Saudi Arabia's real estate regulations aim to sustain growth while preserving stability

Benefitting from rising incomes and a youthful growing population, Saudi Arabia’s real estate sector has seen steady expansion in the past decade. Although this increase has been more modest than in its GCC neighbours, it is clear that strong demand for residential real estate will continue over the long term thanks to the country’s demographics.

Budgetary Concerns

Weighing up the obvious opportunities presented by the biggest market in the Gulf region, investors have understandably taken a cautious approach to new developments at a time of significant change for Saudi Arabia’s economic model. Crude oil has fallen in value before, and to a much lower price than it reached in early 2016, but in previous downturns the country had a smaller population and a far smaller government payroll.

The Ministry of Finance budget statement in 2016 revealed half of expenditure in 2015 was on public sector salaries and allowances. Total expenditure is budgeted at SR840bn ($223.9bn) for 2016 compared to actual spending of SR1.11trn ($296.2bn) in 2014 and SR975bn ($259.9bn) in 2015. To shore up its fiscal health, the government is slashing capital spending on infrastructure projects and looking for ways to raise revenues through new taxes and by cutting subsidies for fuel and energy. Although challenges remain, such as lack of affordable housing, the state has recently taken important steps that are likely to have a positive long-term impact on the sector.

White Land Tax

The most significant proposed tax affecting real estate is a new 2.5% levy on so-called white land – undeveloped tracts scattered across the Kingdom’s largest cities – which constitutes as much as 40% of all land in the capital city, Riyadh, according to Century 21’s 2015 report on Riyadh real estate. This measure was first suggested by the IMF in its 2014 Article IV report. The Shura Council passed the law in December 2015, and it was due to be implemented by the Ministry of Municipality and Rural Affairs in June 2016. Early that month details about the regulations governing the tax began to emerge. Local media reported that the tax would be brought in using a phased approach, though the specifics of how plots would be categorised and the time frame for implementation were not defined at the time.

Owners of white land have been waiting to see if their property would be subject to the new legislation, and if so, what measures they would have to take to avoid paying onerous taxes. Early June press reports were unclear as to how the market would initially react to the new tax, which is designed to help alleviate the housing shortage in the Kingdom.

“I believe that the way the regulatory authority will implement land tax will be very important to generate desired results. Most probably the small-sized real estate developers and owners will be more affected by the land tax as compared with the large-scale major real estate developers and owners,” Asif Iqbal, head of research and advisory for Century 21, told OBG. “The option of land lease to investors and developers will get more popularity where the landlords will lease the lands on long-term basis to investors and developers for development purposes.”

The gradual accumulation of land banks has allowed landlords, large and small, to speculate on a rising market in the hope of maximising returns when they sell or develop parcels of land. The new law means they must weigh up the potential value of their nest egg against the cost of paying the new tax.

“For many of the owners, land is used to store their wealth, and for this reason many landlords have been reluctant to sell. So we will just have to wait and see how much of the land is developed, and for what purpose, and how much is sold to avoid paying the tax,” Fayyaz Ahmed, director at the Riyadh branch of international real estate consultancy JLL, told OBG.

Mortgage Law

While landowners and property developers exercised caution, many potential homebuyers have found themselves priced out of the market by a new law designed to dampen a potential real estate bubble. Passed in late 2014, the mortgage law introduced a 70% loan-to-value (LTV) ratio, restricting home buying to those who could afford to pay a 30% deposit on new property. Developers who saw demand for new homes fall as a result say the market might have been more resilient had the measure been introduced gradually. “The LTV ratio is at a healthy level, but this should have been built up gradually,” Abdulelah Alsheikh, vice-president of real estate developer Maskan Arabia, told OBG. “Asking people to jump from 5-10% down payments to 30% has priced many people out of the mortgage market. This has also brought sales to a halt, negatively affecting the market by driving out some developers and limiting any new projects, which has created an additional lag in supply relative to demand.”

Impact

The white land tax and mortgage law had a significant impact on the residential markets of both Riyadh and Jeddah in 2015 and the first half of 2016. However, the prospect of greater clarity on the tax and efforts to ease the burden of the LTV ratio (see analysis), there was the potential for these two brakes on the sector to be eased in 2016.

In February 2016 the Kingdom’s central bank announced it would allow specialised mortgage companies to increase their maximum contribution to home financing to 85% (see Banking chapter).

