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Kuwait Financial Centre “Markaz” MENA REAL ESTATE RESEARCH

KSA Outlook 2013 & 14 Undersupply in residential to persist

KSA RE fundamentals – expats to grow at 1.5% CAGR

KSA’s real GDP growth is expected to grow by 6.0% & 4.2% in 2012 & 13, with non-oil GDP set to grow at 6.5% and 5.6% respectively. We

forecast Saudi & expat population to grow at a CAGR of 2.0% & 1.5%

respectively over 2011-14, as against government targets of 0.2% growth in non- Saudi population, as we expect KSA’s plan to employ

Saudi nationals in the non-oil private sector to be a gradual process.

KSA aggregate residential- near term undersupply

We estimate the growth in KSA’s population to lead to an annual residential demand of 163,500 units. Annual supply on the other hand

is likely to be lower by c.38,500 units, even after factoring in planned official interventions, which underpins our belief that the residential

market should remain undersupplied in the near term.

Cities residential outlook– different tenor; same story though

Riyadh: The Riyadh city residential market is forecasted to stay undersupplied in 2013 & 14, primarily due to the existing undersupply

in middle & lower middle income housing (2012 undersupply: 44,400

units). We expect the incremental demand to also be higher than supply by c.11,800-13,200 units over 2013 & 14, as most of the

incoming supply is not expected to cater to the middle and lower middle income Saudi households. We expect rentals to surge from an

influx of expats, while higher investment activity from both Saudi &

non-Saudi households leads to higher prices. Jeddah: The undersupply in Jeddah as of 2012 was c.80,200 units, from low supply

of Saudi mid & low income housing and low development activity in rental market dominated by expat households. These continuing

trends should result in Jeddah city’s residential market being undersupplied by c.95,000 units on an average over 2013 & 14. We

forecast the prices of duplexes & multi-family villas and, rents of villas

in compounds to move higher. Dammam & Khobar: We expect Dammam & Khobar’s residential market estimated to be undersupplied

by c.61,000 units in 2012, to remain undersupplied over 2013 & 14, as we forecast population to grow at a CAGR of 4.6%, household sizes in

both cities to reduce, and supply growth to be low.

Office outlook- unwinding of the supply overhang unlikely

We estimate high existing vacancy rates and substantially higher

supply growth compared to growth in demand, to limit any positive catalysts from emerging in Riyadh, Jeddah, Dammam & Khobar’s

office markets, and lead to lower rentals in 2013 & 14. However, we

expect the oversupply situation in Jeddah & Dammam & Khobar to reverse quicker than Riyadh, in a higher demand environment as: 1)

Bulk of the supply in Jeddah comes from one single project, which is already 75%-80% pre-leased 2) Supply pipeline growth in Riyadh is

substantially higher than Jeddah, Dammam & Khobar.

Transaction trends counterintuitive

Transaction trends in KSA portrayed counterintuitive trends to the undersupply situation prevalent in KSA’s residential market, in spite of

healthy lending conditions to the sector. The observations of lower transaction activity being ascribed to diversion of capital towards

equities by the market have been rendered inaccurate, as both real

estate transactions and equities have trended lower since Mar’12. We would monitor this divergence going forward for conclusive trends.

November 2012 Research Highlights:

A study to analyze key emerging

residential trends in KSA and provide an outlook for 2013 &

2014

Markaz Research is available on:

Bloomberg - Type “MRKZ” <Go>

Thomson Research, Reuters Knowledge

Nooz Zawya Investor

ISI Emerging markets

Thomas K. Mathew Senior Research Analyst

+965 2224 8051

[email protected]

Venkat Ramadoss ACA, CFA Manager

+965 2224 8548 [email protected]

Bassam N. Al-Othman Executive Vice President

+965 2224 8011 [email protected]

Kuwait Financial Centre “Markaz”

P.O. Box 23444, Safat 13095, Kuwait

Tel: +965 2224 8000

Fax: +965 2242 5828 markaz.com

mailto:[email protected]



MENA REAL ESTATE RESEARCH

November 2012

Kuwait Financial Centre “Markaz” 2

KSA real estate fundamentals KSA’s real GDP growth is forecasted to grow by 6.0% & 4.2% in 2012 & 13, with non-oil GDP set to grow at 6.5% and 5.6% respectively.

Non-oil GDP in turn is expected to grow, as a result of a 7.0% CAGR in the non-oil private sector over 2012 & 13, while the non-oil public

sector grows by a lower 4.2% over the same period. Real GDP

recovered and grew by an avg. 6.1% over 2010 & 11(2009: 0.1%), as non-oil sectors contributed to 4.5% of the growth in 2010 and 5.9% in

2011.

Exhibit-1: Economic growth trends

Source: IMF, Markaz analysis

KSA authorities in their effort to widen the economic base had laid various development targets in its 9th Development Plan (DP) from

2010-14 which includes, a real GDP growth CAGR of 5.2%, reduction

of oil GDP to 1.2% CAGR, non-oil GDP growth of 6.3% CAGR and non-oil private sector growth of 7.1%.

