Meeting demand: Growing from a solid base, property developers must now address the housing shortage

Having avoided the major boom and bust cycles of its Gulf neighbours, Saudi Arabia’s real estate sector is considered relatively stable. For several years, and certainly since the global financial crisis, the sector has been viewed as a safe haven for local capital. Prices in the market have held firm and returns have been solid. The reasons for this are not hard to discern. As the biggest market in the region with a growing economy and population, the demand across all segments of the sector has been increasing steadily. While low-income housing remains the greatest concern for the government, there is enough growth in the middle and upper segments of the market to encourage developers and investors alike.

Strong Numbers

It is clear that Saudi Arabia will be an important regional market for some time to come. One only has to look at the population figures to see the potential. The country is the most populous in the GCC with 29.2m people, according to 2012 estimates from the Central Department of Statistics and Information (CDSI). Furthermore, with the CDSI also pegging the population growth rate at 2.9%, there should be continued demand for housing in the years to come. This alone is unlikely to excite developers and investors, however. But there is more to the story: with economic growth of 6.77% in 2011 and a healthy per capita GDP of SR78,906 ($21,028), according to the CDSI, there is an attractive combination of size and wealth in the country.

The Fundamentals

This suggests that the fundamentals are in place to support robust and sustainable growth. According to Mohammed Al Samhan, the general director of the real estate department at the General Organisation for Social Insurance (GOSI), “With some risks remaining in financial investments, such as equities, we think real estate is a safer investment. [Compared to Dubai and elsewhere], in Saudi Arabia, the structure of the market is different. You have real demand and real growth in real estate.” Indeed, perhaps a more important indicator of demand for housing that can be provided by the private sector is the general trend in the labour market. (Although the latest available data is from 2008, metrics shows a general movement that is unlikely to have shifted dramatically given the demographic composition of the country.) According to the data from the Ministry of Economy and Planning’s ninth five-year development plan, the labour force increased from 7.18m workers in 2004 to 8.02m workers in 2008, equal to an average annual growth rate of 2.8%.

Coming Up Short

Much of the growth generated by this demand, however, is in the low- and middle-income segments of the market. According to Global Property Guide, 80% of the unmet demand comes from low- and middle-income households. Global real estate services company Jones Lang LaSalle put the total housing shortage at 1m units in 2012, while Banque Saudi Fransi estimates that 275,000 units will need to be built each year between 2012 and 2015 to meet demand. Most of this supply is unlikely to come from commercial developers, however. According to Darwish Bakeer, the chief commercial officer of Rafal Real Estate Development Company, a local developer, “I do not believe that any developers will enter the mass market because there are no margins. It’s a loss maker because the land is too expensive.”

Nonetheless, there is certainly enough demand in the middle and upper segments of the market to interest private developers and investors. The labour market figures from the ninth five-year development plan suggest that not all the new employment opportunities being created are blue collar or low-income jobs. While 17.4% of jobs in 2008 were filled by those who do not possess educational qualifications, 26.4% of Saudi employment is taken by nationals with at least a university degree. Furthermore, 30.6% of all employment opportunities were for clerical positions. This certainly suggests that there are enough workers in the labour force with sufficiently high levels of income to excite the interest of private sector developers.

Young Middle Class

Indeed, many developers and investors point to the emerging young middle class demographic as a source of robust demand for housing. According to Al Samhan, “When young Saudis enter the labour market, there is demand for new residential units, particularly for small families. We see demand for residential units at all levels, but there is a particular demand for small units, either apartments, townhouses or small villas.”

Indeed, Saudis under the age of 30 make up approximately 60% of the population, according to Global Investment House. This is not only creating demand pressure through the number of people entering the housing market, but also because the characteristics of required housing are changing. As the average household size falls, for example (from 6.08 persons per unit in 2000 to 5.84 persons per unit in 2010, according to National Commercial Bank), the demand on housing stock changes and the number of units needed increases exponentially. This change in the market has certainly not escaped the attention of private sector developers.

Rafal, for example, has been looking to cater to this new urban lifestyle in the capital, Riyadh. Moving away from low-density, stand-alone villa living, the company has put an emphasis on building communities for the middle class. This includes Burj Rafal, a new high-rise residential development, a concept that is well established in many markets but remains novel in Saudi Arabia. Rafal is predominantly focusing on the upper-middle-income segment, and for all its developments it is targeting customers with a starting monthly salary of SR15,000 ($4000). According to Bakeer, this will include doctors, engineers, executives and managers.