Urban Planning

If the white land tax does prompt more development across all real estate sectors, it will come at a time when many of the Kingdom’s cities are being transformed and remodelled. In Saudi Arabia, 83% of the population lived in urban areas in 2014, according to the latest World Bank figures. That same year, data from the Central Department of Statistics and Information – now known as the General Authority for Statistics – show that Riyadh, Jeddah and Makkah had populations of 6m, 4m and 2m, respectively, while Taif, Medina, Dammam and Al Ahsa all had more than 1m residents. Unless there is a profound and prolonged cut in public spending, four of these major cities should have urban rapid transit systems completed within five years, although delays are expected for the delivery of the Jeddah and Makkah metros as construction has yet to begin.

The Riyadh Public Transport Project, being developed at a cost of $23bn, is due to be completed in 2018, while in Jeddah a $9.3bn public transport network will cost around $9.5bn and is expected to be operational in 2020. Makkah’s $16.8bn public transport system is also due to finish construction in 2020. The new lines on the Makkah Metro will complement the Al Mashaaer Al Mugaddassah line that was built in 2010 to carry pilgrims to the holy sites. In 2021 Dammam’s residents should be able to use the first metro project in the Eastern Province, which is expected to cost around $9bn, according to Alpen Capital.

As well as speeding travel times, these urban transport system will also present land owners with opportunities to develop sites in outlying communities on the lines, which will enjoy speedier links to central business districts (CBDs).

In the CBDs themselves the value of sites close to transport interchanges could increase rapidly. “The station plan has been public for more than a year, and so if I am a developer putting up an apartment building over the coming five years, I would put it next to a metro station,” JLL’s Ahmed told OBG. “There will also be restaurants in the stations and so opportunities for both food and beverage and retail concessions.”

Shifting Axis

In Riyadh the metro lines running on a northerly axis will speed up the commute for expatriate workers travelling into the city from its poorer southern residential districts.

“Lines connecting east and west might improve some areas close to stations, but it may depend on the type of stations, as some will be transfer stations at the intersection of two lines and others will not be transfer stations,” Ahmed told OBG. To the north of Riyadh’s CBD lie wealthier, more desirable suburbs, as well as King Abdullah Financial District (KAFD) and King Khaled International Airport. The anticipated soft opening of KAFD in 2017, and the expansion of the airport, which has added a fifth terminal while committing an additional $1.45bn to upgrading terminals 3 and 4, is likely to generate increased interest in this part of the city. A metro line will run from the airport to a KAFD metro station being designed by the late architect Zaha Hadid.

The axis in Saudi Arabia’s second city, the Red Sea port of Jeddah, is also tilting to the north with more than SR360bn ($96bn) being spent before 2020 on new projects: development of Jeddah Economic City, which is to include the world’s tallest skyscraper, the Jeddah Tower; construction of 6100 new housing units at Obhur South; and expansion of the King Abdulaziz International Airport, according to Colliers International. Connectivity will also be crucial in Jeddah’s expansion, with the 2-km Obhur Bridge due to carry the city’s metro line.

Denser Development

Some developers believe the metro systems being built in the Kingdom’s larger cities will enable urban planners and developers to revisit the way neighbourhoods and urban districts are designed. One impact may be that urban sprawl is countered by the construction of more small homes supported by shared amenities.

“Riyadh is an incredibly low-density city, largely because of the lack of public transport,” Maskan Arabia’s Alsheikh told OBG. “However, with the new public transport projects here, this city will be able to support higher-density development, so it is imperative that we increase this. We should revisit today how we design neighbourhoods, emphasising public spaces to cut down on the size of individual units and make new housing types more attractive, in addition to the traditional apartment.”

Build To Rent

A combination of demographic pressure, restricted access to home finance and employment options for young Saudis are all likely to sustain the market for rental of smaller apartments across the Kingdom’s cities. Although the traditional family home in recent years has been a villa built specifically for the owner and occupied by multiple generations of the family, there are some signs that apartment living is becoming more common, at least in some parts of the country.

“In Jeddah residential apartments have become more acceptable for local Saudis as a mode of accommodation,” Iqbal told OBG. “In Riyadh Saudis still prefer to live in duplexes and villas which serve their need for privacy in a better way, and apartments are mainly considered as an investment.”

