Expanding population and a rise in tourism boost demand for real estate in Saudi Arabia

A young and growing population coupled with rising disposable income signals an optimistic future for the Saudi Arabian real estate sector and its developers. While the market, which has grown at a steady rate in recent years, seems poised for an uptick, a number of impediments related to land, financing and affordability remain, meaning that real estate firms have primarily been catering to a small segment of the population. Yet the dynamics of the market look set to change, with the government introducing policies aimed at improving the environment for both supply and demand, with a particular focus on the residential segment. A regulation imposing fees on undeveloped or white land within city boundaries approved by the Council of Ministers in March 2015 is also set to have an impact on the market.

Demand Factors

It is clear that demand for residential and retail real estate should remain strong for the foreseeable future. At the most basic level, the demographic conditions in the country will support substantial and sustained housing demand for the coming decades. The Kingdom’s population rose from 9.8m in 1980 to 27.3m in 2010. While growth is unlikely to be quite as rapid in the coming three decades, it should remain robust, thereby contributing to an increasing demand for housing. According to the Central Department of Statistics and Information, the population reached 30.77m in 2014 and was growing at an annual rate of 2.6%, well above the global average of 1.1%. By 2020, the Kingdom’s population is expected to have risen by an additional 2m people. This will all translate into a large housing supply requirement, with government estimates suggesting the need for 200,000 residential units a year, while other forecasts published in the local press have highlighted the need for 3m new housing units by 2040.

Demographics

It is not only population size that is creating demand, but the nature of the growth is also putting pressure on housing. As with much of the region, Saudi Arabia’s demographic profile is heavily weighted towards its youth. Two-thirds of the population is under the age of 30, while more than 30% of the population is under the age of 14, according to recent estimates. This will provide both an opportunity for economic growth as the working age population grows, as well as a demand for housing and other services, including retail opportunities (see Retail chapter). With the average household size declining and the urban population increasing from 65.9% of the population in 1980 to 82.1% in 2010 (and forecast to reach 87.1% by 2040), the demand for more and smaller units is expected to be sustained for some time in the Kingdom’s major urban centres.

The general increase in personal incomes on the back of a growing and diversifying economy is also good news for developers and investors. In 2012 Saudi Arabia recorded an average disposable income of $7500 per capita, surpassing the global average. Indeed, incomes have been growing for some time, increasing at a compound annual growth rate of 10% between 2007 and 2012. While this is expected to slow to 6% in the five years to 2017, such expansion in personal incomes still marks the country as a top performer both regionally and globally.

Unlocking Potential

Still, turning the market potential of a youthful population into growth and opportunity will require a number of adjustments to stimulate demand from this bracket. As with much of the Middle East, youth unemployment remains high, hovering just below 30% – well above the world average, which stands at around 10%. Creating jobs through the diversification and Saudiisation of the private sector workforce, key strategies of the late King Abdullah bin Abdulaziz Al Saud, will be crucial to unlocking potential and generating strong, serviceable demand for commercial and residential properties.

In the short term, such initiatives could be challenging. Saudi Arabia’s quest for expansion and diversification may be hit by the current oil price slump, with the price of Brent crude falling below $57 a barrel in December 2014, a five-and-a-half-year low. The knockon effect on the national economy is now being felt. Real GDP grew by 2% year-on-year in the last quarter of 2014, its lowest level in more than 12 months. Further, while the full-year growth figure for 2014 is relatively strong, at 3.6%, current oil market trends will make keeping growth above 3% for 2015 difficult.

Nonetheless, the local economy remains optimistic. The government has maintained its expansionary budget position for 2015, pushing forward its growth plans. As such, the general consensus, while cautious, seems to be that the local economy should remain steady for the next 12 months. John Sfakianakis, Middle East director at investment manager Ashmore Group, told Arab News that, “Despite the fall in oil prices, non-oil GDP performed strongly in 2014 and is expected to do well in 2015, albeit at a slower pace.” This is an important balance, since the drop in oil prices ultimately reduces government revenues and could affect investor confidence over the longer term.

Affordable Housing

More immediately, and notwithstanding the external investment environment, the government will be crucial to resolving the issue of the current housing deficit of at least 400,000 affordable units. There have been a number of programmes in place for some time to increase supply, including an interest-free loan subsidy run by the Real Estate Development Fund (REDF) and a $67bn plan launched in 2011 to build 500,000 affordable housing units across the Kingdom. However, the former has a waiting list numbering in the millions, while the latter has yet to bring substantial supply to the market.

