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Investment and Development in Saudi Arabia

14 Jun 2009

Interview with John Harris, Country Head, Jones Lang LaSalle

The Saudi economy and in particular the Saudi real estate market has shown itself to be quite resilient. There was a noticeable lull or a chill in the market last year after the Lehman collapse and that lasted right through until the second Eid at the end of last year. Now in 2009 we’re seeing quite a bit of activity and confidence returning to the market. The banking system proved itself to be quite robust and solid. The Saudi Arabia Monetary Agency limits bank lending to 90% of deposits and they had minimal exposure to toxic assets in the West, so the banking system was completely solid. In addition, the exposure of the Saudi consumer was low. Generally people didn’t have exposure to property markets and to debt in the same way that they have in the West. So both on an institutional level and on a personal level, people woke up this year and realised they were fine and that the system was still working.

On the banking side, there was a point at the end of last year where the Saudi banking ratios were at that 90% ratio and they didn’t have that much capacity to lend. But what has happened is the Saudi Arabia Monetary Agency has engineered big drops in interest rates, increased liquidity and placed deposits with the banks so that now those ratios are on their way down to 80% and the banks will have capacity to lend. They have also increased government spending by 15% in this year’s budget - this year they are running a small deficit so there is fiscal stimulus and monetary stimulus. The key message is that the system was in pretty good shape compared to some of our neighbours or back in the west so it didn’t need drastic bailouts.

In which areas is the Government investing?

It is investing into infrastructure, education and they are accelerating their programme to develop new universities and women’s universities. They are putting a lot of money into building schools as part of this year’s budget and announced a totalof 1,500. There is also a lot of very interesting investment happening around power, water, airports and rail projects. The challenge that they have had is that the long term debt markets globally have seized up so they have had to take back control of some that were to be developed by private consortiums. They will now favour EPC contracts to develop these long term infrastructure projects.

Are they developing more affordable housing?

There are some direct initiatives such as the Saudi Development Fund which makes funds available for Saudis to build their own houses. They are really encouraging the private sector to get on with it; because land prices have come off by up to 20% since the peak in 2008, and because the cost of construction materials have come down by at least that much as well, the expectation is it should be good for the provision of affordable housing. There have also been a lot of announcements by developers with schemes targeting what they call the mid market; houses or apartments that are in the SR500,000 – 800,000 range.  Back when land and materials were expensive in the environment of 2007 and 2008, there were far more announcements of prestigious projects but now we are seeing developers announce projects more geared to the mid market.

Is there a rental market and will the new mortgage law have an impact on this?

Rental housing accounts for up to half of the residential units.  Certainly there are many renters who would prefer to own if they had the right mechanism.  The availability of home finance is still quite limited and that is why there is a lot of discussion about this proposed mortgage law. This will facilitate registration of interests and outline the process for repossession and security.  The legislation is also being drafted to ensure it is compliant with Sharia law, which will be very important to the local market.  It is waiting for its final approval and it is not yet clear when that is going to happen but maybe the next six to 12 months. This passage of this legislation will enable much needed supply of new homes.

Another important new set of laws will regulate developers of housing.  The new rules require developers to be registered with the Ministry of Commerce and create escrow accounts for off-plan sales.  This will prevent developers taking payments for one project and then funding another. While the paperwork is going to be awkward for some developers to comply with, it should increase homebuyer confidence and encourage more off plan purchases, which have not really been a big part of the housing market in Saudi Arabia.

The traditional approach here is that land developers put in streets and services and let people purchase their plots and put up their own houses. You may get someone who buys a handful of plots, puts houses up and then sells them.  But there are only a few housing developers who have been building communities like Dar al Arkan or Rafal.  That is something that needs to develop because the grassroots approach just can't keep pace with the growth of the country.

To what extent can foreign firms become involved in Saudi Arabian development?

There is a lot of discussion now among various landowners and developers either looking to build up the skill sets to start developing housing, particularly affordable housing, or alternatively looking at joint venturing with foreign companies which have development expertise.  There are opportunities here and the local developers are open to partnering which is all very good, but the taste and culture in Saudi Arabia is different, so the Dubai model isn’t going to work. You have to know what sells.

What changes have been made to encourage foreign investment?

There have definitely been some improvements. It is now possible for foreigners to get a licence to purchase and develop property in Saudi Arabia but the law states the land has to be worth more than SR30m and you need to have it developed and sold within five years. It precludes foreigners from buying a house or any other purchase which would need to be authorised by licence from the Ministry of Commerce.  What they don’t allow is foreigners to come in and invest in income properties, so if you wanted to buy a shopping centre and hold onto it for ten years, you are not allowed to do that.

What else could change? 

Offering non-recourse debt for property would make the market easier to access for new players, but then the banks might have to put more 'diligence' into their due diligence on assets if they can't go after the parent company.  I think they need to come up with a way of establishing a framework at the developer level to encourage the provision of more affordable housing, rather than just providing subsidies to individuals who need money to buy housing.  