Developers such as Bakeer seem confident that this model can be expanded within Riyadh as well as to other cities, such as Jeddah. However, in the longer term the target segment itself needs to expand for there to be further growth in the real estate industry, thereby providing modern accommodation to a wider proportion of the population and offering strong investment opportunities within the country. Indeed, according to a 2010 study by Ergo, a US-based intelligence and advisory company, 70% of Saudis do not own their own homes, a rate significantly above most developed markets. The primary reason for this is the disparity between income levels and residential real estate prices. The middle class accounts for only around 30% of the workforce, according to a recent study by GOSI, a figure that will hopefully pick up over the coming years, bolstering income levels.

The Question Of Cost

Although a recent survey by Booz & Co, a global management and strategy consulting firm, found that the Saudi middle class only spends 11% of monthly household income on housing or rent, most families cannot afford to purchase property. Indeed, developers such as Rafal remain highly dependent on cash purchases. According to their data, for the Al Rabia project, a 120, 000-sq-metre gated community, which was 73.5% sold by September 2012, 92% of transactions were from cash buyers. For this development, Rafal is targeting prospective buyers with monthly earnings of SR23,000 ($6130) and above. While the uptake and the price trend (units at Al Rabia start from SR1.5m, or $400,000) suggest that there is significant demand for such developments, the effective demand, compared to overall need for housing in the country, is limited by the disparity between the cost of delivering units and the average income of Saudis.

Credit Where It Is Due

As such, many developers and analysts within the Kingdom are looking hopefully towards the development of a more wideranging housing credit market. According to global real estate services firm CB Richard Ellis, less than 1% of all homes in the country are funded by mortgages, while mortgage debt accounts for just 2% of GDP, compared to 15% in the UAE and more than 70% in the US. This has certainly had its upside. Al Samhan suggests that this trend has made real estate investment stable and reliable, insulating the market from bad debt. “Other countries depend 100% on financing. Here they depend on financial resources, not reliant on the financial or credit markets,” he said.

Mortgage Law

Nonetheless, without the expansion of the mortgage market, Saudi Arabia’s real estate sector is unlikely to fulfil its potential, and private participation in bridging the housing gap will be limited. It has come as good news, therefore, that the government announced in July 2012 that it has passed the country’s first mortgage law. This should encourage banks and home financing companies to expand their mortgage operations as the law should allay residual concerns over default procedures and their legal standing with regards to foreclosure.

In September 2012 Al Samhan said that the full impact of this regulation had yet to be felt. “The mortgage market has still not taken off because details have not yet been issued,” he said. “From our point of view, it will not change many facts about demand. Unless the average wage increases tremendously, there will not be many changes, even with the mortgage system.” However, the government announcement was greeted with substantial enthusiasm within the industry. On the news that the announcement was about to break, the Tadawul Real Estate Development Industries Index rose 5.5%, with major developers like Dar Al Arkan, Saudi Real Estate Company and Emaar Economic City all experiencing a significant immediate leap in their share prices.

The law is likely to expedite growth of the nascent mortgage lending market. For example, in the second quarter of 2012, perhaps in expectation of the law, mortgage lending shot up by 83% to SR48bn ($12.8bn) compared to the same period of 2011, according to the central bank. This is the highest lending level on record, with growth rates well above neighbouring countries. In an interview with Bloomberg, Naveed Siddiqui, CEO of Capitas Group International, a Saudi Islamic finance firm, estimated that the mortgage market should steadily increase to an annual value of $32bn over the next decade.

According to Yasser Abu Ateek, CEO of Dar Al Tamleek, a home financing firm, the mortgage segment is a profitable one for lenders. “Mortgage lending is bolstered by a very advanced credit bureau. Non-performing loans have not exceeded 0.5% over the past decade. This is a minimum risk, highly lucrative sector. It is no wonder that the banks are becoming increasingly focused on this market,” he told OBG.

A Helping Hand

The growth in mortgage lending among banking institutions and dedicated commercial home loan companies should support efforts already under way in the market. Indeed, since 2007 Saudi Home Loans Company, an initiative by the International Finance Corporation, the Arab National Bank, Dar Al Arkan Real Estate Development and Kingdom Installment Company, has been offering ijara (Islamic home financing) products with 100% financing for 30 years on loans up to SR2m ($533,000). According to the company, which has a paid-up capital of $533m, it will finance 15,000 homes for middle-income families by 2020.

