowth rateHousing sector accounts for more than 70% of real estate activity. It iscurrently estimated that there are over 4 million units in the Kingdom.According to the eighth National Development Plan (2005-2009), the realestate sector is expected to grow at an annual rate of 6.3% and the demand forhousing 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 adeclining average household size. These factors are driving demand foradditional residential dwellings in all major urban areas. A major opportunityarises in the provision of affordable housing for the fast growing middleincome segments of the market. Some of the factors which will ensures betteropportunity in middle income housing are as follows:Active City Building and Rapid UrbanisationThe majority of the Kingdom’s population is city dwellers, and the countrycontains four out of the five largest cities in the GCC region. Its urbanpopulation has grown by over nine million between 1990 and 2008 as Saudicities continue to accommodate more than ½ million new urban dwellers ayear. Most urban growth is occurring in Riyadh, the capital, and in urbanclusters along the Red Sea Coast (Jeddah, Makkah and Madinah) and EasternProvince (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, SAMAAccording to Table, there has occurred a continuous increase in the ratio of theKingdoms urban population to total population. It rose from 58.3 percent in1975 (against the world average of 37.2 percent) to 81.0 percent of the totalpopulation in 2005 (against the world average of 48.6 percent). It is estimatedthat the ratio of cities’ inhabitants to total population will reach 83.2 percent in2015, which is considered high compared to the world average of 52.8 percent.3rd April 2009 Page 8
  9. 9. Saudi Real Estate SectorThe continued rise in the ratio is suggestive of the expected expansion in thedemand for public utility services and housing in the Kingdoms cities duringthe coming period. Thus, continuing urbanisation will be a major driver of realestate growth. As well the rapid expansion of its existing cities (notably Riyadhand Jeddah), six Special Economic Cities (SEC’s) are being developed, whichby 2020 are expected to account for up to 30% of the Saudi economy andhouse 4–5 million people. This shows the high potential for growth ofresidential market & huge demand for middle income housing sector in theregion.Low penetration in house ownership and increasing supply shortagesThe housing market in Saudi Arabia faces an acute supply shortage, especiallyof affordable housing for those on middle incomes. The total stock ofresidential units across Saudi Arabia was approximately 3.95 million (as at thebeginning of 2008). This represents a significant under-supply in relation to thecurrent demand with this under-supply estimated to be as high as 500,000dwellings. The current housing shortage looks set to worsen over the next fewyears. The small amount of stock (380,000) set to enter the market between2008 and 2012, compares to an estimated growth in the number of householdsacross the Kingdom of circa one million over the same period. In addition tothe growth of the population, according to the eighth National DevelopmentPlan, home ownership fell from 65% to 55% from 2000-2004. Presently, it isestimated that home ownership has further declined significantly and 40% oftotal households and only less than 10% of the overall population owning theirown home. The government has taken this issue seriously and realized theimportance / need for housing and has implemented a vision for it. TheGovernmental housing plan is reflected in KSA’s Eighth Development Plan(2005-09) which targets the construction of one million housing units and thenew housing strategy aims at increase the house ownership from currently 40percent to 80 percent by 2020. The Government’s development planencompasses 280mn sqm of residential land plots to be provided in urban areasand the private sector constructing about 875,000 residential units (of which225,000 units will be supported by the Government). It indicates that there is ahuge potential in the middle income housing sector in the upcoming years.Decreasing size of householdSize of the average household is changing and there is a gradual trend towardsthe western family life style of smaller (nuclear) family units. This is one of theby-products of urban migration. Furthermore, the young population wouldmarry and form new households. The current average household size in KSA isestimated to be 5.62 and it is estimated, the total household size to decline to3rd April 2009 Page 9
  10. 10. Saudi Real Estate Sector5.2 by 2015 and if the expatriate non-Saudi household size to remain constantat 4.1, the household size of Saudi families would decline from approximately 6at present to 5.8 by 2015. The declining household size will fuel demand forhousing, creating demand for a large number of household units.Simultaneously the lower average household size and an improved affordabilityfactor will also accelerate the growth within the apartment segment. Apart fromit, to address the short term short fall serious efforts will need to be made toaccelerate the development of residential dwellings within some of the majorprojects (particularly in the Special Economic Cities).Increasing Per Capita IncomeThe income growth is Trend of Per Capita Income & its Growtha critical determinant Per Capita Income Riyals Growth Rate (%)factor for affordability 70000 25.00of houses. An 60000increasing trend in the 20.00 50000Saudi per capita R iy a ls 40000 15.00Income has been seen % 30000 10.00since 2004. The per 20000capita GDP in KSA 5.00 10000has grown at a CAGR 0 0.00of 12% for the period 2004 2005 2006 20072003-07. Annual percapita income in the Source: Annual report 2007, SAMAKingdom rose by 4.6percent to Rls 59,016 in 2007 against an increase of 10.2 percent in thepreceding year. This growthis expected to continue in double digits with CAGR of 11% forecasted for2007-10E according to IMF estimates. The past four years have shown acontinuous increase in the per capita income. Although GDP per capita is not aperfect measure, it does in part reflect the earning power of an economy, whichin turn affects the asset prices including real estate and changes in the life styleof the people. The income growth will, increase the quality of life, expand thehousing ownership (new and exciting) and make positive impact onaffordability of houses by middle income people.Low penetration in Mortgage Financing and Improved Housing FinanceSchemesThe mortgage finance market may prove a major driver for real estate demandin the Kingdom. Globally, mortgage to GDP ratios vary from 100% inDenmark to 5% in UAE. Comparatively KSA mortgage to GDP stands at3rd April 2009 Page 10
