Building activity in Saudi Arabia picks up as government launches new projects

After a period of stabilisation in which the government implemented a number of reforms, the real estate and construction sectors are preparing for the introduction of a range of projects under the Saudi Vision 2030 initiative. Lower oil prices and the resulting fiscal consolidation of the state cooled demand in 2016 and early 2017; however, public and private investment is set to pick up again, with transport, affordable housing and tourism programmes among the key priorities.

Recent Pressure

The fiscal environment has been the main driver of a dip in construction activity since 2015, with subdued oil prices leading to slower growth and a programme of budgetary consolidation resulting in subsidy reductions and lower state spending. From mid-2014 the price of a barrel of crude oil dropped from over $100 to around $50 in early 2015, plunging further to $30 in early 2016 before recovering to $60 in late 2017. Overall economic growth subsequently declined to 1.4% in 2016, according to the General Authority for Statistics (GaStat), the slowest rate since the global financial crisis in 2009. While the rate demonstrated the economy’s greater resilience amid low oil prices than in the past, it shook the Kingdom after several years of high growth. This had a knock-on effect on the market: real estate activity is strongly correlated with broader economic growth and investor confidence, which feeds through to private construction demand. The construction industry is also supported by public investment in infrastructure building, which slowed during this period.

In the 2016 budget the government moved to cut subsidies on petroleum, diesel, electricity and water, effectively raising their cost, while also curtailing spending plans to reduce the budget deficit from the 17.2% of GDP recorded in 2016. While these measures were widely viewed as necessary, coming at a time of slowing growth, the roll back of subsidies put a squeeze on disposable household income and thus domestic demand. Tax and fee increases have followed, though they have largely targeted specific products, such as the tax hike on tobacco in June 2017 that raised the price tag of cigarettes by 100%.

Optimism Ahead

In general terms, indicators suggest an improving position for the real estate and construction sectors into 2018, partly thanks to a more stable economic environment, fiscal consolidation beginning to ease, and the oil price returning to over $50 per barrel in the second half of 2017.

In its July 2017 Article IV Consultation with Saudi Arabia – an annual assessment of a country’s economic health – the IMF forecast that non-oil growth would pick up to 1.7% in 2017, but with the oil sector shrinking, the economy could see overall growth of just 0.1%. However, the IMF stated that growth would take off in the medium term as structural reforms play through to the real economy. The organisation praised efforts such as fiscal consolidation, moves to enhance the business environment and improvements to governance, which should boost investor confidence and support the property sector.

“We saw declines in most asset classes over the past couple of years as the market was affected by lower oil prices,” Ahmed Almihdar, senior research analyst at real estate consultancy JLL, told OBG. “But some cities and segments are reaching the bottom of the cycle and we’re starting to see stabilisation in the market,” Almihdar added.

Budget Points

Indeed, in September 2017 local investment bank Jadwa Investment noted improvements in the economic outlook. One reason for this was the government’s local $4.5bn sukuk (Islamic bond) sale in July, which is expected to help bridge the budget deficit and support investment. The issue was three-times oversubscribed, indicating investor confidence in the Kingdom’s long-term position. Given that the local sukuk issue came between two additional bond issuances in April and September 2017, Jadwa forecasts capital expenditure to remain relatively high, at SR195bn ($52bn) for the whole of 2017, up 6% from the year before, despite growing current expenditure. Capital expenditure totalled SR35bn ($9.3bn) in the third quarter of 2017, roughly stable from the same period of the year before and 5% up on the previous quarter.

Jadwa noted that in 2016 half of all capital expenditure had been spent in the final quarter of the year, suggesting there would be a similar surge in the last three months of 2017, as the state pushed ahead on major construction projects, further boosting growth and market confidence.

The government’s strengthening financial position bodes well for the construction and real estate sectors, and major projects financed through bond issuances may also capture further interest from foreign investors. “Government contracts are an important driver of demand in several sectors,” Hosam Khairalla, general manager of Flag Realty, told OBG. “However, in real estate, international contractors and investors can also create demand for commercial office space and expatriate residential compounds. In some cases, companies ask for a whole compound or part of a compound.”