Exhibit-2: 9th DP vs. 2010-11 achievements & IMF forecasts

Source: IMF, Markaz analysis

Two years into the 9th DP, the results seem broadly in line with the

targets, with the exception of the reduction of dependence on oil-

GDP. Though non-oil GDP achievements are in line with targets, non-oil GDP continues to be driven by factor accumulation i.e. an increase

in factors of production thorough investment activities, which is largely dependent on oil-GDP, and not as much from productivity growth. IMF

expects the factor accumulation spending, dependant on oil GDP, to

be vulnerable to a sustained drop in oil prices and estimates that the medium term non-oil primary deficit is above the level consistent with

Real non-oil private sector to grow at 7.0% CAGR

over 2012 & 13

9th DP achievement targets on track; 2010 &

11 goals achieved


November 2012


intergenerational equity (share of resources and assets that belong to future generations) by about 10% of non-oil GDP, which it expects to

be on the higher end of the sustainability range. Further, IIF estimates

that improvement in productivity, and much higher private sector investment (2011: 14% of GDP), would be required to sustain non-oil

GDP growth of 6%.

Expatriate population to grow higher than targeted

While growth in Saudi population is driven by demographic factors,

expatriate population growth is a function of economic growth and employment policies of the government. The 9th DP enumerates that,

Saudi national population in KSA would grow by c.2.0% over 2010-15,

while it pegs the target for expats growth at 0.99%, far lower compared to the 5.39% growth achieved during 2004-2010. Also the

Saudization programme targets to increase the share of Saudi workforce in total labour force from 47.9% in 2009 to c.53.6% in 2014

by providing 1.1 Mn jobs to labour market entrants. Also the DP aims to reduce the unemployment rate amongst the national workforce

from c.9.6% in 2009 to about 5.5% by the end of the Plan in 2014. As

of 2011, the overall unemployment amongst Saudi nationals grew to 11%, with youth unemployment (20-29 years of age) much higher at

c.25%. As of 2010, the number of Saudi nationals in the public sector employed was c. 12.1%, while only 10.4% of the private sector

workforce was Saudi nationals.

We consider the government initiatives to increase Saudi national employment in the private sector, implemented with due importance

so far, to have limited impact on expatriate population growth in the near term. Substantially higher public sector remuneration deters

Saudi nationals from joining the private sector where the average

remuneration is over 50% lower. Moreover, the private sector is incentivized to hire willing expats whose skillsets match with its

current business needs, while at the same time they remain more affordable resources for cost driven businesses. Due to these reasons,

we expect the non- Saudi population growth to be higher than the 0.99% targeted by the 9th DP. Nevertheless, we expect the successful

implementation of channelizing the Saudi workforce to the private

sector & allocating capital formation resources to have a significant impact on residential & office sector demand supply trends in the

longer term, and build our forecasts accordingly.

Longer term outlook – need to diversify away from Oil & Govt.

Our analysis suggests that allocation of productive labor resources

have been mainly towards either the oil sector or the government sector from 2000-10. Exhibit-4 depicts that the two largest sectors in

KSA over the ten year time frame have been the Oil & the government

sector. In spite of the higher GDP contribution, the oil sector growth volatility remained the highest during the period. The government

sector on the other hand employed over 40% of the labour force, while providing little incremental growth potential. The non-oil sectors

that provide inclusive growth for any overall economy lag behind the

oil & government sectors in terms of labour force allocation in KSA.

The longer term economic & demographic outlook hinges on realizing KSA’s stated objectives set in its 9th DP, to diversify away from both

the aforementioned dominant sectors into non-oil sectors, with

substantial private sector contribution. This should result in lower growth volatility & broader economic growth, and would have far

Government targets 2010-

15 Non-Saudi population growth of 0.99%

Saudi workforce

unemployment targeted to be brought down from

c.9.6% in 2009 to 5.5% by 2014

Longer term diversification away from

oil & government sectors should reduce growth

volatility & broaden

economic growth


November 2012


reaching implications on our residential and office real estate forecasts.

Exhibit-3: Diversion of labor into Government & Oil Sectors

Source: CDSI, Markaz analysis


November 2012


KSA residential – Undersupply to persist The KSA residential sector is faced with severe shortage of supply of

housing units; evident from the increasing household size trends from 2004-10. The average household size increased from 5.48 in 2004 to

5.84 in 2010, as the number of households grew 16.3% from c.4.0 Mn households to 4.6 Mn households. The increase in overall household

size was largely attributed to the increase in Saudi household size

which grew from 5.98 to 6.12 in the same period, while the average expat household size grew from 5.00 to 5.32 as well. Taking the 2004-

10 trends into consideration, the overall household size is expected to increase to 5.94 in 2014, if left without any official intervention.

The National Housing strategy (NHS) for KSA was put in place among

other initiatives for alleviating the existing housing shortage and unbalanced housing distribution in KSA, especially for the low to

middle income households. The NHS along with the 9th DP, aim to bring down the overall household size to c.5.7, which would entail

supply addition of 200,000 units annually. The other implicit initiatives

of the KSA government are targeted towards reducing the infrastructure gap, curbing significant price & rent increases for

housing units and crowding of households (more than one household living in a housing unit). Furthermore the KSA government has

allocated USD 67 Bn for the construction of 500,000 housing units through its Ministry of housing (MOH) as part of its social welfare

schemes.

Exhibit-4: 9th DP targeted housing demand (2010-14)


As per the NHS, the number of housing units added on an average over 2004-10 was 108,500 units per year, as the expat population

grew by 5.39% over the period, contributing to a take-up of 55% of

the stock added during the period, while the Saudi population grew by a lower 2.09%. In line with the 9th DP, NHS forecasts Saudi population

to grow by a CAGR of c.2% over 2010-15 and expects a significant drop in Non-Saudi population growth rates to a CAGR of 0.2% over

the same period. They also expect incoming supply to reduce the Saudi household size to 5.76 and estimate 50% of the housing

demand to be eliminated by Saudization policies.