Such moves should help to both stimulate demand for residential property and allow developers to expand their target market, penetrating further into the middle- and lower-income segments. Bakeer thinks this can only be good news for both developers and customers. “It will be positive for everyone. It will increase demand and it will also increase supply. It will have an impact on the middle and upper-middle segment of the market in terms of affordability and securing the market.”

However, this could be a longer-term process. An October 2012 economic review from National Commercial Bank stated that, “We do not expect the supply-demand imbalance of the housing market to significantly change in the short term, even after the passing of the mortgage law. The impact of the mortgage law will take time. Banks and non-bank players will need some time to test the robustness of the law. In addition to limited availability of financing, another real constraint has been affordability.”

Supply-Demand Imbalance

Currently, there is an evident imbalance in supply and demand. This is having a consequent impact on both sales and rental pricing. In its April 2012 GCC real estate report, Global Investment House stated that, “Our view is that Saudi Arabia enjoys more solid fundamental prospects for growth in the real estate sector than do the UAE and Kuwait. Prices of land and ready units as well as rents have seen significant increases in 2011, with rental yields in Jeddah and Riyadh now among the highest in the world.”

Sales Prices

According to Global Investment House calculations, average villa and apartment prices increased by 8-10% in 2011 in Riyadh and by 13-15% in Jeddah. In the capital, average villa prices had hit SR3130 ($834) per sq metre, while average apartment prices had reached SR2490 ($664) per sq metre. In the commercial and port city of Jeddah, prices were even higher, with villas selling for an average of SR4070 ($1085) per sq metre and apartments reaching SR2660 ($709). While Global Investment House estimates seem to be slightly on the high side, they are broadly in line with the estimates of other research firms. According to Colliers International GCC, villa prices in Jeddah rose by 15% to SR3980 per sq metre ($1060) in 2011, while apartment prices increased by 14% to SR2450 ($653). In Riyadh, villas and apartment sales prices displayed an annual increase of 9% and 8%, respectively, to SR3150 ($840) and SR2860 ($762) per sq metre. Into 2012, sales prices were up further in Jeddah, reaching an average of SR3820 ($1020) for apartments and SR4500 ($1200) for villas in the third quarter, according to Jones Lang LaSalle. In Riyadh sales prices rose 7% for villas to reach an average of SR4112 ($1095) per sq metre in the third quarter, while those for flats were up 3% to SR2729 ($727).

Rentals

However, given that the rental segment accounts for 70% of the residential market, much of the demand and price pressure is most evident here. According to Jones Lang LaSalle, prices continued to increase into 2012 as well. In Jeddah, rental prices for apartments were up 19% from third-quarter 2011 to third-quarter 2012. In Riyadh, villa rental prices were up 6% in third-quarter 2012 over the same period the previous year. Al Samhan told OBG that for properties managed by GOSI, annual rents start from SR25,000 ($6660) for low-income tenants and go up to SR100,000 ($26,650) and above.

Such figures suggest that investors can get very handy returns from rental yields. Indeed, Global Investment House ranks Jeddah and Riyadh second and third, respectively, in terms of global gross rental yields. Only Jakarta in Indonesia offers a better bet for regular rental income. Colliers estimates that rental yields for villas in the capital ticked upwards to 8.4% in 2011 from 7.9% in 2010, while two-bedroom apartments saw yields increase to 7.8% from 7.4%. Given the low interest rates in the country and continued instability in the equities market, real estate continues to be seen as a strong investment. Al Samhan believes that the residential real estate segment offers investors strong and stable returns. “We assume there are good opportunities for housing units. Across the board, we are looking for returns in the range of 5-7%. Real estate is still safe. It could save your money from inflation at least.”