Moreover, in April 2017 the government reinstated financial allowances for civil servants and military personnel six months after they were suspended. This was interpreted as an easing of austerity measures in the wake of rising oil prices and stronger-than-expected budget figures in the first quarter. Authorities at the Ministry of Finance (MoF) stated that the allowances would not overly strain the budget, only costing SR7bn ($1.9bn) for 2017. Markets reacted favourably to the move in anticipation of higher disposable incomes and spending.

Building Up

The construction sector’s contribution to the economy had been growing prior to 2016, expanding by 6.7% in 2014 and 4.1% in 2015, faster than the rate of GDP growth. However, it shrank by 3.1% in 2016, accounting for 8.5% of non-oil GDP and 4.7% of overall GDP, according to Jadwa Investment.

In the first half of 2017 the construction industry contributed SR78.1bn ($20.8bn) to the economy. This represented 6.2% of total GDP for the period but was down 2.3% year-on-year (y-o-y), according to GaStat. While sector growth is only expected to be 0.8% in 2017, this outperforms the near-zero forecast for the economy as a whole.

Steel and cement production also began to fall in 2016, but Jadwa forecasts a recovery in 2017 and 2018 as a number of factors push the industry back to higher production. These include the timely resumption of government payments to contractors after some delays and bottlenecks, with the MoF saying it had paid 98% of invoices up to September 2017 within 45 days; the rollout of tens of thousands of affordable housing units; and a boost to real estate investment and diversification from newly established real estate investment trusts.

Industry players see this period as a good time to push ahead with construction, capitalising on lower costs and an eye on recovering demand. “Prices of construction and building materials have gone down, creating a good opportunity for developers with healthy financial positions to develop, rather than holding off until later,” Khairalla told OBG.

Vision 2030

The highly anticipated Vision 2030 was unveiled in April 2016. The plan is a wide-ranging strategy to transform Saudi Arabia into a diversified, knowledge-based economy. According to professional services company KPMG, funding already allocated to construction under Vision 2030 and its related, shorter-term National Transformation Programme (NTP) 2020 includes $90bn for new public transport in Riyadh, Jeddah, Makkah and Medina; $8bn for the expansion of the national railway network; and $60bn for water utilities. Vision 2030’s emphasis on developing sectors such as health care, defence, and transport and logistics should see increasing sums invested in the construction of hospitals, factories and other infrastructure. In the longer term, the strategy’s aim of boosting private sector contribution to the economy should help the construction sector become less reliant on government demand, which accounted for around 70% of contract awards in the Kingdom in 2016, according to industry press (see analysis). “In addition to residential housing, we are seeing major opportunities in health care, driven by both the government and the private sector, but also in entertainment, where the market will soon demand more cinemas, parks and zoos, among other facilities,” Faisal Bouzo, managing partner of contracting firm C&P, told OBG.

Major Projects

Another component of Vision 2030 is to transform the government’s Public Investment Fund (PIF) into a $2trn sovereign wealth fund. The PIF already has a considerable impact on construction demand, backing a number of multibillion-dollar development projects in major cities like Jeddah, Makkah and Taif. These include projects by the newly created Rou’a Al Madinah and Rou’a Al Haram development companies for Medina and Makkah, respectively. The former will develop an area of 1.3m sq metres to build 500 housing units and 80,000 hotel rooms, beginning construction in 2018 with completion of the first phase expected in 2023. The latter, in the meantime, will develop an area of some 854,000 sq metres with 115 buildings in its first phase, expected by 2024. The buildings will comprise 9000 residential units, 70,000 hotel rooms and 360,000 sq metres of commercial space.

One of the main aims is to make the cities safer and more pleasant for religious pilgrims. Strengthening the infrastructure of the cities will also enable the Kingdom to raise pilgrim quotas. In October 2017 Crown Prince Mohammed bin Salman bin Abdulaziz Al Saud announced the even more ambitious $500bn Neom project, a 26,500-sq-km zone in the north-east of the country on the Gulf of Aqaba, adjacent to Egypt and Jordan. Neom is designed to be a high-tech city focused on attracting innovative investment from around the world.