What is the demand for office and retail space?

It is a growing country and the cities are growing very rapidly with neighbourhoods cropping up every year which need retail facilities and shopping centres. The problem with shopping centres is that there has been quite a bit of supply and the market is now at a stage where it is still digesting some of these. Management teams are working now on making them more successful. There is demand for it but the supply of brands is controlled by perhaps four groups which might control several chains. They are both tenants and developers so it can get complicated and is a bit of an unusual market.

On the office side, demand here is not going to be as explosive as it would be in a place like Dubai which experienced huge numbers of professional immigration during the boom years.  Certainly in Saudi Arabia the number of white collar employees is going up. Demand here is much more domestic, the multinational occupiers represent no more than a third of the market, which is quite different to Dubai. There is a very strong government demand for offices in Riyadh and a lot of Saudi companies like to own their own buildings. We have got some very exciting projects coming which will give occupiers a better grade of office space. At the moment it is very basic with the exception of something like the Kingdom Tower. We’re seeing some great new schemes such as the King Abdullah Financial District and the ITTC campus which are going to offer state of the art facilities to companies.

How is the development of the Economic Cities progressing?

They are still progressing but have had to cope with the fact that this is less funding available than there used to be and that user demand is also reduced.  If you go up to the King Abdullah Economic City, you’ll be impressed by the five class A office buildings, a variety of attractive waterfront residential buildings and the site for a new resort that will be launched soon. There is still some of the infrastructure that needs to go in, such as the station for the Mecca-Medina high speed train service, which will also link to the Jeddah airport – that won't be there for another few years.  The KAEC will receive a real boost when the port is operational, which will enable all their plans for logistics and industrial development.  There will probably be businesses up there in the next year.

Knowledge Economic City in Medina is progressing well.  This project has the advantage of a manageable scale and a site that sits comfortably beside an existing city.  I understand they have signed agreements for six new schools and educational institutions which will act as a catalyst.  We understand they will be going for an IPO sometime in the next six months.

There has been a lot of discussion at the moment whether the economic city model needs to be changed or adjusted in order to accelerate the progress as the economic cities are not advancing as fast as had been envisaged. Does the government need to take any action to accelerate the construction of these economic cities?

Is there investment in Religious Tourism?

Yes, there is a lot of investment going into the Holy Cities and into the related transportation infrastructure. They are also increasing the quality and amount of housing and accommodation that is available. We’re very busy at the moment in Mecca and are working on three projects that are being built in and around the Mosque. There is quite a bit of adjustment, regeneration of existing neighbourhoods and new buildings going in. In terms of infrastructure, they are building the Mecca - Medina high speed rail which will also go through Jeddah airport and the King Abdullah Economic City before heading up to Medina. GACA and aeroports de Paris International are investing in a new terminal at Jeddah airport which will increase the capacity of the airport which along with the rail and the road connections will facilitate more tourism. They are also increasing the number of visas they grant to pilgrims.

What are the challenges and opportunities for Saudi Arabia?

The big opportunity remains housing and particularly affordable housing.  There are a lot of foreign investors looking at getting involved in this market. There are also a lot of funds being formed in Gulf countries and in Saudi Arabia; they are all establishing joint ventures with local developers but I think more construction and development expertise is going to be needed to enable these funds to develop housing with this these investments. 

There is a big opportunity to develop business parks and business campuses. A lot of the office sector development has traditionally been conventionalaverage quality office buildings in urban type settings and I think tenants are keen to move to more peripheral locations with more campus style settings like in Cairo's Smart Village or Dubai Internet City.

All the investment in transportation infrastructure should enable the development of the logistics sector. Most of the warehouses here pretty basic but I think there will be requirements to develop warehouses that incorporate all of the design innovations and technology that we have seen in the West and parts of Asia.  Apart from the affordable category, the population of expatriates is increasing quite rapidly, particularly expatriate professionals, so there is a real shortage in this area.  Deand drivers on the hotel side look good:  More foreign companies are setting up in KSA so you have more business tourism, and there is still a lot of opportunity there in addition to the religious tourism.

Is government infrastructure spending still going ahead?

Yes, the government budget is pretty solid. The only question mark in Saudi Arabia is not about funding, it is more about when and how long will it take to happen. With the King Abdullah Economic City and King Abdullah Financial District, I think there is frustration that these things have not materialised more quickly. Execution is the big challenge in Saudi Arabia whether it is the infrastructure projects or development of houses or business parks; they often take longer than announced. 

To what extent is environmental sustainability a consideration?

It is starting to be an issue – I met one of the members of the founding committee of the Saudi Green Business Council, so there is a new non-governmental organisation working with the private and public sector. They are just getting started and having discussions on what regulations would be appropriate. Some developers are leading the way this issue.  For instance, in the King Abdullah Financial District the PPA have mandated that the design of the buildings should be LEED certifiable.

Cityscape Intelligence Focus on Saudi Arabia June 2009 PDF

Source: Cityscape Intelligence