Aggregate residential demand of 163,500 units annually

The two most important factors expected to affect KSA’s aggregate

residential demand over 2010-15 are the rate of Non-Saudi population growth, as a result of Saudization initiatives and MOH housing

Saudi household size in KSA grew from 5.98 to

6.12 over 2004-10

NHS targets overall

household size to decline from 5.84 in 2010 to 5.7

in 2014

108,500 residential units added per year from

2004-10


November 2012


implementation run rates. A faster implementation run rate of MOH supply is expected to lower prices and lead to higher demand during

the period, while any delay is expected to result in a push out of the

targeted household size reduction.

The NHS lays out three demand scenarios for housing take up:

Upper bound: In this scenario, NHS expects 257,100 units of

residential demand, as non-Saudi population CAGR continues

at 5.39%, while the household size of Saudi nationals is

expected to decline by the construction of 350,000 units by

2015.

Lower bound: Saudization initiatives are successful, leading to

a non –Saudi population CAGR of less than 1% over 2010-15,

and non MOH housing units are constructed. This demand

estimate is expected to result in 115,400 units of annual

residential demand.

Intermediate scenarios: These intermediate scenarios assume

a non-Saudi population CAGR of c.1.5%, with MOH

construction of 250,000-350,000 units by 2015, and are

expected to result in 160,000-180,000 annual housing units of

demand over the period.

Exhibit-5: NHS annual construction demand scenarios

Source: NHS, Markaz analysis

We consider the intermediate demand scenario estimate of 163,500

units per annum, driven by a non- Saudi population growth of 1.5% and c.230,000 MOH units addition to be the most aggressive supply

scenario, given the current implementation run rate. Nevertheless, the estimate is driven by our belief that, although we expect a reduction in

non-Saudi population growth rates, we do not expect the growth rates

to come down to 0.2%, as we expect KSA’s target to employ Saudi nationals in the non-oil private sector to be a gradual process, due to

the aforementioned challenges involved. Moreover we do not expect MOH to complete the targeted 500,000 units before 2015 and remain

comfortable with an estimate of c.230,000 units.

Supply shortfall to continue in spite of MOH addition

To arrive at the annual residential supply over 2010-15, we looked at

the impact of both a reduction of non-Saudi population growth to 0.2% CAGR, and the effect of MOH & private sector addition. We

arrived at a supply estimate of c.125,000 units which still lags behind demand by c.38,500 units. Our supply estimate also incorporates the

Demand estimates of 163,500 residential per

annum over 2010-15

0.2% non- Saudi

population growth 2010-15 highly unlikely


November 2012


effect of a 40% private sector crowding out phenomenon, which is the lower construction from the private sector, as a result of supply

adjustments from MOH housing units being constructed. We expect

this supply estimate to be more on the aggressive side, as we do not expect a reduction on non-Saudi population growth of this magnitude.

Therefore we conclude that, despite efforts to stabilize the undersupply situation in KSA, from MOH housing units addition and

other policy initiatives, we expect the overall undersupply in the residential market to persist in the medium term until the full effects

of Saudization and supply of MOH addition are realized.

Exhibit-6: KSA annual supply addition

Source: NHS, Markaz analysis

Residential real estate underinvestment still a concern

The undersupply scenario is also evident from the trends in residential

real estate capital formation. The KSA government in its 9th DP set a target total Gross Fixed Capital Formation (GFCF) growth of 10.4%

over 2010-14, with private sector GFCF growth forecasts of 11.8% in the same period. Over 2010 &11, a total GFCF growth of 13% was

achieved, which was higher than targeted, however non-oil private GFCF grew at only c.8% over the period with bulk of the investments

still flowing into creating government productive capacities which grew

by c.25%.

Exhibit-7: GCFC real estate investment trends


Annual supply to remain

c.23% lower than demand over 2010-15 in

spite of MOH addition

Total GFCF growth of 13% achieved over 2010

& 11 against 9th DP target of 10.4%

Non-oil private residential real GFCF declined from

45% to 18% of real estate GFCF over 2002-

2011


November 2012


Further, our analysis suggests that the two components of real estate capital formation: 1)Non-oil private real estate GFCF of Real Estate

GFCF and 2) Non-oil private residential real estate GFCF of Real Estate

GFCF showed a slowing trend from 2001-2011 (Refer Exhibit 3). Over the period, private real estate GFCF as a % of total real Estate GFCF

decreased from 77.3% to 32.8%. Moreover, private residential real estate GFCF as a % of real estate GFCF also declined from 45.6% to

18.8%, showing a clear trend of underinvestment in residential real estate.

Mortgage law approved – finer details to decide impact

In our 2009 KSA Residential Real Estate Report, we had mentioned

that the younger generation of KSA, in the age group of 20-35, was deprived of real estate ownership due to the lack of supportive home

financing terms, and that once the mortgage law is passed, the

potential for residential real estate in KSA would increase significantly thereby turning around the waning investment trend. Moreover, lack

of financing is also a key impediment to alleviate the mid income housing undersupply. The mortgage law was passed by the Council of

Ministers on 2-Jul-12, which includes the enforcement of mortgage

contracts, mortgage registration and real estate financing companies’ laws. On 19 Nov-12, SAMA released the draft versions of implementing

regulation of 1) Real estate finance, 2) Financial lease law and 3) Law on supervision of finance companies. Central to the implementation

strategy, was the setting up of the “Real Estate Refinancing

Corporation” to provide a regulated secondary market and liquidity for real estate financing. The Real Estate Refinancing Corp. would have

minimum capital of SAR 2 Bn and would be responsible for issuing Islamic bonds or securities backed by mortgages or real estate. Real

estate finance companies are permitted to acquire equity in the Real Estate refinancing Corporation up to an upper limit of 30%. Even

though the secondary market draft details should provide stability and

liquidity in the real estate sector, implementation details of the law in the primary mortgage market are yet to be clear, and we would

update our demand-side forecasts once the full impact can be studied, as and when these details are available.