However, the villa, or even the duplex, comes with a high price tag, out of reach for many of those hoping to buy their own home. According to Century 21, a potential homeowner looking to buy a duplex in one of Riyadh’s more popular northern suburbs might expect to pay SR1m-1.3m ($267,000-347,000). The 70% LTV ratio means these buyers would need down payments of between SR300,000 ($80,000) and SR390,000 ($104,000) to invest in such a property.

Millennials

According to Mazin Al Ghunaim, CEO of Bidaya Home Finance, there is no issue with demand as Saudi Arabia has a large, young population, and these youths are eager to become homeowners. “The issue is the supply side of the equation. We currently don’t have enough products that match incomes,” Al Ghunaim told OBG.

However, younger generations of Saudis will need well-paid jobs to be able to save enough money to finance their housing requirements. An IMF report in October 2015 predicted that 1.6m-1.8m Saudis would enter the country’s labour force by 2021, but in that time the public sector would only generate 800,000 new jobs, an estimate based on 3.7% growth a year in hiring of nationals by the state.

The alternative would be to work in the private sector. However, the latest data on employment trends produced by the research and investment house Jadwa Investment showed that in 2015 private sector employment of Saudis actually declined for the first time since 2011. Instead, 88% of all new private sector jobs went to non-nationals.

At the same time the Saudi participation rate fell for the first time since 2009, showing that the number of Saudis outside the labour force rose by 85,000. Jadwa attributed this to the number of young people remaining in education, but it may also reflect the number of highly educated young Saudis who are not prepared to accept low-skill private sector jobs.

Employment Trends

The 2015 Saudi Economic Report published by the Ministry of Economic Planning showed a large increase between 2013 and 2014 in the number of Saudi citizens who choose not to work. Of the 8m Saudis of working age who were out of the labour force, 50% were housewives and 39% were students, but some 55,985 were people who said they were not interested in working. This number had grown nearly three-fold from 14,103 in 2013, with men constituting 43% of the demographic.

“The reason behind the increasing growth rate of this group,” the report said, “is the refrainment of the Saudi youth from lower skill jobs offered to them by the private sector companies which are not consistent with their qualifications as most of them are the holders of university degrees.” Unless these employment patterns change, there may be more young Saudis who are prepared to remain living under the same roof as their parents in family villas.

Affordable Homes

However, it not only Saudi Arabia’s burgeoning younger generations that are affected by property prices. According to a 2015 JLL report on middle-income housing in the MENA region, the 3.3m Saudi families with monthly incomes between SR6000 and SR20,000 ($1600-5330) constitute 62% of the population. The affordable house price for a family in this income band is SR450,000 ($120,000), the equivalent of SR47,000 ($12,500) in annual rent. Under the 2014 mortgage law, the down payment on a property of that value is SR135,000 ($36,000), the equivalent of seven months’ salary for wealthier middle-income families, and around 23 months for those at the lower end of the band.

JLL estimates that home ownership ratio in Saudi Arabia is around 30%, and in 2011 it estimated there was pent-up demand for 400,000 new homes for middle-income families. In that year King Abdullah, recognising the need to supply citizens with new homes, issued a number of royal decrees to build 500,000 low-cost housing units costing SR250bn ($66.6bn), but progress has been slow.

In 2014 the Eskan fund was created to work with the private sector to facilitate the process of providing good-quality affordable homes for Saudi families, and by 2015 work had commenced on two major affordable housing schemes, one by the airport in Riyadh and the other at Salman Bay near Jeddah. The Eskan airport project is on 5m-sq-metre site, located about 5 km from King Khalid International Airport. This will be the nearest metro station for residents commuting to KAFD, 22 km away, and to the CBD, 30 km away. The new community will have 3000 homes, 76% of them individual villa plots, and will include schools, shops and other amenities. In 2015 the first 2240 plots were handed over to eligible citizens. Private developers Tamlik, Abdulrahman Al Rashid and Sons, Alargan, Sumou and Salman bin Saedan Group are building villas in a number of different styles.

The Salman Bay project in Jeddah is being built on 3.5m sq metres and will have 25,000 residential apartments in 1250 buildings. At the end of 2015 the first 46 buildings constructed in the SR1.5bn ($399.9m) first phase of the scheme were handed over, with 97% of units sold, according to JLL. The asking price for apartments ranges from SR248,000 ($66,100) to SR550,000 ($147,000). The last of the buildings on the site, which will also have community facilities, should be completed by 2023.

