Saudi's day in the sun

With high oil prices and $150bn earmarked for development in the nation, the future is bright for the KSA.
Saudi's day in the sun
By Amy Glass
Tue 04 Sep 2007 04:00 AM

Like any society that experiences weakness in the financial market, there is perception of safety in real estate.

This is certainly true for the Kingdom of Saudi Arabia, as many large investors unwind stock positions and move into real estate, following the abrupt end to a spectacular stock market growth story in February 2006.

The Saudi government is proposing mortgage legislation, with mortgage institutions currently discussing the establishment of a housing lending market.

The Saudi stock market peaked at its all-time high of 21,000 on February 26, only to deflate in excess of 50% throughout the remainder of 2006.

However, the Kingdom has scarcely looked back from the massive correction and now tells a story of high oil prices, resurgent government expenditure and the beginning of various mega economic projects.

The Kingdom's population of more than 20 million is the largest in the Gulf and demand for housing exceeds supply, with more than 70% of the Saudi population aged below 30.

This situation is changing fast with 50 companies licenced to sell and develop real estate in the Kingdom last year. This fast expansion, added by a resurgent private sector, has lead to a growth explosion within the building materials industry. Cement production is expected to double to more than 90 million tonnes a year by 2010.

While existing KSA cities and communities are seeing major developments, there is also an intense focus on the US$150bn government-sponsored investment committed to new cities to be built around the economic projects.

All of these economic cities will feature major residential and commercial real estate developments. Approximately 1.5 million people are expected to move to the new cities in the medium term and three times as many by 2020.

Saudi Arabia-based economist Mohamed Ramady expects the Saudi government to close 2007 with a surplus current account balance of US$55bn, government revenues of US$155bn and foreign reserve of US$320bn.

The existing domestic debt will continue to be reduced to approximately 24% of GDP, compared with nearly 94% levels in 2002, Ramady believes.

"Following the stock market falls, the Saudi stock market is now characterised by modest daily swings. An upper and lower Tadawul trading index seemed to have been established for the time being of 8,100 on the upper range and 7,100 on the lower range. The recent partial flotation of Kingdom Holding shares is illustrative of the new mood of cautious trading, with the new shares rising nearly 20% on the first day but falling back to the next day to a 4% decline. In the old days, the share price would have continued to rise, driven by speculative pressures but today the mood is one of short-term gains and taking a run."

Ramady conceded this market behaviour is unhealthy for long-term capital market developments, but was to be expected from nervous investors who had lost lifelong savings when the market fell in 2006.

The real estate bubble that formed following the equity market crash has been uneven in the country, according to Ramady.

"The sharpest price rises are concentrated in potential economic and mega city zones and prime residential areas. However, the Saudi government is encouraging an expanded private sector home ownership, especially for its young population and will not wish to see land prices go beyond the means of this section of society."

The Saudi government is proposing mortgage legislation, with mortgage institutions currently discussing the establishment of a housing lending market.

Ramady believes the mortgage market will open up an avenue for the private home ownership sector, but said it will be politically explosive if repossessions take place due to non-payment and defaults.

"The mortgage institutions that are being discussed now are aware of this and are walking a tightrope between protecting their lending and yet being seen to be socially responsible.

"What will emerge is a compromise on longer-term borrowing and fixed rates with some form of government safety repayment net," he adds.

Ramady believes Saudi's pace of development and structural reform is proceeding faster, with the Kingdom's accession to the WTO in 2005 accelerating judicial reforms in terms of clearer arbitration rules and encouraging foreign investment.

"The private sector is diversifying and some are beginning to take opportunities within overseas markets and investment potential for Saudi capital, but the economy is still hydrocarbon-reliant in the near future.

The attention to the small and medium-sized enterprises sector and the emergence of potential economic clusters of higher quality industries are certainly creating some high-value employment opportunities.

