Reforms Amplify Uncertainty in Saudi Arabia’s Real Estate Sector
Bonds & Loans
Published: 14 June 2018 03:30
Saudi Arabia’s grand ambitions to create new large-scale residential, industrial, “shoppertainment” and other mixed-use developments could be a boon for the country’s – indeed the region’s – real estate developers, investors and financiers. But the sector’s potential has never looked so mixed.
The Saudi Arabian property market has undergone tremendous change over the past two years as the region’s largest oil producer was forced to adjust to larger deficits by curbing spending and raising taxes, which weighed on consumer sentiment and salaries alike. Rents on residential and commercial space have largely remained flat since 2016 in the country’s largest cities, while the volume and pace of transactions came under pressure in 2017, according to Knight Frank, a global estate agency.
The residential sector remained fairly unpredictable in 2017, with rents in some parts of the country – like mid-tier residential in Riyadh – jumping by high double digits, and others – like high-end villas – dropping by near equal amounts.
“Economic uncertainties continued to weigh on occupier expansion plans in 2017. This is particularly true in Riyadh where government entities remain a key occupier of office space,” explained Raya Majdalani, one of the firm’s research managers, in a recent report.
“This lacklustre performance could be mainly attributed to tightening market liquidity triggered by the fall in oil prices. This is further exacerbated by a combination of more inherent factors, namely the lack of affordability and limited access to finance, a supply shortage in the mid-to-lower end of the market, as well as the lack of suitability of the existing stock of residential units.”
But despite those cuts and a flatlining real estate market, the government is pushing ahead with significant new initiatives in the sector – under its flagship Vision 2030 and National Transformation Plan – as part of its wider USD19bn bid to stimulate the non-oil segments of the economy.
Its objectives, which are anything but modest, include increasing the percentage of the real estate sector’s contribution to GDP from 5% to 10% by 2020 (the regional benchmark is 13%, and internationally, 20%); increasing the annual growth rate in the real estate sector from 4% to 7% by 2020 (regional benchmark of 6%; internationally, 11%); reducing the average waiting period for citizens to obtain housing financing from 15 years to 5 by 2020 target; and increasing the household ownership ratio from 47% to 70% by 2030.
To complement new funding and help increase home ownership, the Saudi government converted its state-owned housing fund into a domestic lender, the Real Estate Development Fund (REDF), tasked with offering cost-competitive mortgage financing solutions for residents in conjunction with the private sector.
The fund previously offered interest-free loans for buyers of new property developments, but its mandate has since expanded to include existing properties; it is now tasked with cultivating a vibrant secondary mortgage market by aggregating and packaging portfolios of mortgages than can then be sold off as mortgage-backed securities to mainstream domestic and international investors. This is line with the Kingdom’s bid to boost the size of the mortgage market to more than SAR502bn (approx. USD133bn) by 2020, up from roughly SAR270bn currently. Analysts say this is optimistic, but not wholly unachievable.
“The key driver for the sector at the moment is the Vision 2030 and the [National Transformation Plan] 2020,” explains Ibrahim Al Buloushi, Country Head for Saudi Arabia at JLL MENA and member of the Housing Committee in JCCI, a group mostly composed of experts from the Ministry of Housing and Municipal, Rural Affairs, Ministry of Commerce, Justice, and the National Guard. The Committee is tasked with enhancing relations between real estate developers and the government, and helping to provide affordable housing in Jeddah.
“The KSA government has taken many steps in the right direction and I am positive about the achievability of their objectives,” he added.
Grand Ambitions, Equally-Sized Challenges
Indeed, the pace at which the government is moving on the affordable housing portfolio is as impressive as it is ambitious. In conjunction with the National Housing Company, effectively the Ministry of Housing’s investment arm, REDF has already launched five housing programmes this year and allocated more than 105,000 residential and financial products during the first five months of 2018, with a target of 300,000 by the year’s end.
In early May, the Ministry of Housing and REDF announced a further 8,000 units would be developed in Makkah and Eastern Province, with a further 5,100 units to be developed on plots in Riyadh, Qassim, the Eastern Province, Asir, the northern border region and Al-Jawf.
But reforming a sector rife with inefficiencies won’t be easy. The average time required to approve and license new residential real estate development projects is currently about 730 days – an eternity by most standards.
How the government plans to hit its target of 60 days by 2020 and simplify the legal and procedural structures surrounding the approval process, without significantly adding headcount at the Ministry of Housing, is somewhat of a mystery. And, if those efficiencies were to be achieved, dealing with the rapid acceleration in occupancy that would result from them would be difficult.