New Bank

In October 2015 the SR183bn ($48.8bn) Saudi Real Estate Development Fund (REDF) announced it would be converting into a bank so that it could offer a broader range of services to enable Saudi families to buy affordable properties. According to JLL, the REDF had loaned SR229bn ($61.1bn) between its inception and the end of 2014, resulting in the development of 928,000 residential units. From 2011 it provided buyers with loans of up to SR500,000 ($133,000) paid directly to developers for new-build properties. After the process of converting to a bank is completed, the REDF will work with the private sector to offer a broader range of home loans and mortgages on existing properties.

Foreign Ownership

A potential source of stimulus for all real estate segments in Saudi Arabia may come from a relaxation in the laws governing foreign ownership of some businesses. The Tadawul stock exchange opened to limited foreign direct investment in 2015, and in September 2015 the Saudi Arabian General Investment Authority announced it would allow 100% foreign ownership of retail and wholesale businesses in the Kingdom to encourage more diversification of the economy. The idea is to promote Saudi Arabia as a centre for import, re-export and retail goods. Until this change was introduced, an international retailer would require a Saudi partner, who would take a 25% stake without necessarily adding extra value to the concern.

As well as stimulating interest in the Kingdom by high-end Western brands, the new regulation should also free expatriate entrepreneurs already living in Saudi Arabia from burdensome bureaucracy. There are 10.4m expatriates living in Saudi Arabia, according to CDSA figures, and Jadwa reports that in 2015 some 369,000 expatriates found new private sector jobs in the Kingdom, 29,000 of them in retail. Allowing some of these expatriates to trade more freely could have a significant impact on the economy if their success in other GCC countries is replicated.

Retail Market

The impact of this new rule is expected to increase demand for space from international retailers just as a raft of new developments open from 2016 onwards. Century 21 recorded over 192,000 sq metres in gross leasable area (GLA) entering the supply in 2015 in Riyadh, with a further 666,000 sq metres anticipated by 2018, bringing total retail space in the city to 3.2m sq metres.

In its report on Saudi Arabia’s real estate market in 2015, JLL stated that Riyadh’s retail sector comprised 1.4m sq metres of GLA in 2015, with an additional 300,000 sq metres to be completed in 2016 and a further 214,000 in 2017. The company reports that in 2015 the relatively small amount of new shopping space coming into the market kept vacancy rates stable and allowed small increases in rentals of 2% in “super-regional” malls (90,000 sq metres and above) and 4% in “regional” malls (30,000-90,000 sq metres).

New Malls

In February 2016 Dubai’s Majid Al Futtaim announced it was building its first two malls in the Kingdom and that it was in the process of bringing a ski slope to the Saudi capital. With a combined investment of SR14bn ($3.7bn), the Mall of Saudi will be the Kingdom’s largest shopping mall at 300,000 sq metres, while the City Centre Ishbiliyah will comprise 112,000 sq metres and be anchored by a 9000-sq-metre Carrefour hypermarket.

The first phase of development at Mall of Saudi, which includes the mall, ski slope, a hotel and a serviced apartment building, is set to commence by mid-2017 and be completed by 2022.

Meanwhile, City Centre Ishbiliyah will be Saudi Arabia’s first city centre mall, featuring 250 stores, a food court and an entertainment complex.

According to JLL’s report, Jeddah had 1.07m sq metres GLA of retail space in 2015, with a further 177,000 sq metres and 175,000 sq metres entering the market in 2016 and 2017, respectively. JLL reported that retail space in Jeddah had vacancy rates of 7% in the first half of 2015, but saw this rise to 11% in the second half of the year as some older malls undertook renovation or lost tenants to new centres. Retail rents grew by 7% in Jeddah in 2015.

Residential Performance

Market surveys of the residential sector in Riyadh in 2015 undertaken by Century 21 and JLL both point to a decline in sales and an increase in rents. For Century 21 the fall in sales of villas and apartments was 5% in some areas and 12% in others, while JLL cited Ministry of Justice figures suggesting an 11% decline in sales transactions in Riyadh and a 19% drop in Jeddah. In the capital it reported that villa sales prices fell by 6%, while those in Jeddah rose by 6%, albeit from a lower base.

At the same time average rents grew by 6% in Riyadh and 11% in Jeddah in the year to November, according to JLL. Both companies cited the anticipated white land tax and the new LTV mortgage rules as reasons behind falling sales and rising rents.