  11. 11. Saudi Real Estate Sectorapproximately 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 KSAremains highly under-leveraged compared to regional peers. According to theArabian News Property Survey 2008, nearly 80% of investors would opt for amortgage while purchasing a property in the Middle East. The constrainingfactor in KSA housing market has been the lack of a well-defined mortgagelaw. A much awaited new legislation is expected to be released very shortly andit is expected that the draft proposal is currently being reviewed by theGovernment. It is expected that the Government will expedite the proposedmortgage law soon, which will unlock significant demand. The law is designedto allow much wider access to property ownership in a country where currently43% 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 marketApart from it, Saudi banks and financing companies have introduced housingShariah-compliant loan programs to finance home purchases that extend up to25 years in advance of the approval of the mortgage law. This will againexpected to boost the demand in housing sector in upcoming period.Additional benefits to the CompanyProduct DiversificationCurrently, 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 thecompany revenues; as cash flows of real estate sectors are not perfectlycorrelated with the cash flows of existing business segments. In normalscenario; it is also seen that in medium term stock prices not moves in tandemwith real estate prices; thus it may help company to maintain stability in cashflows.3rd April 2009 Page 11
  12. 12. Saudi Real Estate SectorIncrease in Cash FlowsIn present scenario, world economy is facing a deep downturn. Due to suckout of liquidity, dull performances of stock markets & decrease in demand forgoods and services have adversely affected the M & A activities and fundraising activities. Apart from it, trading volumes have also come down. Allthese have increased pressure on margins of the company and furtherdeterioration in economy may put downward pressure on revenues. Entry inreal-estate sector will increase the cash flows of the company.Increase in market presence and liquidityEntry in this business segment will reduce the volatility of cash flows and thuswill reduce the business risk of the company. Increase in business operationswill also increase the overall market share of the company and thus its marketpresence. Increase in market presence would lead to increased liquidity andmarketability in company stock.Decrease in cost of capitalIncrease in business operations & cash flows will decrease the financial risk ofthe company as company having greater cash flows is less susceptible to short-term fluctuations as compare to company having lesser cash flows. Thisdecrease in financial risk would further lead to decrease in cost of debt andequity and thus will reduce the cost of capital of the company.Issues and ConcernsDespite Saudi Arabia’s significant growth potential, a number of challenges torealizing its full potential remain. The government has recognized thechallenges and has made progress in tackling issues such as modesttransparency, delays in implementing legislative reforms and opportunities toincrease foreign ownership. The government is also tackling issues such asbureaucracy and labour shortages which have resulted in extended delays indeveloping real estate projects in the past. Some other factors that need to beconsidered are:Unsustainable Growth in Cost of land and housing pricesThe price of raw land has abnormally gone up by 20-25% on an annual basisover the past three years followed by more or less similar increase in housingprices. It was due to increase in demand for land, ample liquidity and searchingfor a safe heaven by investors following the collapse in Saudi stock market in2006. Such growth in prices is unsustainable in long run and correction inprices may take place in upcoming year as a result of the marked expansion in3rd April 2009 Page 12
  13. 13. Saudi Real Estate Sectorconstruction of residential buildings by the public and private sectors inaddition to the potential decline of most of the economic activities affected bythe global economic crisis which is expected to alleviate the increasing demand.This is supported by the cost of construction that is expected to continuedecreasing as a result of a decline in construction inputs such as steel andcement, which recorded a marked decline recently in view of fierce competitionamong local manufactures.Unrelated business segment need high level of effortsCurrently, company deals in asset management of financial asset, brokerageservices and corporate finance. Entry in new business segments need higherlevel of management commitment and competency & greater managementefforts to get success; as on failure of which may leave the desired resultunachievable.Increase in Construction costs - laborA problem facing the industry is the difficulty in getting adequate labor. Laborcosts would increase, given lack of skilled labor in certain sectors in theKingdom. Efficient human resources are often not willing to relocate to Saudifor employment given the significant demand for similar skill sets both in theregion as also the traditional labor markets of the Indian subcontinent. This iscreating a shortage in talent, resulting in an increase in labor costs. Thisbottleneck is being faced across industries. For example, research study revealthat wages to drivers of cement trucks have risen over 100% in just a year incertain parts of the Kingdom. This may put downward pressure on margins.OutlookThe first half of 2008 that witnessed high oil prices and in turn windfall oilrevenues for the KSA is estimated to have experienced property prices rising inthe range of 40% to 80% in the Kingdom’s capital city of Riyadh. Besides thestrong domestic demand in the country, the heightened real estate activity wasfurther catalyzed by the participation of investors from other Gulf states. Themomentum of rising real estate prices during early 2008, started to slow downas the year end approached and is expected to consolidate at relatively lowerlevels in 2009. However, the residential segment is expected to continue topresent under supply situation for the near future. Saudi Arabia is witnessing anescalating demand from young middle income group. Thus, if Saudi is to meetsuch demand it will need to build 1.5mn new homes by 2015 and it will be upto the financial institutions (both governmental and private sector) to providethe finance that makes this expansion possible. Overall, the Kingdom’s real3rd April 2009 Page 13
  14. 14. Saudi Real Estate Sectorestate sector is expected to continue its growth trajectory between an averageannual rate of 5% to 7% till 2012. The rising trend may slow down in nearfuture but will continue its upward journey.3rd April 2009 Page 14