As such, the government launched a new scheme, known as Eskan, to expedite and streamline the process of funding prospective homeowners and developers. Under Eskan, an electronic system assesses applicants’ eligibility for loans to speed up the process of bringing purchasing power to the market. The government is also looking at other ways to support the delivery of supply, including loans for developers and a fee on undeveloped land, a factor in the high construction costs and expensive supply (see analysis).

This is expected to help push up ownership figures, which are currently low when compared regionally. Indeed, the rental segment is currently an important component of the market given the difficulties of getting on the property ladder. In 2014 Saudi households spent approximately SR81bn ($21.6bn) on property rental, or some 12.5% of a family’s monthly income, according to a report by the Economic Reports Unit of the Central Department of Statistics and Information. This illustrates the gap between the rental and mortgage markets, with the latter consuming as much as 40% of a prospective buyer’s monthly income, according to data supplied by Deutsche Gulf Finance.

Top of the Market

Given the problems of land availability, development costs and affordability for middle-income Saudis, it is not surprising that developers have been largely targeting the upper-income segments of the market. In this regard, the Kingdom offers rich potential. The top 10% of households in Saudi Arabia have the highest average earnings among the 20 largest emerging market economies, according to global market researcher Euromonitor International. Income in this group stands at approximately $120,000 per household, a figure comparable with peers in Spain and the Netherlands.

This segment has certainly offered substantial opportunities for developers over the last decade. According to the most recent available data from the Saudi Arabian Monetary Agency (SAMA), residential building construction increased by 11.4% in 2012, the ninth consecutive year in which it has grown. Moreover, and despite the challenges in place, the performance of the real estate markets in the Kingdom’s major cities largely bears out the confidence expressed by the stock exchange and investors. The capital, for example, saw strong growth for much of 2014. This sends an important signal about the health of the industry in the country, given the central role Riyadh plays in driving the sector forward. Indeed, between 2003 and 2013, the capital accounted for 27% of all residential and commercial construction activity in the Kingdom. The city outperformed the country as a whole, with number of construction permits issued there growing by 319% in the decade to 2013, compared to a figure of 215% overall.

Capital Trends

This trend looks set to continue. Riyadh’s population is expected to grow by 35% to 6.4m in the 10 years to 2020, according to Demographia International, which conducts surveys on housing affordability. As such, there is an annual accommodation requirement of 50,000 units for the next five years, but this is not currently being met. Instead, supply grew by 3.7% in 2014 to 971,000 units, according to global property management and consultancy firm JLL. Another 77,000 units are expected to be delivered in Riyadh through 2017.

Prices in the capital have been performing well given these market dynamics. In November 2014, for example, Riyadh residential property costs grew by as much as 7% year-on-year. In the apartment segment, sales prices increased by around 8% in 2014, according to Century 21 research.

However, there are some signs that the formal real estate sector serviced by private developers is beginning to slow down in the capital. During the second quarter of 2015 real estate activity was slower when compared with 2014. In the villa market, JLL figures show sales prices fell by 1% on a yearly basis and 2% on a quarterly basis. Rental rates, on the other hand, showed strong growth as new down payment rules pushed up demand for rentals. Villa rents rose15% year-on-year, while apartments saw a 10% increase from the second quarter of 2014.

Second City

According to JLL, residential property in Riyadh is reaching the top of the market. At the same time, the Kingdom’s second city, Jeddah, experienced a similar phenomenon with a slowdown in sales prices in the second quarter of 2015. In the villa segment, prices fell by 7%, though in the apartment market they rose by 11%. Again the introduction of new regulations regarding down payments contributed to this slowdown, while also building momentum in rental growth. Indeed, rates in the apartment segment rose 14% year-on-year for the second quarter of the 2015.

Geographical Spread

As the market levels out in the Kingdom’s two biggest cities, developers are increasingly looking to an extended area for new projects. As well as bolstering returns on investment, this move is expected to help meet demand for affordable housing. “The real benefit to the real estate sector is spreading growth outside of the primary urban areas and encouraging the development of satellite cities. These cities will offer cheaper land prices and therefore help provide more affordable housing,” Naif Al Baz, CEO of Deustche Gulf Finance, told OBG. This geographical expansion has been facilitated by the state and has had an impact across a number of segments. “The government has done a good job by extending municipal services to a large geographic area. This creates more space for development and therefore reduces prices,” said Ibrahim A Mughiseeb, CEO of Saudi Real Estate Company (known as Al Akaria).