The reports also remarked that individual residential developments delivered in Riyadh in 2015 consisted of 150 homes or fewer. In addition, both surveys agreed the number of new homes likely to be delivered in 2016 would be more modest than originally anticipated as developers delayed in the hope that prices might pick up if LTV ratios were reduced and the white land tax clarified for investors. Century 21 expected 2500 new homes to be completed in the capital in the first half of 2016, while JLL reported that 28,000 units were originally scheduled for completion in 2016, but that a significant proportion of these might not materialise during the year owing to the unfavourable market conditions. JLL expected the number of new homes in Jeddah to increase by 24,000 and 25,000 in 2016 and 2017, respectively.

In the first quarter of 2016 the villa market in Jeddah saw a decline in both sale prices (-5.4%) and rentals (-2.5%), according to JLL. Apartments in the city performed slightly better than villas, with both prices and rents remaining largely stable.

Meanwhile, in the first three months of 2016 property prices in Riyadh stabilised for the first time since the introduction of the new mortgage regulations. The residential market saw a general slowdown, with sale prices for villas and apartments decreasing by 6% and 4% year-on-year, respectively.

Office Space

Office space in Riyadh is a buyers’ market as the capital anticipates a 20% increase in available space between 2015 and 2017. KAFD is expected to account for 800,000 sq metres in 2017, but before then almost 250,000 sq metres of prime office space will become available in the Information Technology and Communication Complex (ITCC) buildings, with the Endowment Project, the Majdoul Tower and Hamad Tower also expected to provide 95,000, 70,000 and 31,000 sq metres of additional up-market office space by the end of 2016.

“The ITCC is a high-tech compound that will offer top-quality data infrastructure,” Ali Al Assaf, CEO of Raidah Investment Company, told OBG. “This will attract high-level IT companies, helping to establish Riyadh as an important tech centre in the region.”

In 2015 Century 21 noted a reduction in rental rates in the CBD area, which was exacerbated by traffic congestion caused by the Riyadh Metro construction work, while JLL noted that office rental rates across the capital remained stable with an average monthly rental price of SR1056 ($282) and a 16% vacancy rate. Both Century 21 and JLL anticipate vacancy rates will go up and rents come down in the immediate aftermath of relocations to KAFD and ITCC. In Jeddah JLL saw office rents rising by 7% in the first half of 2015, but receding to 4% for the year as a whole.

In the first quarter of 2016, 33,000 sq metres of office space was added in Jeddah, with total supply reaching 925,000 sq metres, according to JLL. Average lease rates increased by 2% year-on-year, while vacancy rates remained stable at 5%.

The expansion in office space has created opportunities for related markets, such as office solutions providers. “The office solutions business continues to expand in two areas: the office furniture industry and the office equipment industry,” Rakan El Hoshan, CEO of Hoshan Group, told OBG. “The office furniture industry is a lagging industry, so even after the real estate boom ended, people still need to furnish the space which they’ve built. With regard to the office equipment industry, most companies and almost all the public sector had been buying their equipment, however, now they are looking to cut spending and thus leasing business has expanded dramatically.”

Hospitality

While Jeddah may be the country’s second city for office space, it outperforms Riyadh in the hospitality sector. According to JLL’s 2015 survey, average daily hotel rates in Jeddah were $259 compared to $233 in the capital, while its occupancy rates were 76% to Riyadh’s 58%. In 2015 a Mövenpick and a DoubleTree by Hilton opened operations in Riyadh, adding 653 keys between them, while the 112-key Blu Plaza opened in Jeddah. There are substantial development pipelines in both cities with 7500 keys due to be added in Riyadh and 5600 in Jeddah by the end of 2017, according to JLL; there are currently 10,500 keys in Riyadh and 8600 in Jeddah. JLL reported there were no new additions to Jeddah’s hospitality market in the first quarter of 2016, although a number of projects were under way, including Radisson Blu Al Salamah, the Ritz Carlton, Mövenpick City Star, Assila Hotel and Elaf Galleria.

Outlook

In the short term the hospitality and office segments may face a surfeit of supply and a shortage of demand with major new real estate developments in the pipeline. On the residential side rents are stabilising, but tenants face financial obstacles to home ownership. The central bank’s announcement that it will allow specialised mortgage companies to increase their contribution to home financing to 85% is a positive step to improve access to home loans. Meanwhile, owners of undeveloped plots are playing a waiting game over the new white land tax. Should its introduction increase the volume of land transactions, the new tax will be a boon to the 70% of Saudis who cannot afford to buy property.