Mortgage law impact on

demand to depend on the finer details of the passed

law yet to be released


November 2012


Riyadh city residential outlook The results of the Census carried out during 2010 have been published in brief, and while we use the same for our base year data

and analysis, we await a detailed publication of the results. Especially, while we have the population estimate for each province and city, data

on households is not part of the information published so far. We

would be able to provide a more detailed analysis and outlook once the remaining data is also published.

Census – 2010 statistics provides three population estimates related to Riyadh; 1) population at province level 2) population at the level of

Riyadh administrative region and 3) population in Riyadh city. For our

analysis, we chose the relevant population estimate in Riyadh city to estimate the demand for residential real estate.

As per the statistics, Riyadh city had a population of 5.2 Mn as of 2010, and we estimate the number of households in Riyadh city to be

c.880,800 households. Our estimates are based on household size of

5.89 in Riyadh city, which we expect to be similar to the household size of Riyadh province (5.89 as per NHS). We derive our estimate by

extending data from the 2004 census where household size in Riyadh City was similar to that of Riyadh Province (5.46), and that population

in Riyadh city constitutes significant portion of the population in Riyadh province. The population in Riyadh city grew at 4.6% CAGR

over 2004-10, with Saudi population growing at a CAGR of 1.8%,

while expat population jumped by 10.2% (CAGR) over the period. Residential supply on the other hand was c.857,000 in 2010 as per JLL

estimates, which leads to undersupply estimate of c.23,000 units. The structural undersupply in the overall Riyadh residential market is

driven by an undersupply in Saudi housing, mainly in the lower and

middle income segments, due to lower affordability, and lack of new residential supply in this segment. Housing for expats mainly

comprises of the leasing market, which remains marginally undersupplied. JLL forecasts supply to grow at a CAGR of 3.3% from

2010-14, and expects over c.117,000 units to be added over this period, most of which is expected to be added in north Riyadh, where

residences are more upmarket than central or South Riyadh where

most of the middle and low income Saudis reside.

Exhibit-8: Riyadh incremental demand-supply gap (2011-14)

Source: JLL, Markaz analysis

c.880,800 households in Riyadh city as on 2010

Residential supply in Riyadh city to grow by

3.3% CAGR over 2010-14

4.3% CAGR population

growth expected over

2010-14


November 2012


We forecast potential demand from incremental population growth alone in Riyadh city to grow by 4.4% over 2013 & 14. We assume the

average household size to remain at 5.89 - the provincial household

size as of 2010, leading to an average of over 39,000 units of incremental demand being added per annum. However, in the NHS,

the government mentions that it aims to bring down the provincial household size from 5.89 to 5.75. Nevertheless, we do not expect a

reduction in household size, due to the lack of focused supply, but include the effect of the reduction to understand desired future

trends. Furthermore, our demand estimates for 2013 & 14 includes

replacement demand of an average of c.3,800 housing units per annum. As most of the supply is not expected in the Central &

Southern parts of the city, where most of the middle and lower middle income Saudi households reside and who constitute a substantial part

of the overall population in the city, we expect the Riyadh’s aggregate

residential market to remain undersupplied.

Rentals & Prices

Rents and price in Riyadh’s residential market have continued to climb higher, as a result of the undersupply of Saudi housing and crowding

of households (more than one household living in a housing unit, mostly seen in families with more than one generation occupying a

single housing unit). Published rental data for apartments and villas by

JLL suggests that apartment rents have increased more in comparison to villa rents since Q1-11 with average apartment rents having

increases c.23% driven mainly by rental growth in Western Riyadh apartments (+65%), while villa rents increased at a lower 8.5%.

Warooud, Malaz, Olaya and Sulaimania remain popular locations in

Riyadh city due to their proximity to school and hospitals, which is evident from high occupancy rates and increase in rents noted by JLL.

Rents in Eastern and Central Riyadh, mainly characterized as high income villas reportedly moved up higher compared to other areas.

Further rents for villas in compounds rose higher than standalone

villas, due to short supply and high popularity amongst Western expats.

Exhibit-9: Riyadh villa rents Q1-11 to Q2-12 Exhibit-10: Riyadh apartment rents Q1-11 to Q2-12


Prices for apartments and villas in Riyadh city reportedly rose by 14.3% and 23.9%% since Q3-08. Also, compared to a year ago (Q3-

11) apartments & villa prices rose by 9.5% & 8.8%. The marginal

lower price increase for villas since Q3-11 was mostly attributed to price declines for villas situated in Central Riyadh in Q2-12 Q-o-Q,

where most of the sales activity was for older projects due to limited supply of new villa projects. Nevertheless, the increase in prices over

Over 39,000 units of

demand to added per year over 2010-14

Average apartment rents in Riyadh increase by

c.23% since Q1-11


November 2012


the period was driven by: 1) Higher investment activity from Saudis for income generation as gross rental yields for apartments were 8%-

9%, while villa residences earned 4.5%-6%%, 2) Expats preferring to

buy rather renting residences.