Contract Awards

According to business intelligence company MEED, as of mid-2017 there were $5.8bn worth of construction and transport projects in the main contract bidding stage, with $17bn worth of projects having prequalified their major contractors. Public-private partnerships (PPPs) are becoming prevalent and are expected to gain further traction as part of Vision 2030’s aim to raise private sector participation in the economy and provision of services, and as a way of easing pressure on the government budget at a time of fiscal consolidation. Four regional airports in Taif, Qassim, Hail and Yanbu are to be delivered under PPP models.

Outside of the transport sector, the value of contracts in the first four months of 2017 fell 77% over the same period of 2016, from $5.9bn to $1.3bn. Infrastructure contracts include the $120m deal for a housing development in the Mutrafiah district of Jubail for employees of Saudi Basic Industries Corporation, with 543 villas, granted in the first half of the year. Other major non-transport projects that were announced in 2017 include 116 water supply and sanitation projects worth a total of SR4.9bn ($1.3bn) to be delivered as part of the NTP, and a possible framework agreement for the construction of approximately 3000 health care centres across the country by the Ministry of Health.

Sources Of Opportunity

In a June 2017 report MEED asserted that Saudi Arabia represented the biggest potential for the construction industry in the GCC, with more than $250bn worth of projects in the pipeline, compared to $184bn in the UAE and $69bn in Qatar. Other factors are also at play to support the industry in coming years. Ilhan Ildeniz, area manager for the Middle East at Tekfen Construction and Installation, told OBG that while population growth is the leading driver of construction demand, efforts by state-owned oil giant Saudi Aramco and others to boost fuel production are also increasingly important. “Bulk plants, tanking facilities and petrol stations all need to be upgraded, while Saudi Aramco is aiming to increase pipeline capacity,” he said. “We are also seeing demand from the expansion of gas field exploration, production and facilities, such as pre-refining.” Insiders also see a reshaping of the sector, with younger, more flexible contractors finding increasing opportunities. “Engineering, procurement and construction contractors and the construction industry as a whole had a challenging year in 2016,” Yousof M Al Hammouri, operations director of Jeddah-based Mechanical and Chemical Supplies Company, told OBG. “However, while expenditure cutbacks resulted in the slowdown of major construction projects, there are still plenty of opportunities to be seized in the market, especially for new, smaller construction companies that have less overhead costs than the large corporations.”

White Land Tax

One of the most significant developments in the real estate and construction sectors of late was the introduction of a white land tax in March 2017. The new levy is designed to encourage the development of undeveloped urban land and is expected to lead to a notable boost in the construction sector by bringing down the cost of land and stimulating building work.

The tax will be rolled out in four phases, with the second phase not expected to be fully implemented until 2020. The first phase institutes a tax of 2.5% of land value on undeveloped plots bigger than 10,000 sq metres in urban areas subject to master plans if the plot is not developed within 12 months of purchase. Initially applied only to residential zones, it will soon be extended to areas earmarked for commercial development as well.

One of the aims of the tax is to narrow the gap between the two tiers of land markets that have developed in the Kingdom – land banking and land development – with owners often finding it more profitable to hold and trade land than develop it. By increasing the cost of holding land, the Ministry of Housing (MoH) hopes to encourage development, not least in affordable housing.

Land prices in urban areas already dropped significantly – by 10-20% in some cases – between the announcement of the tax in November 2015 and its introduction in spring 2017, partly as landowners looked to sell before the levy was introduced and partly due to a degree of uncertainty in the market about the law’s details. Macroeconomic headwinds affecting the property sector as a whole were also an important factor. “In the first half of 2017, most real estate players were at the monitoring stage, holding off until it was clear what the operating environment would hold in the year to come,” Khairalla told OBG. “But now we should see dramatic changes towards the end of 2017 and onwards, with the impact of the white land tax and the new real estate market legislation enforced by the MoH.” With the legislation now much clearer, the market has been positive about the tax, with construction companies naturally well placed to benefit from a boost in development demand (see analysis).

Ownership Growth

In line with the white land tax and affordable housing efforts, one key point of government plans that directly relates to residential construction is the Vision 2030 objective of raising the share of the population who own their homes from 47% in 2016 to 52% in 2020.