Leasing & Buy-To-Let

While capital appreciation has been strong, it is perhaps the steady income from rental yields that makes the market most attractive. As such, several developers in the market have been looking to hold onto units for leasing. For example, at the King Abdullah Financial District, owned by the Public Pension Agency, much of the residential component will be retained for leasing. Bakeer also believes that their properties offer strong prospects for buy-to-lease, particularly in the high-rise Burj Rafal. “It is a good investment for rent. Prospective tenants are those who inhabit the residential compounds in Riyadh, particularly those at the executive level. Burj Rafal is the first vertical residential compound in Riyadh. There could be a rental premium here.” Internal research by the company has found that of those buying for investment purposes, the vast majority (89%) is buying for lease purposes and a regular income stream, rather than for resale (11%).This suggests that there are significant opportunities in the buy-to-lease market. However, in the low- to middle-income range, rental inflation presents a significant challenge for the government.

Affordability

Housing affordability is a key concern and the government has been looking into measures to address this. According to a report by Arab News in March 2012, the Ministry of Housing is looking to implement a system that will limit residential rents. This will include providing subsidies to investors and developers building low-income housing, as well as grants to government employees to pay a percentage of their rent. Government departments will also be empowered to provide employees with certificates that will demonstrate to landlords the leasee’s ability to cover rental costs.

Since the introduction of the Ministry of Housing in early 2011, the government has been looking at a number of measures to deal with the shortfall in housing. For example, it has allocated SR250bn ($66.6bn) for the construction of 500,000 new units in the coming years. A spate of reports in the third quarter of 2012 all said that the ministry is expected to break ground on the project soon. The government has also introduced a number of other measures to support the supply of housing. As part of a stimulus package unveiled in the first half of 2011, the government increased funding to the Real Estate Development Fund (REDF) by SR40bn ($10.7bn), allowing the fund to increase its maximum loan size from SR300,000 ($80,000) to SR500,000 ($133,250). The fund also dropped the stipulation that loan applicants must own a plot of land in order to apply. A report by Saudi Gazette in July 2011 found that 3.5m Saudis had applied for a loan since the change in regulations. The REDF continues to play a crucial role in financing for lower-income nationals. In April 2012 it was announced that the REDF had approved a further SR5.9bn ($1.6bn) worth of loans to build 14,462 housing units, the second batch of loans approved under the 2012 budget.

State-Backed Housing Drive

In addition to these measures, there are several state agencies and state-backed projects that will bring a huge number of residential units to the market over the coming decade, catering to a range of income levels. In August 2012, for example, the Saudi Pension Fund announced plans for a large-scale project north of Jeddah that will cater to middle- and upper-middle-income families. The project will consist of 10,000 apartments as well as residential villas. Built in two phases over the next 10 years, the project will span 2.6m sq metres and consist of 10 housing districts. It will also include parking areas, hospitals, hotels, schools, mosques, parks and social amenities.

The Pension Fund believes the project will offer a steady return on investment, as well as provide much-needed housing in the Jeddah area. The development may be ambitious, but it pales in comparison to the four economic cities. According to the Saudi Arabian General Investment Authority (SAGIA), these developments, all of which are now under construction, could house and employ up to 5m people. The cities, the King Abdullah Economic City, Prince Abdulaziz bin Mousaed City, Knowledge Economic City and Jazan Economic City, are expected to cost $60bn and contribute as much as $150bn to GDP. Chief among these is the King Abdullah Economic City, located at the commercial nexus of Jeddah, Medina and Makkah. The $27bn development is being billed by SAGIA as a city the same size as Washington DC. It is expected to focus on ports, logistics and light industry and will house up to 2m people.

Striking A Balance

The question for the real estate sector is what this will do to the balance between supply and demand. The addition of residential units for up to 5m people might suggest that the country will shift from a position of undersupply to one of oversupply, given that the housing deficit has been estimated at 1m units. However, with infrastructure in the cities not expected to be complete until 2025, population and economic growth should continue to push demand upwards. Whether it will be enough to absorb this supply has yet to be determined, but these planned developments will undoubtedly offer investment opportunities and possibilities for private developers. The challenge will be to avoid the pitfalls of speculation and oversupply that have hit neighbouring states.

Outlook

Government attempts to energise the mortgage market with a new law offering legal guarantees and recourse for lenders should help in this process. With greater confidence in foreclosure procedures, banks are more likely to support the sector, enabling the lower-middle-income segment to entertain the prospect of homeownership. This, in turn, should offer opportunities for developers to widen their net, expanding demand and helping the government to meet the housing shortfall. If the mortgage law has the impact that initial trends suggest, and the homeownership market expands, the Kingdom will go along way towards fulfilling its potential as the region’s standout real estate market.