“Renting the three million square meters of built-up areas at reasonable prices, or even achieving decent occupancy rates, will be very challenging indeed,” Al Buloushi said. Prices are set to rise as new commercial and residential property sales are now subject to the 5% VAT, which came into force 1 January 2018 (residential rents are exempt, as are purchases for first time homebuyers up to a purchase value of SAR850,000).
One way to achieve this, says Nawaf Saymeh, Director of Advisory Services and Capital Markets at Colliers International KSA, is to transform monotype real estate into more mixed-use developments, enhancing their appeal to a broader swathe of real estate buyers and boosting local businesses at the same time. Vision 2030 aims to repurpose some of the built-up areas and changes the real estate mix, increasing the allocation for residential accommodation, services and hospitality areas.
Another is to provide buyside stimulus. In February this year, the government announced a plan to pump USD32bn into subsidising home mortgage loans, including a USD6.3bn loan guarantee programme, through 2030.
Housing Minister and REDF chairman Majed Al Hogail says the move will help boost occupancy and reduce a rapid accumulation of private sector risk in the residential real estate sector, but analysts say close monitoring of the programme will be key if a bubble is to be avoided. Real estate financing as a percentage of GDP is just 5% of Saudi Arabia, compared with 69% in the United States and 74% of the United Kingdom, so there is considerable room to grow.
Sentiment on the ground is that the reforms are working, and the latest data coming out of the Kingdom is starting to back up that perception. Real estate loans increased 5.7% during the first quarter of 2018 according to SAMA, as did private sector lending on aggregate (0.7%), a sign that the reforms may be starting to take hold and confidence beginning to return.
REDF’s recently anounced plans to support fixed-rate long-term mortgages later this year – a welcome shift from the variable-rate loans that currently dominate the segment – will also help insulate borrowers from the challenges of living in a currency-pegged environment with rising interest rates and boost home loans in the Kingdom.
Projects on the Table, but Will Money Follow?
The government is also supporting a number of large real estate PPPs and mega projects which are poised to create additional residential and commercial supply. These include Neom, a USD500bn 26,500km2 “transnational” city that along the Gulf of Aqaba and the Red Sea that extends across the borders to Jordan and Egypt, which is pegged to become the Kingdom’s high-tech hub, and Qiddya, an USD8bn 334km2 entertainment complex said to dwarf Disney World by a factor of three, and a 34,000km2 luxury tourism development along the Red Sea between Umluf and Al Wajh, two cities in the north of the Kingdom.
Finally, there is the King Abdullah Financial District, a new development under construction near King Fahad Road in the Al Aqeeq area of Riyadh, which is more than just a supersized version of the Dubai International Financial Centre. Upon completion, the 17.2 million square foot development, originally conceived over a decade ago, will include more than 60 towers of residential, retail and commercial space; have its own monorail; and house up to 50,000 residents.
Most of these and other real estate projects are being funded by local banks. The Saudi sovereign wealth fund, Public Investment Fund (PIF), is supporting these projects – but international liquidity on an almost unparalleled scale will be required to bring them to fruition. That in itself will be a huge challenge for a number of reasons, according to bankers, despite the growing chorus of banks securing investment banking licenses in the Kingdom.
“There is a fairly well-established track record for foreign direct investment in Saudi Arabia and international lending in the country has picked up significantly in recent years, but the amounts we are talking about here are just eye watering,” one UAE-based banker explained. “Is there a big enough market to attract hundreds of billions from foreign investors and banks in five years? That isn’t clear.”
“The other problem is that save for one or two large-scale developers known outside the Kingdom, many don’t actually have international exposure from a banking perspective, which could be an uphill battle for many of these companies, and challenging for us from a KYC perspective.”
Developers are finding other ways of tapping into both domestic and international liquidity. Listed real estate investment trusts (REITs), a relatively new asset class for the Kingdom, are starting to gain more traction with investors. Eight REITs were listed on the Tadawul, Saudi Arabia’s largest stock exchange, in 2017. That number is set to rise – but analysts say only if they are underpinned by high-quality assets.
There is little doubt the debt markets are to play a growing role in funding these and other ambitious real estate projects – but again, the bond market will only be able to absorb so much, particularly if both the sovereign and real estate developers start turning to international investors to essentially fund the same projects. Some believe sukuk, which is structurally well-suited to the real estate sector and ethically aligned with the Kingdom’s religious base, could be the answer.
“There is huge appetite for Saudi risk, and real estate is particularly appealing because there are tangible assets in play – so there is breadth in terms of the types of instruments that could play a meaningful role in financing these projects. There is also potentially huge upside, given the relatively low exposure of international banks to the sector,” the banker added.
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