Retail

For many developers, however, residential real estate is taking a back seat. Some of the strongest opportunities for investors and real estate firms are in the retail and hospitality sectors. Average retail rents grew by 7% in large modern shopping centres in Riyadh to some SR2900 ($773) per sq metre in the second quarter of 2015, JLL data shows, while community centres saw rents rise by 1% over the quarter to SR2750 ($733). This followed gains of between 8% and 12% during 2014, according to Century 21 estimates, with the increase at the lower end of the range in the south of the city and at the top in the north.

Indeed, demand for space is robust thanks to high visitor numbers. The vacancy rate across all shopping centres in Riyadh stood at 8% at mid-year 2015, down from 10% at the end of 2014. The capital’s shopping centres generate significant traffic. Two of Riyadh’s busiest malls, Hayat Mall and Panorama Mall, achieved footfall of 10m and 6m, respectively, in 2014.

It is not only Riyadh that is attracting interest in the retail segment. The market is also performing strongly in Jeddah. The vacancy rate in the city has held steady at 7% since the end of 2014, while sustained pressure on supply is keeping rents high. For the largest retail centres, rental rates grew by 2% to SR3350 ($893) per sq metre in the second quarter of 2015.

Given the figures across both cities, it is hardly surprising that substantial supply is expected to hit the market over the coming years. Shopping space will increase by more than 60%, or almost 900,000 sq metres, in Riyadh in the next three years, while in Jeddah it is projected to rise by 32% to 1.22m sq metres in the same period (see Retail chapter).

Office

While the other element of the commercial sector, office space, is also undergoing a period of transformation, expansion is projected to be slower in this segment in the short to medium terms. This is particularly evident in the capital, where a huge supply of quality international standard space is being brought to the market in the northern reaches of the city. The symbol of this modern expansion is the King Abdullah Financial District, a 42-building, 900, 000-sq-metre development in the north of Riyadh.

Projects such as this are leading to a migration to quality that is expected to push up vacancy rates across the city. Although occupancy actually increased in 2014, with vacancy rates falling from 18% to 16% (and standing at 10% in the central business district), they had risen back up to 17% as of June 2015, according JLL. Indeed, a further 1.4m sq metres of space will be brought to the market in the next three years, pushing up the available supply by some 61% from current levels. This is unlikely to be fully absorbed, especially given an expected economic slowdown in 2015.

The commercial real estate market in Jeddah is seeing better prospects. Office rental rates decreased by 1% year-on-year in the fourth quarter of 2014, but had rebounded by mid-2015, showing 6% growth on the year, according to JLL. Indeed, vacancy rates stood at just 6% as of the second quarter of 2015 and while there is supply in the pipeline, it is limited to an increase of 30% of existing inventory, or 248,000 sq metres.

Hotels

It is not only the Kingdom’s leading two cities that offer real estate opportunities, with the holy city of Makkah undergoing an extensive building programme as well. Given that the city welcomed nearly 2m pilgrims in 2013 (1.3m of whom were foreign arrivals), it is unsurprising that the main focus of this development is on hospitality facilities.

Indeed, tourism’s direct contribution to Saudi Arabia’s total GDP is expected to grow from SR47.5bn ($12.7bn) in 2013 to as much as SR78.9bn ($21bn) in 2024 (see Tourism chapter).

The headline project currently under construction in Makkah is the Jabal Omar development, a SR33.1bn ($8.8bn) mixed-use facility extending over 230,000 sq metres of land. The development will include hotels, residential units, a retail concourse and a conference hall. It will provide more than 11,000 hotel and residential rooms over a total built area of 2m sq metres. However, this is just the most prominent of a comprehensive programme of development in the city. The government-led projects to enlarge the Grand Mosque and build a metro are matched by numerous private sector developments (see Makkah chapter).

Makkah currently has a total of 650 hotels with 125,000 rooms, an inventory that can accommodate up to 500,000 pilgrims. To expand capacity, the government has issued licences for 500 further hotels, including one that will house 5000 rooms. However, such a reliance on tourism also highlights the vulnerability of the holy city’s property market, such as was the case in 2014 when a reduction in pilgrim quotas and fears of the Middle East Respiratory Syndrome virus saw visitor numbers drop significantly. Indeed, in the first five months of the year room rates in Makkah had fallen by as much as 15%.