Exhibit-11: Riyadh villa & apartment prices Q3-11 to Q2-12


We forecast prices in Riyadh’s residential market to continue to

increase in 2012 & 2013, as housing for Saudi middle income households would continue to remain undersupplied as incremental

demand continues to outstrip incremental supply and, rental yields still

warrant investment activity from Saudis.

The rental market mostly comprising of expats, is likely to see rents

surge higher, as we expect the influx of expats into KSA to continue in 2012 & 13 at over 1.5% per annum. Our forecasts are in contrast with

Govt targets, as we do not expect expat population growth to slow down from the 5.39% CAGR over 2004-09 to 0.2% over 2010-14. We

expect villa residences in compounds which are currently very much in

demand due to popularity factors from Western expats to witness slower rental growth as more supply is expected to come on-stream

over the remainder of 2013 & 2014.

Villa prices in Riyadh increases 23.9% since

Q3-08

Gross rental yields for apartments in Riyadh

c.8%-9%


November 2012


Jeddah city residential outlook Similar to Riyadh city, we derive our residential demand side- the total number of households in Jeddah city for 2010 using city population

estimates from the 2010 census data, as the households’ data is yet to be officially published from the 2010 census.

Using the 2010 Census as our base year data, we estimate the total

number of households in 2010 to be c.735,000 based on a household size of 4.72 and Jeddah city population of c.3.45 Mn. The population

in Jeddah city grew at 3.9% CAGR over 2004-10, with Saudi population growing at 3.1%, while expat population increased by

4.7% over the period. The household size in Jeddah city was lower

than the household size at Mekkah province in 2004 Census. We extrapolated similar trends to 2010 and lowered the household size

estimate in Jeddah city below the household size of 5.14 estimated by NHS for the Makkah Province. Residential supply as per JLL estimates

was c.702, 000 in 2010, which indicates that demand exceeds supply

by c.32,000 units. The higher demand can be ascribed to: 1) The undersupply of Saudi housing similar to Riyadh city, mainly in the

lower and middle income segments, due to lower affordability and 2) Lower income levels of expat households, leading to lower rentals and

subdued development activity 3) Replacement demand flows from households who reside in the Central districts of Jeddah where

housing infrastructure quality standards are lower and residences are

older, while most of the newer & higher quality residences are located in North Jeddah.

Exhibit-12: Jeddah residential market trends


JLL forecasts supply to grow at a CAGR of 2.9% during 2012-14 and expects over c.94,000 units to be added over this period. Supply

initiatives from government agencies and other semi government

agencies, such as JDURC* and the proposed NHS is unlikely to result in any meaningful supply being delivered over 2012-14. We forecast

demand to grow by 3.8% over 2013 & 14 contributing to c.63,500 households of total incremental residential demand based on a

household size of 4.60, as the NHS expects an overall reduction in the Makkah Province household size to 5.01 over the period. Our demand

estimates also include replacement demand, mainly from the Central

districts of Jeddah, to contribute c.3,000 units of demand.

We expect the Jeddah residential market to continue to remain

undersupplied, mainly due to the undersupply in the Saudi middle &

Population in Jeddah city grew by 3.9% CAGR over

2004-10

Undersupply of c.32,000

units in Jeddah as of 2010

c.63,500 units of

incremental residential

demand over 2013 & 14

*Jeddah Development & Urban Regeneration Company


November 2012


low income housing. Also, we expect land costs to continue to remain expensive for developers, providing less incentive for development

activities, as rental yields continue to remain low, arising from expat

housing affordability constraints. Moreover, established private developers also continue to focus on upper and upper middle class

households due to higher rental realization rates. The mortgage law and the NHS initiative should help alleviate these affordability

constraints in our view; however, we do not see any structural improvements altering existing demand-supply trends drastically over

2013 &14.

Rentals & Prices

A similar rental trend to Riyadh was observed in Jeddah from 2011

until Q2-12, with apartment rents witnessing higher rental increases than villas. Apartment rents in the Western Jeddah continue to

command higher rentals and witness higher rental increases than

other parts of Jeddah (+24.7%), as per JLL estimates. Also, rents of villas in residential compounds continued to reportedly witness higher

rental increases than the overall villa market (+1%) due to high demand from expat households to live in gated villa residences. The

higher increase of apartment rents in comparison with villa rents is likely attributed to the larger number of low income expats in Jeddah

(as compared to Riyadh), who prefer to stay in apartments rather than

villa residences. While residences in close proximity to the city like Al Balad, Malak are still preferred, new residential projects away from the

city like Al Fareeda & Mashraf are likely to see higher interest coming in, as these projects are targeted towards Jeddah’s mid-income

households.

Exhibit-13: Jeddah villa rents Q1-11 to Q2-12 Exhibit-14: Jeddah apartment rents Q1-11 to Q2-12


Prices in Jeddah surged across locations in both villa(+26.3%) and

apartment markets (+40.4%) from 2011 to Q2-12, driven by undersupply and pass-through of higher progressive development

costs incurred by developers as a result of the shortfall of housing supply, mainly in the middle income and lower middle income

segments. However, certain locations have witnessed Q-o-Q declines

in Q2-12, as a result of new supply.