Ownership of dwellings contributed 9% to GDP in 2016, according to Jadwa Investment, having increased steadily over recent years, even as the wider economy has slowed. The category grew by 3.5% in 2014, 3.4% in 2015 and 3.6% in 2016, and Jadwa forecasts that it will post a strong result in 2017, expanding by around 7.5%. However, according to GaStat, by June 2017 ownership of dwellings had risen just 0.75% over the first half of 2016, totalling SR97.7bn ($26bn) and comprising 7.7% of overall GDP in the first six months of 2017. Still, several factors are expected to contribute to acceleration in 2018, including the solidity of oil prices. Government policy stands to play an important role as well, with the MoH implementing an ambitious house-building programme through schemes including “My House”. This will provide support to approximately 85,000 citizens for the construction of homes, with 120,000 new units expected over three years for a total investment of SR562bn ($149.8bn).

Further steps have been taken to support mortgage growth. In September 2017 the central bank announced measures to help cut home financing costs. Lifting of the maximum loan-to-value ratio for a housing loan from 70% to 85% should also provide stimulus (see Banking chapter). “We expect the residential mortgage market to almost double from SR280bn ($74.6bn) to SR500bn ($133.3bn) in 2020. We are aiming to refinance upwards SR75bn ($20bn) worth of mortgages in the next 5 years, hence contributing to the national goal of 52% home ownership. In terms of macroeconomic effects we are expecting an average GDP multiplier of 1.55 in the next 10 years from our initiatives,” Fabrice Susini, CEO of Saudi Refinance Company, the new venture launched by PIF and the Ministry of Housing in October 2017 to develop the Kingdom’s house financing market, told OBG.

Jadwa also sees potential from the establishment of the General Authority for Real Estate, the new authority responsible for regulating and developing the real estate sector. The body aims to boost investment and achieve the objective set out in the NTP of raising sector growth to an average of 7% per year by 2020 from 4% in 2014-16.

Capital Offices

As the increasingly influential and financially confident capital of Saudi Arabia, Riyadh has gone through a building boom in recent years, expanding into the desert and upward to the skies through new developments. However, as in the rest of the country, real estate in Riyadh in 2016 and early 2017 saw a period of subdued performance, as the market settled after its growth spurt and digested the impact of the government’s fiscal and supply-side reforms. But with rents bottoming out from mid-2017, the city’s political importance in the region, and progress on a range of new public-and private-backed projects, the real estate market should see a pickup in the coming years.

Riyadh’s office stock totalled 3.9m sq metres as of the third quarter of 2017, up 200,000 sq metres on the end of 2016 thanks to openings including Elegance Tower, which supplied 24,000 sq metres, and the Administrative Palaces, adding 32,000 sq metres. This followed on from the 200,000 sq metres added in 2016. Real estate consultancy JLL did not expect any major completions in the fourth quarter, but 200,000 sq metres is forecast to be added in 2018 and 300,000 sq metres in 2019. One of the largest projects due to finish in the near future is the twisted Majdoul Tower in early 2018, with 75,000 sq metres of gross leasable area.

Additional supply and softer demand saw office vacancies rise to 16% in the third quarter of 2017 from 15% in the same period of 2016, pushing rents down 4% y-o-y to SR1244 ($331) per sq metre per month. The future will be largely influenced by the progress of the King Abdullah Financial District (KAFD), an ambitious mega-project in the north of the capital which, when completed over several phases, will bring a further 1.7m sq metres to the market. If the district’s development goes according to plan, it should boost demand for office space as financial institutions set up or expand in Riyadh, using it as an operational centre for the region.

KAFD’s development has been delayed by red tape hurdles and uncertainty over its ownership, but the district is expected to push forward due to its potential in driving the development of the financial sector in the Kingdom, which is an important aspect of economic diversification.

Riyadh Residential

One of the most important stories in Riyadh’s residential segment is that of the long-awaited affordable housing projects, which are now beginning to gain traction. The MoH is working with six private developers to bring more supply of this category to the market, including 4500 units currently being developed by Dawaween Al Jazeerah in the south of the capital.

The ministry is also working through plans that include assistance to some 280,000 families across the Kingdom, with 185,000 families being reached in the first nine months of 2017.

