In addition to Saudi Arabia’s hydrocarbon production quotas, subdued global oil and gas prices, and an escalation in regional geopolitical tensions have impeded growth. S&P Global Ratings expects Saudi real GDP to contract by about 0.4% this year, driven mainly by a fall in oil production tied to the OPEC deal and the foreign attacks on two oil production facilities (see “Saudi Arabia ‘A-/A-2’ Ratings Affirmed; Outlook Stable”, published Sept. 27, 2019, on RatingsDirect). L
ow confidence has affected key growth sectors, such as real estate. But, in our base case, we expect government incentives for the private sector will gradually strengthen domestic demand, while large government projects will also add to growth. Saudi Arabia is implementing a series of reforms that include social measures aimed at increasing labor participation, particularly of women; improving education levels; and boosting the private sector’s role in the economy. ‘
Alongside these factors, we expect a rebound in economic growth to 2.3% on average over 2020-2022 to support the real estate market. And, although political volatility will remain high, which remains a risk to the country’s growth outlook, we do not expect a direct military conflict with Iran.
Ratings Impact On Saudi Issuers
We expect the ratings impact of the price and rental decline to be minimal at this stage. The Saudi banking sector’s exposure to real estate is contained at 17% of total credit to the private sector as of mid-year 2019. Of this, 63% is to retail clients, predominantly via mortgages, and the rest to the construction sector. Although Saudi banks seems to have written off a significant portion of their problematic contractor exposures, we do not rule out some volatility in the asset-quality metrics of this segment as the economy continues to adjust.
Mortgage portfolios have been expanding rapidly over the past two years, at about 30% per year, fueled by government-subsidized programs and regulatory incentives introduced by The Saudi Arabian Monetary Authority over 2018-2019. We positively note that mortgages remain predominantly salary assigned. This means banks are exposed to unemployment risk, which is low for public sector employees, rather than asset-pricing risk. The cost of risk on mortgages has also been negligible so far. Nevertheless, government efforts to promote housing affordability, including lower regulatory requirements for mortgage exposures (such as a loan to value of up to 90%-95% and risk-weight of 50%) could mean a build-up of risks in the long term. However, we believe the risks are well-reflected in our ratings on Saudi banks at this stage.
Real estate valuations have no major effect on the ratings of insurers in Saudi Arabia due to the regulatory framework, which caps insurers’ investments in real estate at 5% of assets. Any investment in real estate beyond the prescribed limits is not admissible when calculating the solvency ratio of an insurer.
Real Estate Trends In Saudi Arabia
The general market trend is of weakening prices and rents across various segments and we consider the sector to be sensitive to unexpected changes in economic growth. Saudi Arabia is the largest and most populous country in the GCC, with a number of big cities. We focus on the two biggest markets, Riyadh and Jeddah, in this report. However, it’s important to note that other cities may have varying trends depending upon demographics, supply (current and future), and demand.
Residential real estate is under pressure due to the departure of foreign workers
The performance of the segment has been soft, residential sale prices have declined 5%-6% year over year and rentals by 1%, according to real estate agency JLL’s third-quarter 2019 report. Supply is slated to increase albeit slowly, which means residential rents and prices are expected to remain under pressure. There appears to be good demand for affordable and modern units but the overall market is suffering from declining prices. This is linked to the exit of foreign workers, which has followed new and increasing taxes applying to expats and their dependents. Official labor force statistics show the non-Saudi workforce has declined by about 1.9 million since 2017. However, we expect government initiatives, such as those incentivizing developers to build affordable homes, or encouraging banks to introduce more home financing options, to increase home ownership rates among Saudi citizens. Saudi Arabia has recently approved a program that offers permanent residency to some foreigners to attract investments, which could also boost prices. In addition, we forecast improving regulation to promote transparency and investment in the sector.