Jeddah to remain structurally undersupplied

over 2012 & 13

Western Jeddah apartment rents increases

24.7% since Q1-11


November 2012


Exhibit-15: Jeddah villa prices Q1-11 to Q2-12 Exhibit-16: Jeddah apartment prices Q1-11 to Q2-12


We expect prices in low & middle income housing in Jeddah to

continue to move up, depending upon locations and type of residence,

as demand would continue to exceed supply. With land prices constituting over 60% of the total development costs, larger

developers more focused on catering to the mid and high income housing. As a result of the high land prices, we also expect emerging

trend of buyers opting for multi-family villa dwellings and duplexes to

continue as against owning single family dwellings. As for rentals, we expect villas in compounds to continue to increase higher than the

overall villa market due to the limited supply expected over 2012 & 13, and apartments with good amenities and infrastructure to witness

rental increases from higher expat leasing activity.

Land prices constitute

over 60% of total

development costs in Jeddah


November 2012


Dammam & Khobar residential outlook Based on the 2010 census data, we estimate the number of households in Dammam & Khobar as of 2010, representing residential

demand, to be over 231,000 households, derived from population estimates of over 962,100 in Dammam & 597,800 in Khobar. We

assumed a lower household size for Dammam (5.86) & Khobar (5.44)

than the estimates of the Eastern Province as whole (6.38), provided by NHS. The population in Dammam & Khobar grew at 0.4% CAGR

over 2004-10, with lower Saudi population in 2010 than 2004 (-3.1%), caused likely by internal migrations, while expat population jumped by

6.9% over the period. Based on residential supply estimates from

Saudi Rama, Dammam & Al Khobar were undersupplied by c.42,800 units in 2010, as Saudi middle income households remained

undersupplied similar to Riyadh & Jeddah.

Exhibit-17: Dammam & Khobar undersupply build-up

Source: Saudi Rama, Markaz analysis

Supply in Dammam & Khobar is estimated to increase by 3.4% (CAGR) over 2011-14 with over 8,300 units of supply expected to be

added each year, as per Saudi Rama. We forecast the undersupply

situation in the Dammam & Khobar to increase over 2011-14 with c.15,500 units of incremental demand expected to be added per year

on an average during the period. Incremental demand is expected to be driven by population growth of 4.6% CAGR in these cities over the

period, higher than the average Eastern Province growth rate (+3.4%) primarily due to higher expat population growth and family size

reduction in Dammam (5.72) & Khobar (5.31).

Exhibit-18: Dammam & Khobar rental trends Exhibit-19: Dammam & Khobar price trends

Source: Broker estimates, Markaz analysis

Dammam & Khobar undersupplied by c.42,800

residential units in 2010

Incremental demand in

Dammam & Khobar to grow by 4.6% CAGR over

2011-14


November 2012


As per estimates from various brokers, rents in Dammam & Khobar grew by c.20% on an average from FY08 to Q2-12, with villa rents

(+24%) growing more than apartment rents (+16%). Prices of villa

residences (+13%) grew higher than apartments (+11%) from FY-08 to Q2-12. We forecast the rental market in Dammam & Al Khobar to

remain particularly strong until successful implementation of the mortgage law, as home ownership still remains out of reach,

particularly for the middle income households. Prices of high income residences should continue to grow on higher demand, but the growth

rates are likely to be lower than what was witnessed in the past, as

incremental demand from migration is largely expected in the middle and lower income brackets. In spite of home ownership options, the

lack of the availability of home financing would continue to hamper higher realization of this latent demand potential until the mortgage

law is successfully implemented and terms are conducive to home

ownership for the middle income bracket.

Apartment and villa rents

grew by c.20% avg. since 2008 in Dammam &

Khobar


November 2012


KSA office fundamentals The office real estate market is primarily driven by 1) existing demand

–supply trends 2) office based employment generation, reliant on overall economic growth particularly in the private sector for

incremental trends and 3) government initiatives towards encouraging office based business activity.

Labor growth in the services sector is the foremost driver for office space demand. The non-oil private sector employment in KSA is

expected to grow by 2.5% over 2010-14 and account for 73.1% of the total increase in jobs under the 9th DP. Labor growth in the services

sector is slated to grow by a higher 3.1% (CAGR) during 2010-14 and

constitute c.65.5%of the incremental employment, which should drive higher demand for office space over 2013 & 14. Also licenses for

commercial establishments provided by the Ministry of Commerce and Industry grew at a CAGR of 18.8% over 2009-11, after Y-o-Y growth

slowed down to 2.3% in 2009, which should help absorb supply if

trends continue over 2012-14. Further, the ease of starting a business in terms of number of days KSA is c.75% lower than the MENA

average, which could provide faster take-up of office supply.

Exhibit-20: KSA commercial license issuance trends

Source: Ministry of Municipal & Rural Affairs, Markaz analysis Supply side drivers in the form of construction permits for commercial & industrial sector grew at a CAGR of 16.1% over 2007-11, as

approvals in KSA take c.40% lower approval time than the MENA

average according to the World Bank. This should ensure that there are no delays in construction of office space getting underway. Based

on the aforementioned observations, we expect the office market demand fundamentals for KSA to remain conducive for higher office

space activity, while the overall prospects of the office sector would

also depend on existing and forthcoming supply dynamics of each city.

