Healthy demand: Measures are under way to support home ownership and boost the supply of housing

Something of an anomaly in the region over the past decade, Saudi Arabia’s real estate market should present the best opportunity on the Arabian Peninsula in the coming years. It has the largest potential market in the GCC with abundant oil wealth and a growing and youthful population. But whereas its counterparts to the east have experienced the highs and lows of a full boom-and-bust cycle, and the headlines that accompany this, the Kingdom has ticked along quietly. There has been modest, uninterrupted capital appreciation in the residential property segment, but limited investment opportunities given the small scale of the formal market. This situation may begin to change in the next 12 months, however, not only because the underlying dynamics of the market are so promising, but also because the government is now working hard to put in place the framework (in terms of regulation and capital support) to rapidly grow the housing stock and market.

DEMAND DRIVERS: The long-term trends in the country point towards a robust and sustainable real estate market over the coming decade. The Kingdom’s oil- and industrial-driven economic growth has created a platform for investment and development of property. According to figures from Jeddah Economic Gateway, GDP is expected to grow at a compound annual rate of 9.2% between 2010 and 2015. This should translate into higher incomes in Saudi Arabia, with per capita GDP forecast to rise from $16,267 in 2010 to $22,725 in 2015.

While employment remains a significant issue – the unemployment rate among Saudi nationals was 11.5% in the fourth quarter of 2013, according to statistics from the Central Department of Statistics and Information (CDSI) – personal and household spending power should both be on the increase. The Economist Intelligence Unit estimates that personal disposable income in the Kingdom will grow at a compound annual rate of 10.3% between 2011 and 2017, reaching a total of $10,800 per head in the latter year.

Indeed, spending power in the market has been helped by aggressive government policies to support employment and wages. The Nitaqat programme, which was introduced in 2011 and is designed to improve the employment situation for Saudis, has been hailed as a success by the government.

Under the programme, Saudiisation rates have been set for the private sector. In a December 2013 investor note Al Rajhi Capital stated that 600,000 nationals had received employment under Nitaqat by the first half of 2013. Adel Fakeih, the minister of labour, also suggested the programme was responsible for reducing the unemployment rate from 12.4% to 11.7% in the third quarter of the year and had contributed to more than 1m nationals receiving a pay increase of at least SR3000 ($800).

STATE SPENDING: Beyond such programmes that have the potential to increase spending power, government intervention has also been a key driver of economic growth and hence real estate demand. The government has adopted an expansionary fiscal policy for the last half decade. Reuters reported that since 2008 the government has spent almost $800bn on stimulus measures. The 2013 budget recorded a massive rise in spending of 18% to SR820bn ($218.6bn), although actual expenditure reached SR925bn ($246.6bn). While the growth figure is less for 2014, targeted spending is still expected to increase by 4.3% to an estimated SR855bn ($227.9bn).

Much of this spending has been on infrastructure development, whether that is transport or social infrastructure. As such, the construction sector has been one of the main drivers of the economy (see Construction & Engineering chapter). In the first half of 2013 more than SR60bn ($16bn) worth of construction contracts were awarded. The capital has been the focus for much of this investment, with Riyadh Province implementing 3088 ongoing projects with a total value of SR278bn ($74.1bn) as of the end of June 2013, according to realtor Century 21.

By the third quarter of the year, construction was the standout economic performer. In that period of 2013, GDP rose by 3.19% at current prices compared to the same period of 2012. The construction sector grew well above this rate, reaching 9.76% in the same period, above the increases seen for oil (9.54%) and downstream industries (7.87%).

The expansionary stance of the government is certainly stimulating demand and absorbing supply in both the residential and office real estate segments, as the construction industry becomes a strong employment generator in the short to medium term. According to Asif Iqbal, head of research and advisory at Century 21, “Demand is coming from the metro project and companies working on this. Contracts for construction are helping to absorb additional compound supply and having a very positive impact on the office leasing market.”

DEMANDING DEMOGRAPHICS: Similarly, the demographic trends of Saudi Arabia should add volume to a market with growing spending power. Over the past 40 years the population has quadrupled to around 30m, and is expected to reach 40m by 2025. According to the CDSI, the population growth rate in 2013 was 2.7%. In addition, the structure of the Kingdom’s population should also support property demand. In 2010 the dependency ratio stood at 33.4%, with estimates putting it at an even lower 32.3% by 2015. This should create a demographic window for rapid economic growth and, if utilised well, reduce the burden on government social spending.

Given that only 30% of the population currently owns residential property, and that the urbanisation rate in 2015 is expected to reach 91.4%, there should be a sizeable need for residential projects built by private companies in the coming years. In fact, demand for housing already well outstrips supply.