"What is more encouraging in the short-term is the growth and diversity in the Saudi financial markets with the opening up of the Sukuk Islamic leasing, insurance and potential mortgage sector. This sector is fast evolving into a major contributor to the Saudi economy with nearly 80 financial services companies currently operating compared with about 12 in 2004.

"The Kingdom has strong economic and political ties with the US, with the western superpower positioned as Saudi's premier trading partner. However, the US has seen its total market share eroded by new entrants such as China and India as Saudi Arabia diversifies into other regions," he adds.

The Far East is one notable example of this diversification, as Saudi's petrochemical and oil products obtain premium prices compared with the US or Europe.

"The Saudis are uncomfortable seeing oil prices rise too high and worry about a recession in the consuming countries. If this starts with the US, it could then have a knock-on effect on other trading nations. At the same time the possibility of diversification away from the dollar might take place if the unified Gulf currency takes off. But for the time being the Kingdom will not take any abrupt actions to jeopardise their US economic relations."
The Saudi government could become concerned by further tightening in US interest rates, leading to commensurate rises in Saudi Riyal domestic rates, Ramady believes.

"This would cause domestic inflation to rise further. The government could counteract this by pumping more liquidity in the domestic economy, or allow the spread between the two currencies to narrow through swap actions with local banks. With inflation still comfortably lower than some other Gulf countries, even this is not a major concern for US-Saudi economic relations."

We believe by officially introducing all-new laws and regulations, this will support the developers and secure the buyer’s rights and result in a huge boom in the industry.

Hyder Ali, head of project sales and marketing at Better Homes KSA, said major local, GCC and international investors and developers are looking seriously to enter the rapidly developing Saudi property markets.

"These investors are especially looking at the residential sector of the market as the demand is growing and the markets are in the forming stage. Facilities such as mortgages and laws allowing non-Saudi property ownership are being introduced and these will further ignite the boom."

Alongside the advantage to developers from project finance, rates per square metre across all sectors are considerably low compared to the rest of the region, and the largest population within the region by far is Saudi Arabia.

Ali believes the markets are only weakened by the issue of being in their initial stages.

"Because markets are still forming, this means things are not clear to buyers or investors or to developers. We believe by officially introducing all-new laws and regulations, this will support the developers and secure the buyer's rights and result in a huge boom in the industry."

He described the unofficial Saudi mortgage system as an ‘industry dream' for Saudi real estate representatives.

"However, it is a new and major step which all providers are cautiously stepping into, and taking consideration that the laws and regulations are not yet officially enforced by the government.

Ali predicts Saudi sales transactions for residential units at first stage will increase by at least 10 times the existing sales figures, which will in turn push the real estate cycle.

"This push will create larger developments and competition to improve service and quality for the benefit of the end user."

Better Homes KSA is currently working on several projects in the Saudi western region, which include commercial retail projects, office towers, residential villas, commercial plots and land projects.

Ali said these projects were located in the western region due its stronger infrastructure and modern population.

"The movement of the city has been growing northwest since early the early 1950s, and all new developments are in that zone. We are developing short-term rentals since the tourism industry is expanding and growing in the western KSA region."

The company has undertaken the largest gated resort city within the KSA, the Durrat Al Arus which covers a total area of six million sq m, he added.

Better Homes KSA has also acquired five major project contracts within the city of Jeddah, including the Jeddah Yacht Club, Commercial AAA boutiques, ENMA Towers, Al Brooj New Residential Communities and the Durrat Al Arus Beach Resort City.

Ahmed Linjawy, executive director, external relations, Emaar the Economic City, said a significant percentage of the KSA's total population currently live in rented units.

"This proves the demand for home ownership, which will become a viable option through financial mortgaging.

"Since approximately 70% of Saudi Arabia's population is under 30 years of age, this illustrates that demand that will continue to outweigh supply until projects such as King Abdullah Economic City are completed and ready for handover," he said.

"The introduction of the mortgage law can be seen as a positive factor for real estate markets, as the option of purchasing a home will become available to a much larger audience, eventually increasing even more demand for construction of property within the Kingdom."