Exhibit-21: Commercial & industrial construction permits trends


Office space drivers to

grow by 3.1% CAGR over

2010-14

Commercial & industrial

construction permits grew

by 16.1% CAGR over 2007-11


November 2012


Riyadh city office outlook Our analysis suggests that the Riyadh office market is likely to remain

oversupplied over 2013 & 14. The total city wide office stock as of

2011 is c.3.2 Mn sq.m and they estimate city wide vacancy rates to be 14% as of Q2-12, while CBD vacancies were estimated to be higher at

16%, as per JLL estimates. However in spite of vacancies in the aforementioned areas, completed Grade A space reportedly remains in

short supply as the government, Saudi conglomerates & multinationals continue to seek high quality office spaces. Further office supply of

grade A and B office spaces located in the CBD, North & East ring

Roads, Khurais, Mazer and Sitteen Streets, estimated at 1.8 Mn sq.m in Q2-12 by JLL (c.56% of the total Riyadh office market), is expected

to grow by 21.3% over 2011-14, with c.1 Mn sq.m expected to be added over 2013 & 14. The increase in supply is largely expected from

the delivery of the first buildings of the new office stock from the King

Abdullah Financial District (KAFD) and Information Technology Communications Complex (ITCC) projects with c.500,000 sq.m of

office space combined likely to be added over 2013. KAFD, developed by the Public Pension Agency is located north of Riyadh, is mainly

Grade A quality office space along with a financial academy and other

recreational facilities has a floor area of over 3 Mn sq.m. The ITCC complex is located next to the King Saud University & King Abdulaziz

Science & Technology City, with a floor area of 0.8 Mn sq.m mainly constituting office spaces, along with a research & development

building, and housing for IT & communications companies.

Exhibit-22: Riyadh office rental trends Q3-08 to Q2-12


The continuing addition of office stock and the gradual pickup in office

supportive economic activity post the global financial crisis resulted in

lower average office rents in Riyadh over 2008-12. Average CBD office rents declined c. 27.1% from Q3-08 to Q2-12 as a result. We forecast

office rents to continue their receding trend, as the supply overhang is expected to continue weigh on rentals in spite of likely project delays.

Growth of labor and employment, primarily in the services sector form

the foremost drivers for office demand potential. We forecast overall labor growth in Riyadh to grow by 2.9% over 2011-14, and expect the

services sector labor demand to increase by 3.6%, which should be beneficial for higher take up of office space. Nevertheless, with

existing oversupply and high vacancy rates, new office supply expected to grow by a CAGR of 21.3% over 2011-14, and demand

side drivers expected to grow by 2.9%, we do not foresee any

Riyadh city wide office stock of c.3.2 Mn sq.m as

of 2011

KAFD & ITCC to

contribute to c.50% of

the supply over 2013 & 14

Demand drivers to grow by only 2.9% CAGR; while

supply grows at 21.3%

CAGR over 2011-14


November 2012


structural positive trends emerging from the Riyadh office market. However, as new supply from KAFD and ITCC come in, and overall

office supply increases, we expect rents in current Grade-A (JLL Q2-12

average: SAR 1,330/sq.m) & Grade B (JLL Q2-12 average: SAR 900/sq.m) office market to decline and vacancy rates to increase, as a

result of the exodus to these new office spaces. These reduced rentals should translate into higher affordability for office space occupants

who could potentially deviate from existing Grade B & C office spaces and take up higher quality Grade A & B office spaces in Riyadh,

thereby bringing down vacancy rates in such types of office spaces in

the longer term.


November 2012


Jeddah office outlook The Jeddah office market, similar to Riyadh is likely to remain oversupplied over 2011-15. However as most of the new supply added

in 2012 is limited to one single project which is already 75%-80% pre-leased, we expect incremental office demand-supply trends to be

much more balanced as compared to Riyadh, and higher

achievements of the services sector labor growth to result in a quicker take up of the excess supply of office and unwinding of the supply

overhang.

Exhibit-23: Jeddah office supply trends


Grade A & B office stock in Jeddah’s CBD as of 2011 was 574,000

sq.m and estimates of CBD vacancy rates stood at 27% as of Q2-12,

according to JLL. Further office supply of grade A and B office spaces located in the CBD are reportedly expected to grow by 17.4% over

2011-14, with bulk of the supply coming from the addition of c.75,000 sq.m from a single project-The Headquarters by Q4-12, which is

already 75%-80% pre-leased. The increase in supply and the gradual recovery of economic activity post the global financial crisis resulted in

lower average office rents in Jeddah over 2008-12. Average CBD office

rents declined c. 29.5% from Q3-08 to Q2-12 as a result. We forecast office rents to remain subdued over 2013 & 14, as the supply of office

stock is expected to exceed demand for office space during the period.

Exhibit-24: Jeddah office rental trends Q3-08 to Q2-12


Overall labor growth in Jeddah is forecasted to grow by 2.8% (CAGR) over 2011-14, and we expect the services sector labor demand to

increase by 3.3%, which is expected to aid office space demand, in our view.

Unwinding of office space

oversupply in Jeddah to be quicker than Riyadh

Avg. CBD rents in Jeddah

declined 29.5% from Q3-08


November 2012


Dammam & Khobar office outlook Office space in the Dammam & Khobar market largely followed trends witnessed in other office markets in KSA and remains oversupplied.

Our estimates of vacancy rates stands at c.20% and our market research suggests that supply is reportedly expect to increase at a

CAGR of 7% over 2012-14 with almost half of the supply catered

towards office spaces for organizations with 10-39 employees.