With an existing supply of 4.9m units, there is currently a significant gap. In Riyadh, around 70,000 units per year are required to meet the increasing residential demand. According to Mohammed Al Khalil, president of FAD Investments, apartments will need to account for a growing share of housing stock. “With the increasing urbanisation of Saudi society, there needs to be a greater acceptance of apartments to prevent untenable urban sprawl. This will take a change of mindset, but the government can jumpstart this process by easing restrictions on ownership of apartments by foreigners,” Al Khalil said.

Changing family dynamics are likely to support the shift towards apartments as well. Hamza Al Attas, the managing director of Durrat Arriyadh, told OBG, “The nature of the Saudi family has changed over the last few years. With shrinking family sizes combined with an increase in the cost of living, Saudis are becoming much more open to living in apartments.”

AFFORDABILITY CONUNDRUM: At first glance, it may appear that the supply gap could be comfortably closed. However, it has remained a perennial and persistent problem in the Kingdom, largely as a result of the issue of affordability.

Al Rajhi Capital has calculated that a customer would need a monthly salary of SR6200 ($1653) to afford a basic apartment in Riyadh (although the assumptions in the calculation include a loan-to-value ratio of 75%, while some home loan providers will go to 100%, and loan repayments that do not exceed 30% of income, while lenders will often go beyond 50%). In Jeddah, the minimum salary for a mortgage on a basic apartment would be SR9200 ($2453). The minimum salary to take out a loan for a basic villa would be SR23,300 ($6212) per month in Riyadh and SR24,800 ($6612) in Jeddah. Given that the lowest salary for public sector workers is SR3000-5000 ($800-1333) per month, affordability remains an issue for many nationals.

The gap between salaries and residential unit sales prices means the actual market private developers cater to is substantially smaller than many of the published figures would suggest. As such, crude measurements of demand, such as population figures, do not tell the whole story. The disconnect between mass demand for housing and the active formal real estate market in the Kingdom was made abundantly clear in the latter half of 2013.

In November 2013 the conclusion of a government amnesty on undocumented labourers and employees led to a substantial exodus of foreign workers from Saudi Arabia. Yet there has been little knock-on effect on the formal market. Although around 1.5m people have left the country since the start of the amnesty, so far this does not seem to have had an impact on the real estate market.

While there is extremely high demand for housing in Saudi Arabia, most of it is at a lower price point than private property developers are currently targeting. According to Iqbal, “Everybody knows demand is there in the middle class for sales prices between SR800,000 ($213,280) and SR1.2m ($319,920), but it is difficult for developers to hit this sales price because of the land cost. Demand is still there, but affordability is a big question mark.”

MARKET BANDS: Century 21 estimates that the greatest demand, accounting for as much as 55% of the overall market, comes from people who earn a monthly salary ranging from SR8000 ($2133) to SR15,000 ($3999), labelled as the “B” class. However, most developers are building for the “B+” (salaries of SR15,000-30,000, or $3999-7998) and the “A” classes (salaries above SR30,000, or $7998).

Residential developers selling units priced between SR450,000 ($119,970) and SR1.8m ($479,880) for apartments to stand-alone villas target customers with salaries ranging from SR8000 ($2133) to SR25,000 ($6665), a reasonably large demographic. Below this level, developers say, potential customers would require a government subsidy as they would not be able to make the instalment payments on their own. Indeed, the affordability ratio could be as high as 10 years of income to meet the house prices at the lower end of the property ladder.

LAND ISSUES: One of the biggest impediments to affordability is the cost and availability of land in the Kingdom. According to Mohammed Al Abdani, director-general of the Real Estate Development Fund (REDF), “The price of land remains a big issue. Land can be 60% of the total cost of developing a unit.”

One developer that OBG spoke to estimated that land accounts for 50% of the cost of an average development, a ratio well above that seen in developed markets. At prime locations in Riyadh, residential land prices had reached as much as SR3500 ($933) per sq metre in the first half of 2013, according to Century 21. This represents an increase of 9% on the same period in 2012 and a rise of as much as 6% in the first six months of the year.

Commercial land prices in the capital grew at a rate of 17.5% compared to the first half of 2012 and 6% in the first six months of 2013, reaching a maximum rate of SR22,000 ($5865) per sq metre along the King Fahad Road in central Riyadh. Price escalation has been inadvertently supported by a lack of incentives for owners to sell or develop their land. As such, it has become a prized commodity that owners are willing to sit on to realise substantial gains.