The US$26bn King Abdullah Economic City being developed by Emaar, EC, is the largest private sector project in Saudi.

Linjawy said the KAEC is expected to spark a new era of economic prosperity for Saudi Arabia and has the potential to create one million jobs. The development will be home to two million residents.

"KAEC enjoys a strategic location advantage of being on the Red Sea coast which makes it an ideal hub for serving the African and European markets. It is also central to the two Holy Cities of Makkah and Madina. KAEC will also serve as a complement to Jeddah, the commercial hub of Saudi Arabia," he said.
The city is divided into six zones including the Sea Port, Industrial Zone, Central Business District, Financial District, Resort District, Educational Zone and Residential Communities. The Residential Communities will house 150,000 apartments and 22,000 villas.

Total retail space in the entire development is 8.7 million sq m, with over 58,000 individual shops.

"The Saudi property market is definitely on the up and the demand for more versatile community lifestyles, such as master planned communities, is increasing," Linjawy added.

Apart from its involvement in joint ventures to build the KAEC, Emaar is among a growing number of regional developers committed to residential developments in Saudi Arabia.

These include the Al-Khobar Lakes and Jeddah Gate projects. The latter involves a US$700m investment to build 5,000 homes on the five million sq ft former Jeddah airport site.

Meanwhile, other big players within the region are seizing Saudi opportunities.

HRH Prince Alwaleed bin Talal Al Saud's Kingdom Holding Company, following on from its towering Al Faisaliah development, is planning multibillion dollar real estate investments in both Riyadh and Jeddah.

The government's go-ahead for construction of high-rise buildings in Jeddah is being seized upon by companies keen to develop sites overlooking the Red Sea.

Dubai-based Damac Properties has also decided to enter Saudi Arabia's plans for a 40 storey tower block development on Jeddah's corniche.

Major development of hotels and residential accommodation as well as new infrastructure development is also stimulating real estate markets in the pilgrimage cities of Mecca and Medina.

Anouar Hassoune, credit analyst at Standard and Poor's Ratings Services, said Saudi Arabia remains by far the financial heavyweight of the Middle East region, despite the spectacular 2006 crash.

Hassoune's comments were published in July in the Standard & Poor's report Bank Industry Risk Analysis: A Bright Future for Saudi Banks, Despite Stock Market Collapse.

"Some of the weaknesses behind the major 2006 correction have been tackled, through share splits, opening up to foreign investors, and management reshuffling at the Capital Market Authority," he said.

The 2006 correction was fuelled by the combination of several factors including a limited number of listed companies and actively traded shares, the lack of market makers and derivative products and a further lack of sophistication and knowledge by the retail investors.

"Banks demonstrated their ability to weather the effects of the crash in local equity prices in 2006. However we consider a tumble in real estate prices, while unexpected since it is currently largely demand-driven, could have severe indirect consequences."

Hassoune noted that Saudi Arabia's risk ratings are influenced by the external geopolitical risks that affect all countries in the Gulf region.

"The deterioration of the security situation in Iraq and the escalation of tensions between Iran and the West over the question of Iran's nuclear fuel programme potentially pose risks to the region's political and economic stability.

"Although these factors are unlikely to pose a direct threat to the security of the Kingdom, and while it is recognised that they may contribute to sustaining oil prices at elevated levels, the conflicts increase uncertainties in the region, and potentially impeding future investment and growth."

However, Standard and Poor's holds a stable outlook for Saudi Arabia, which reflects the balance between positive economic developments and the prospects for the success of the government's ambitious and broad-based reform effort.

"The ratings will be raised if the security situation in Iraq improves and the uncertainty surrounding the Iranian nuclear fuel programme crisis is resolved," he said.

"The Saudi economy remains poorly diversified and dominated by the public sector in a context of high unemployment and a fast-growing population.

"However, the pace of change in the oil-rich Kingdom is certainly accelerating to encourage reforms in the areas of taxation, employment for its fast-growing national workforce and further capital markets liberalisation."

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