The total housing stock stood at 1.17m units in the third quarter of 2017, up from 1.15m in 2016. JLL expects supply to rise fairly slowly to a total of 1.18m units in 2018 and 1.2m in 2019, as developers take a more cautious approach and look to sell off existing units. Some companies are also scaling down projects and selling off land previously allocated to residential development. The market is also starting to see a shift towards smaller units that has already taken place in other major cities, with developers adjusting their plans accordingly.

“More awareness should be spread among the public on different housing solutions and borrowing options,” Mohammed Al Khalil, chairman of FAD Investment & Development Holding, told OBG. “Apartment buildings are common in cities like Jeddah or Dammam, and Riyadh will soon move towards this kind of housing option.”

Higher-value properties saw lower demand in 2017 as a result of wider economic and market conditions, including some highly paid expatriates leaving the country. Still, the number of apartment and villa sales in the third quarter of 2017 increased by 39% and 7% y-o-y, respectively.

Despite the rise in transactions, sale prices of apartments and villas fell somewhat, declining 4% and 5%, respectively, compared to the same period of 2016. Rents witnessed a similar performance, with apartment rents down by 6% and villas by 4% y-o-y. JLL expects a further slip in prices and rents through the first half of 2018, due to rising supply.

Central Retail

Riyadh’s retail sector has benefitted from increased consumer confidence since the reinstatement of public sector benefits in April 2017. A number of major companies have announced plans for expansion projects, while mall owners are investing in enhancing their properties.

“Shoppertainment” is now a growing trend, with malls looking to stay ahead of the pack in the provision of leisure facilities. According to Rashid Saad Al Rashid, partner and CEO of Al Rashid Trading & Contracting Company, public space in the city is rapidly evolving. “Malls and retail profits were down around 30% in 2017, and this has engendered the repurposing of these spaces towards more entertainment-oriented facilities, such as cinemas and restaurants,” Al Rashid told OBG. “People are also spending less leisure time in their houses. There is a growing demand for public leisure space, and the real estate sector is beginning to offer this.”

Meanwhile, Al Khalil said, “Although there has recently been a slowdown in commercial real estate, the prospects for this market segment remain bright, driven by a sustained demand for recreational areas, including children’s entertainment facilities, restaurants and food courts.”

As of the third quarter of 2017, Riyadh had a total of 1.7m sq metres of retail stock, with an average of 79,000 sq metres added to the market annually since the third quarter of 2014. Proposed projects could see this to accelerate to an average of 250,000 sq metres per year through to 2020, with 96,000 sq metres expected to be added in 2018 and 288,000 sq metres in 2019. Major completions in the third quarter of 2017 in the city included Square 6, which has 21,000 sq metres of gross leasable area, and Welfare Centre with 14,700 sq metres. The bulk of new offerings fall into the convenience, community and neighbourhood centre categories of retail.

Retail rents have held fairly steady over the year to September 2017: regional malls saw a 1% y-o-y decline in the third quarter, while community mall rents dropped by 3%. The overall vacancy rate was recorded at 9% in both the third quarter of 2016 and the same period of 2017.

Jeddah Overview

Jeddah is Saudi Arabia’s second-largest city, a hub for the west of the country and a major commercial centre. As such, it has benefitted from growing trade and investment. The real estate sector as a whole cooled in the first half of 2017, with signs that the market was nearing the bottom of the cycle and would start to pick up again.

The city has been affected as much as others by the rising cost of living and lower economic growth, acting as a drag on domestic demand. However, both hotel and retail property are likely to benefit from the expected rise of quotas for non-GCC Hajj pilgrims, with medium-term efforts to allow more visitors to the Kingdom once expanded infrastructure is in place. As in other centres of the country, retailing has also had a boost from the reinstatement of benefits for public sector employees.

Retail vacancy increased in 2017 as new supply came on-stream, though this is likely to be absorbed over time as pilgrim numbers rise, economic growth quickens and consumers become accustomed to higher costs in other areas of life, such as energy, resulting from the reduction of subsidies.

The city is due to see a new wave of construction thanks to the PIF’s SR18bn ($4.8bn) New Jeddah Downtown project announced in September 2017. The development will overhaul the city’s corniche over the course of 10 years, with initial planning under way. The mixed-use development will include 12,000 residential units, as well as retail, entertainment, office and hotel facilities (see Jeddah chapter).