THE STATE OF THE MARKET: Consequently, many developers are focusing exclusively on low-volume, high-return units in the luxury segment of the market. Saadat Ali, senior market analyst at Century 21, said, “A lot of developers are doing small, 30- to 50-unit projects.” The ability of developers to carry out such projects was bolstered in 2010 with the introduction of new regulations by the Ministry of Commerce and Industry that allowed for off-plan sales in the residential segment. As a result, developers are able to generate funding for their projects through these sales, rather than by using other forms of financing. As long as the market remains healthy, this will allow them to construct more units.

Expectations on rates of return in the luxury segment are high and many developers are meeting them. At the upper end of the market, developers are often targeting second-home buyers, but even here, it is clear there is significant demand, looking at the sales status of existing projects. One developer told OBG that its stand-alone villas priced at up to SR1.8m ($479,880) experience capital appreciation of approximately 25% per year in Riyadh.

Hesham Al Mogren, vice-president of finance at Daem Real Estate, which is focused on luxury residential properties in Riyadh, Jeddah and Dammam, said, “There is still strong demand for luxury units in the market.” Daem is targeting professionals with a salary above SR25,000 ($6665) per month and is catering to both cash buyers and customers accessing finance. There are around 300 units under construction in the high-end segment in Riyadh, with enough demand to absorb this supply. However, if this pipeline of units were to increase, there could be an erosion in sales prices within the luxury segment.

FLATS & VILLAS: In this market, demand is often led by the specifications of supply. In Riyadh, villas have to have unique designs, the latest technologies, a big built footprint and at least four bedrooms, according to Al Mogren. In the capital, the villa is king, and the market for apartments is not as developed as it is in Jeddah. Issues such as shared services regulation and implementation, as well as a lack of trusted property management and services companies have hampered the uptake of apartments in Riyadh. Nonetheless, given the high demand for housing across the country, apartment units still continue to perform well, even in the capital.

In the first half of 2013 apartment sales prices increased by around 6% in select districts of the capital, according to Century 21. The median sales price for a three-bedroom apartment was SR700, 000-800,000 ($186,620-213,280) in central Riyadh by mid-2013. In the northern part of the city, the range was SR500,000 ($133,300) to SR750,000 ($199,950), while in the east, it was SR450,000 ($119,970) to SR650,000 ($173,290). In the same period, villa prices across the capital rose by an average of 4%. In prime locations, small villas or duplex units were priced at up to SR1.7m ($453,220) in the first half of 2013.

Some in the industry, however, remain cautious about such constant price increases. With property values continuing to rise seemingly unabated, the persistence of the upward trend leads many to question how long it can remain sustainable, given the price correction in Saudi Arabia that followed the global real estate crisis in 2007-08.

RENTAL MARKET: Given the issue of affordability in the property sector, the rental market also remains prominent. Rental rates on apartments in Riyadh increased by as much as 7% in the first half of 2013, reaching prime rates of up to SR45,000 ($11,997) per year for a three-bedroom unit in central Riyadh. In southern Riyadh, the same size unit could go for SR18,000 ($4799) per year.

Rental yields across the capital vary considerably. The rental yield in central Riyadh is around 7.3 %, in northern Riyadh about 6% and in southern Riyadh around 5.5%. Given the Kingdom’s low interest rate environment, these figures are considered fair.

However, although this segment offers some potential for investors, it faces issues relating to informal transactions and a lack of oversight. This brings associated risks. Accordingly, the Ministry of Housing is trying to support the market through a programme to bring greater information, transparency and enforcement to the rental industry. In the last quarter of 2013 the Ministry of Housing launched an automated online system for the rental market that logs information on the availability of rental units, the details of contracts between landlords and tenants, and the monthly payments for rental property.

“The aim of the programme is to encourage the private sector to invest in rental accommodation,” said Mohammed Alzamea, the deputy minister of planning and study in the Ministry of Housing. The new system should give landlords greater security when assessing the reliability of tenants and also provide data on rental rates. The ministry was marketing the scheme in early 2014 to encourage people to subscribe to the system. Although there is no clear time-line, the ministry plans to make subscription to the system mandatory for landlords and tenants at some point. The formalisation of the rental market should provide a number of benefits, encouraging investors to engage in the buy-to-let market and bringing greater rental inventory to Saudi Arabia’s cities.

HELPING TO BUY: Nonetheless, the government’s major priority is tackling the affordability gap so that citizens can move from the rental market into property ownership. Traditionally, the instrument used for this purpose has been the REDF. Established in 1974, the role of the REDF is “to put people in homes and use government funds to support social growth”, according to Al Abdani. While it has a long history of working towards this goal through the extension of interest-free loans to Saudi nationals, the fund has been strengthened in the last few years to better achieve this aim. The capital of the fund has risen to SR191bn ($50.9bn) from SR250m ($66.7m) at its inception. In line with this, in 2010 the interest-free loan amount extended to Saudi applicants was increased by SR200,000 ($53,320) to SR500,000 ($133,300) repayable over a period of 25 years By the third quarter of 2013, the outstanding loan portfolio of the REDF had reached SR95.4bn ($25.4bn), up from SR77.6bn ($20.7bn) at the end of 2010. Although the increase in loan size inevitably contributed to this jump, Tariq Al Asmar, director of transaction advisory services at Ernst & Young, consultant to the REDF, insists that such growth is mainly driven by an increase in the volume of loans offered.