Exhibit-25: Dammam & Khobar office rents Q3-08 to Q2-12

Source: Markaz analysis

Demand-side fundamentals in the Dammam & Khobar are still

expected to be driven by the government and oil sectors which are likely to grow by a CAGR of c.4.5% and 2.4% respectively over 2012-

14. However though the growth rates seem to be healthy, c.75% of the employees continue to be employed outside the government and

oil sectors. The office space demand, mainly resulting from the

incremental growth in number of employees outside the government and oil sectors, mainly in the services sector, is only likely to grow by

c.3.5% as per our forecasts. Therefore with vacancy rates of 20% and relevant demand set to grow at only c.4%-5% at best, while supply

gets added at over 7.0% over 2012-14, we expect the oversupply in the Dammam & Khobar office market to persist over the medium

term.

Office rents in Dammam & Khobar declined by an avg. 15% over 2008-12, lower than Riyadh (-29.5%) and Jeddah (-27.1%), as most

of the office demand was from the government and the oil sector providing stability to office rentals. Office spaces in Khobar are more

preferred compared to Dammam, as office spaces in Khobar are more

high quality driven by the hospitality industry, and close proximity to Bahrain. An alternate source of office space demand in Khobar is also

seen from representation offices setup in the city, as many projects are being set up in Jubail in the areas of contracting and oil & gas. We

forecast office rents to recede over 2012 & 13, in-spite of a pick-up of

office space demand in H1-12 due to high vacancy rates as aggregate office supply is expected to exceed demand for office space over the

medium term.

Office rents in Dammam & Khobar declined by.

15% avg. over 2008-15

Representation offices from other Eastern

Province cities constitute alternate source of

demand in Khobar


November 2012


Real estate sector liquidity

Property and construction sector lending has been increasing steadily

from 2009 to 9M-2012 at a CAGR of c.17%, aiding property and

construction GDP to grow at over 6% over the period. Further, lending to the sector in 9M-12 has already surpassed the full year 2011 figure

by c.4% pointing towards adequate liquidity available for the sector. Credit lending to real estate & construction sector as a percentage of

total credit remained broadly stable from 7.2% in 2010 to 7.4% in 9M-

12, after dipping in 2009 to 6.1%. Furthermore, real estate credit grew marginally from c.7.5% of private credit in 2010 to c.7.8% in

9M-12, and increased from c.3.9% of total assets in 2010 to c.4.4% in 9M-12. Mortgage financing trends have grown substantially from Q1-

09 to Q2-12 growing over 200%, and witnessed a c.53% jump from

Q-o-Q from Q1-12 to Q2-12. The jump is mostly ascribed to increased lending confidence on behalf of banks from the Real Estate

Development Fund (REDF) recapitalization and anticipation of the mortgage law getting approved.

Exhibit-26: Building & Construction credit trends Exhibit-27: Mortgage financing trends

Source: SAMA, Markaz analysis

We expect the liquidity situation for the KSA banking system to remain

extremely strong, fully supported by internal funding (resident

deposits), as total combined public and private sector credit requirements only constitute 62% of the internal funding of Q3-12,

and has remained c.60% since 2007. The excess internal funding is channelized mostly into investments (13.2% as of Q3-12) and

reserves (10.1% as of Q3-12). Further, bank internal funding

constituted over 94% of the overall asset position as on 9M-12, and remained above 90% since 2007. Moreover, resident customer

deposits amounted to c.85% of overall customer deposits in Q3-12, and have remained above 80% since 2007, while the liquid assets-to-

total asset ratio remained over 22% over 2007 to Q3-12.

As the overall banking system remains strong & well capitalized from internal funding and resident deposits, we expect the credit lending

situation to the real estate & construction sector to remain comfortable over 2012 & 13. Furthermore, the implementation of the

approved mortgage law by the Saudi Arabian Council of Ministers in Jul-12 would have a positive impact on mortgage financing trends if

affordability constraints are adhered to effectively.

Construction and real estate lending remained

Stable from 2010 to 9M-

12

Total funding requirements constitute

only 62% of funding

receipts


November 2012


Exhibit-28: KSA liquidity funding position

Source: SAMA, Markaz analysis

Transaction trends counterintuitive

Transaction trends, an indicator of the liquidity environment prevalent

in the key real estate markets of Riyadh & Dammam declined from Q1-11 to Q3-12 and are counterintuitive to the undersupply situation

prevalent in KSA’s residential market, even more so as lending to the real estate sector has been stable. Earlier, the lower transaction

activity was ascribed by the market to diversion of capital towards the equity market looking at trends from Aug’11 to Mar’12. However,

those observations have been rendered inaccurate as both real estate

transactions and equities have trended lower since Mar’12. It remains to be seen whether the decline in transactions can be ascribed to

investors remaining on the sidelines, due to the substantially higher price environment. We would continue to monitor this divergence and

trends in real estate transactions going forward for conclusive trends.

Exhibit-29: KSA weekly RE transactions & TASI index trends

Source: Bloomberg, MOJ, Markaz analysis

The downtrend in transactions is more evident in Riyadh as residential

real estate & office transactions were down 69% and 55% on six

month summation basis over the period; whereas the decline in Dammam was lower at 22% and 10% respectively.

Liquidity scenario strong

as 94% of total banks funding from internal

sources

Intriguing transaction

trends witnessed since Q2-2011

Residential transactions

down 69% since Jan-11

till date


November 2012


Exhibit-30: Transactions* on trailing six month summation basis

Riyadh transactions Dammam transactions

Source: MOJ, Markaz analysis

Exhibit-31: Yearly transactions trends

Riyadh transactions Dammam transactions

Source: MOJ, Markaz analysis, * until 21-Nov-12


November 2012


Disclaimer

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