Office Market

Average office rent in Jeddah fell 11% y-o-y in the third quarter of 2017, reaching SR998 ($266) per sq metre per month from SR1124 ($300) the year before, according to JLL. Quarter-on-quarter (q-o-q) rents slipped 2%, suggesting they are reaching the bottom of the cycle. Vacancies were up to 14% from 7% in the third quarter of 2016, largely due to new supply coming to the market. Further additions of new office space, mostly mid-scale, are expected in early 2018, possibly putting more pressure on rents. Thus, tenants have taken advantage of the new supply and softer demand from companies in the hydrocarbons sector to either negotiate better rents or relocate to newer buildings on more favourable terms.

Overall gross leasable area of prime office space in the central business district is expected to rise at a fairly rapid pace from 974,000 sq metres at the end of 2016 to a total of 1m sq metres by the close of 2017, 1.1m sq metres in 2018 and 1.2m sq metres in 2019. While the market is currently in the recovery phase, it is expected to pick up more quickly once $400bn in trade deals are implemented, signed between the US and Saudi Arabia during US President Donald Trump’s visit to the Kingdom in May 2017. This should give a substantial boost to Jeddah as a financial and trading centre.

Residing In The West

The residential market of Jeddah has been similarly subdued, with sales prices for apartments falling by 9% y-o-y in the third quarter of 2017. However, villa sale prices remained fairly stable with a small y-o-y dip of 0.5% and a q-o-q increase of 1.3% during the period.

Apartment rents slipped 9% y-o-y, and villa rents 4.2%. Still, rent prices for both apartments and villas seem to be stabilising, with q-o-q decreases of just 0.5% and 0.3%, respectively. By September 2017 the city had a total of 812,000 residential units, up 9000 from the end of 2016, with supply expected to grow further to 814,000 total units in 2018 and 826,000 units the following year, according to JLL.

The consultancy expects interest in northern Jeddah to pick up as new projects come to the market. Particularly significant is the Public Pension Agency’s Al Raidah residential complex, which is currently under construction. The first phase will bring around 2500 units to the market, making it one of the biggest residential areas in the city. Later phases will see the total number of units rise to around 4000 apartments and 1100 villas. However, the softer market conditions have seen some projects delayed, such as Kingdom Holding’s 170-storey Jeddah Tower, which is set become the world’s tallest building when complete, at around 1000 metres.

Jeddah Retail

The retail segment has felt the squeeze of rising costs and the several months in which public sector employees’ benefits were suspended. However, the reinstatement of benefits in April 2017 has led to an uptick, with consumer spending increasing during the summer of 2017.

Average rents in regional malls fell 2.3% y-o-y in the third quarter of 2017, while rents in super-regional malls dropped 7.6%. However, vacancies remained stable at around 10% between the third quarters of 2016 and 2017.

Overall supply rose during 2017 with additions such as the expanded Red Sea Mall, which brought 18,000 sq metres of new gross leasable area to the market, and the Alireza Shopping Centre, which added 7300 sq metres. Total retail space in Jeddah stood at 1.2m sq metres in September 2017.

JLL expected 12,000 sq metres of new space to come on-stream in the final months of 2017, followed by 176,000 sq metres in 2018 and 116,000 sq metres the following year. Completions expected in the first half of 2018 include Jeddah Park and the refurbished Al Basateen Centre, both on Tahliya Street, a heart for retailing in the city. JLL forecast stronger household expenditure offsetting the downward pressure on rents if retailing outfits occupy more of the available supply.

Outlook

The implementation of the NTP and Vision 2030 will have a huge impact on the construction industry if its planned mega-projects are rolled out according to schedule. Increased demand should stem from a growing range of segments, including affordable housing, transport, tourism and commercial space for international tech developers. As the biggest economy in the Middle East and a market of 32m people, Saudi Arabia is also an increasingly attractive place to invest, meaning that private demand is likely to play a growing role in real estate and construction in the coming years.

While downside risks from oil prices remain, the government is continuing to work to manage the budget, trimming costs where necessary and seeing that priority projects stay on track. Regional relations and security is also a smaller, though present, concern. However, with Vision 2030, the Kingdom not only has a clear roadmap for the future, but it is already moving forward on achieving its goals.