Nonetheless, the indicators for hospitality development across the Kingdom look strong in the medium to long term. The government aims to attract 88m tourists by 2020 by focusing on the business and domestic market segments. Investment in the wider travel and tourism industry is expected to reach SR29.5bn ($7.86bn) by 2022, with an average growth of 3.3% per year in the 10 years to that date.

Across the country, there is significant supply in the pipeline to meet this expected demand. According to STR Global, which provides data and benchmarking information on the hotel industry worldwide, the Kingdom had 35,587 hotel rooms under development by the middle of 2014. In the short term, the hospitality market continues to be relatively stable. According to global commercial real estate services firm Colliers International, occupancy rates will remain above 60% in Saudi Arabia’s major cities in 2015. At the same time, there will be modest growth in revenue per available room (RevPar). In Riyadh, for example, average occupancy is expected to stand at 61% over the year, while RevPar is forecast to grow by 3% to $145. In Saudi Arabia’s most expensive city for hospitality, Jeddah, RevPar is expected to rise by 2% to $200, while occupancy will be at 76% for the full year. Makkah is estimated to have an occupancy rate of 65% and RevPar of $143, an increase of 1% on 2014.

Eastern Province

The eastern seaboard, a centre for industrialisation and economic diversification in the Kingdom, is also growing substantially. Hotel occupancy in Al Khobar is forecast to be the second highest in the country at 67% in 2015. Indeed, the region is generating demand across a range of property segments. Much of the land is allocated for industrial use, with the province accounting for more than 85% of Saudi Arabia’s industrial output. Nonetheless, with a population of 4.5m (15% of the country’s total) and 16% of the active workforce, there is demand for both residential and commercial property.

As such, there are substantial opportunities in this part of the country. Developers such as the UAE’s Emaar and Al Suwaiket are beginning to tap into the potential in the residential segment by building high-end towers and units with associated facilities. There is sufficient demand to suggest that pricing will remain on an upward curve through the next few years. JLL forecasts a current demand in the Dammam Metropolitan Area of 280,000 residential units and expects this to expand by 3% per year for the next half decade.

The majority of this demand is driven by population growth and employment generation, although there will also be opportunities for holiday home construction along the coast. JLL predicts that supply in the Dammam Metropolitan Area will reach 340,000 units by 2017. At the top end of the market, in terms of quality, villa sales prices ranged from SR2500 ($666) to SR4000 ($1066) per sq metre, while apartment prices were in the range of SR3500 ($932.75) to SR4500 ($1199) per sq metre in October 2014. In the rental segment, villas commanded annual rates between SR300 ($80) and SR450 ($120) per sq metre, while apartment rents were going from some SR350 ($93) to SR450 ($120) per sq metre.

Compound Growth

As a result of the proliferation of white-collar expatriate labour in the Eastern Province, compound developments, which afford more privacy, are also popular. According to JLL, there are currently 12,000 compound units in the Dammam area and 3200 units in Jubail. Although almost 3000 further units are under construction across the two cities, this is unlikely to fully meet demand. Waiting times for existing developments can reach two years and rents in the compound segment have increased by an average of 5% annually for the last three years.

Although this phenomenon is particularly pronounced in the Eastern Province, the compound market is potentially lucrative across the Kingdom. For such projects, developers expect returns of up to 12% where the design includes high-security features.

“High-security compounds have the highest demand, but there is little supply here,” Ahmed Bakarman, CEO of Raseel Properties Company, told OBG. Demand for such living spaces not only comes from expatriates but also from some Saudi nationals. However, supply is limited as the high-security compounds are those in which the government, rather than a private contractor, supplies security. Unsurprisingly, this extra security is not granted lightly.

“Because of the limited supply, high-security compounds can charge a substantial premium. Units in such projects can go for SR1200 ($320) per sq metre per month, compared to a normal compound averaging SR600 ($160) to SR650 ($173) per sq metre per month,” Bakarman told OBG.

Outlook

The compound development market illustrates the current state of the Saudi real estate industry. Developers are still focused on the highest income segments, but even here there are constraints that limit supply and maintain prices.

However, if issues around land and financing can be resolved, and the state subsidy programme implemented smoothly, residential property developers should begin to target the high-potential middle-income sector. Indeed, it is likely to be this volume-driven segment that will generate sustainable residential and retail development moving forward.

Furthermore, given the strong performance of the domestic economy, plans for further diversification and a growing tourism industry built on the pilgrimage market, the office and hospitality segments should also enjoy growth in the medium term. Indeed, the most populous market in the region should offer plenty of opportunities across the full range of property segments as the market matures in the coming years.