Government companies are creating demand for quality office space
We understand the commercial market is quite fragmented, with limited new supply in the pipeline. According to JLL, rents have stabilized for Riyadh office space featuring premium locations, amenities, and asset quality (also known as Grade A), in part due to demand from newly created government companies, which come under Vision 2030. This demand for quality assets and amenities may lead to diverging trends, given the majority of office space isn’t Grade A. Other pressures include the increasing popularity of co-working spaces, particularly for business incubators and start-ups. In Jeddah, the trend is quite negative, with vacancy rates as high as 21%. More broadly, a further decline in rents is expected, despite limited new supply, due to increasing competition.
High competition is expected to persist in retail real estate
In our view, the retail market is quite competitive and unorganized, especially outside the big cities. Lackluster economic growth has led to a soft retail environment that in turn has negatively affected retail rents. According to JLL, rents in Riyadh and Jeddah, especially for regional and community malls, have declined 5% year on year and are trending downward. In contrast, we believe super regional malls have managed to stabilize rents due to asset quality, newly opened entertainment centers, and more varied brand offerings. JLL suggests there is considerable new gross leasable area (GLA) scheduled for delivery until 2021, which will increase competition and constrain rents. In Riyadh, 400,000 square meters (sqm) of new GLA is expected, which is 18.3% of the existing stock, and in Jeddah 285,000 sqm of new GLA, or 20% of existing stock.
The Saudi government has announced a number of reforms under Vision 2030. These include a tourist visa to boost international visitors, the development of the entertainment sector via the introduction of cinemas and other attractions, and greater female involvement in the workforce. These factors will likely help fuel real estate growth.
Drawing Parallels With Neighbors
The key difference between Saudi Arabia and neighboring countries is the sheer size of the local population and demographics.
The United Arab Emirates (UAE) population was estimated at 9.5 million in 2018, of which only 10%-15% are UAE citizens. Furthermore, in cities like Dubai, the vast majority of real estate is owned by expatriates or international investors. We believe the market will remain under pressure in 2019-2020, with no meaningful recovery in the near term due to the current supply-demand imbalance. Dubai Expo 2020, which is expected to attract millions of visitors to the emirate, may have a positive effect on market sentiment. Since the decline in prices has been gradual, relative to the previous cycle, we believe any meaningful recovery will take longer. The “Higher Real Estate Planning Committee” was established in September 2019 to manage supply-demand imbalances in Dubai. How the committee will operate and the influence it will have on the market is currently uncertain. However, with 122,000 units to be delivered over the next 24-30 months (JLL third-quarter 2019 report), presumably largely presold, any meaningful halt to new supply will be post 2022.
In Qatar, prices have declined 23%-27% since their 2015 peak, according to Qatar Central Bank’s real estate price index. This is despite the population increasing to 2.8 million in October 2019 from 2.4 million in December 2015, according to Qatar’s Planning and Statistics Authority. Alongside lower oil prices, the property price slump is in part due to the boycott of the country by certain neighbors since June 2017, which has significantly affected real estate, tourism, and construction. Continued geopolitical issues mean we don’t expect a meaningful recovery in real estate prices and rents any time soon.
In contrast, Saudi Arabia has a population of about 34 million, of which approximately 60%-65% are citizens. According to the Saudi Housing Vision Realization Program, the home ownership rate among Saudi nationals was 50% in 2016 and the government aims to increase it to 60% by 2020 and 70% by 2030. To achieve this objective, the government has sought to increase the availability of private sector funding for real estate and boost middle- and low-income housing stock, while also establishing cooperative social housing programs to increase supply.
Market Opportunities To Come
We believe Saudi Arabia has the opportunity to better manage property supply than its neighbors, with a key strength being its growing population and rapidly changing demographics. About 60% of the population is 15-54 years old, a group that has increasing disposable income, a taste for a better quality of life, and a preference for urban centers. Meanwhile, the increased participation of women in the workforce will result in higher household spending power.
The country can also proactively plan for new concepts that are disrupting traditional brick-and-mortar real estate elsewhere such as co-working spaces, co-living developments, and online shopping.
Saudi population trends, combined with government reforms and potential economic growth, are supportive of a sustainable real estate market in the medium term and could see Saudi Arabia outperform neighboring countries.