To be eligible for a REDF loan, an applicant has to be Saudi, at least 21 years old (if not married) and not already own a house. The loan can be used to purchase a unit or to build a property (as long as the applicant has land). Since its inception, the fund has helped to secure homes for about 1m applicants. However, much still needs to be done. The REDF has a current waiting list of 2.7m applicants, which it is addressing by developing a number of new products. Some of these will be offered in conjunction with mortgages from the commercial banking sector as a result of the new mortgage law (see analysis).

WORKING WITH BANKS: At present, the fund helps both Saudis who are unable to obtain bank financing (in most cases those with salaries below SR3000, or $800, per month), as well as those who can go to banks. To better focus on the former, the REDF is hoping to get those in the latter camp off its books by working with the commercial banking sector. It is currently developing several new products to this end, including a guarantee to developers of up to SR500,000 ($133,300) for Saudi customers purchasing ready-made units, a top-up loan up to SR500,000 ($133,300) that can be used in conjunction with a mortgage to purchase a property and an expedited loan in which the fund will pay the interest on a mortgage for 10 years up to SR500,000 ($133,300).

According to Al Abdani, “The whole point of these products is to pull people off our waiting list who have relatively high incomes and push them onto the banking sector.” Al Abdani hopes that this will shorten the waiting list for these social loans and also reduce the cash burden on the fund (given that for many of these products applicants will not need to access the full SR500,000, or $133,300, available).

While the REDF has in recent history largely focused on the demand side of the market, the organisation is now turning its attention to supply-side issues as well. The fund hopes to revive a programme that was suspended two decades ago, in which interest-free investment loans up to SR10m ($2.7m) were made available to developers, repayable over 10 years. If this product is approved, it should complement the work of other government bodies in bolstering supply in the market. According to Bader Al Saedan, the CEO of Al Saedan Real Estate Company, “The public and private sectors must work together to address the issue of housing. The public sector has the trust of the people and the private sector has the knowhow of where and what to build.”

The Ministry of Housing, which is taking responsibility for policy development, including the future assessment of REDF loans, has embarked on an ambitious plan to construct 500,000 additional housing units across the country. While this may be a long and arduous process, the ministry remains committed to this target, according to Alzamea, and has begun work on an initial 17,000 units.

If the ministry is able to meet its targets for additional supply, this will create opportunities for a secondary market and bring added maturity to the real estate sector. However, it is unclear how this will affect pricing and appetite in the market. “We just have to wait to see what will happen when the government delivers the first 70,000 units,” said Iqbal.

MORTGAGE LAW: One thing that will certainly shake up the market is the full finalisation of mortgage legislation (see analysis). First conceived more than a decade ago, the legislation’s final regulations are expected to be implemented in November 2014.

The package includes regulatory infrastructure to give greater security to commercial banks in lending against property and introduces a government lender, like Fannie Mae and Freddie Mac in the US, which will underpin a secondary market and bring greater capital to the home financing market. Together, these changes should stimulate demand for housing by opening loans to a greater share of the population.

However, certain regulations, such as the enforcement of a maximum loan-to-value ratio of 70% (against a current scenario in which some banks lend at 100%), could also dampen demand. As a result, there is likely to be a shake-up of the property sector in the Kingdom in the coming 24 months. For many years, the property market has been small, conservative and consequently stable. According to Moath Jamaan, head of sales at Saudi Home Loans, “We have never really faced a correction in the property market in Saudi Arabia.” But with the market being reshaped in the coming years, growth and instability could increase.

OUTLOOK: It is likely, therefore, that after years of ticking over the Saudi property market is now on the cusp of a period of significant change. While the formal private sector market continues to produce steady returns, it does not fully represent the underlying dynamics of the market. In terms of both supply and demand, formal private developers – as opposed to private individual self-builds and companies providing units on an ad hoc basis – cater to just a small part of the overall market. However, with the government trying to augment home ownership in the Kingdom through several measures, this could well change going forward. The ambitions for mortgage legislation and an abundant supply of government-built housing will change the considerations and parameters for established real estate developers. In the short term, it could lead to a fall in prices. In the longer term, however, it is likely to lead to greater stability and opportunity in the real estate market.