In this issue
Real estate suggests an oasis of stability
Worldwide, the ongoing financial crisis has had a devastating impact on the real estate sector, across developed and developing markets alike.
- Ahmed S. Banaja
- Published: 18:35 November 18, 2009
- Image Credit: David Lomax
The global asset price bubble — facilitated by a toxic combination of excessive leverage, irresponsible short-termism and inadequate regulation — burst when the US subprime mortgage sector imploded. This, in turn, led to the broader financial crisis, which continues to impact the performance of the real economy.
While no sector has been hit as hard as financial services — especially in the United States, which has now exceeded 100 bank failures this year alone — the real estate sector has also witnessed vast losses.
Here in the Middle East, speculative investments, sometimes based on off-plan promises that never materialised, have gone disastrously wrong; access to funding has become more difficult than ever; and, along the way, the fundamentals of supply and demand appear to have been frequently forgotten.
The medium-term drop in oil prices, driven by global recessionary pressure and resulting in demand contraction, has also had a short-term impact on the region’s hydrocarbon economies, especially the Gulf oil states.
The knock-on effect on the real estate sector is obviously being felt — though a short-term correction is not likely to have a major impact on the overall stability of the regional economy. As well, reduced speculative activity is in some ways a good thing, easing inflationary pressure and making life more affordable for those who call the region home.
Unlike during the last oil price-led boom, governments and the private sector have invested in creating world-class hard and soft infrastructure that will support the long-term growth of our young and vibrant population. This investment — in transportation and education, energy and health care — has been accompanied by significant economic diversification. Importantly, this diversification has been primarily encouraged, rather than managed, by government.
All of this has contributed to the longer-term stability of the Middle East property sector, despite the current challenges.
Amidst so much regional and international volatility, the Saudi real estate market has proved an oasis of stability. Because the kingdom is not decoupled from the global economy, the sector has been impacted by worldwide trends.
But that impact has proved limited; the long-term outlook for Saudi real estate remains extremely positive.
Saudi Arabia is one of the few markets that continues to witness strong underlying demand, despite the overall global economic slowdown. And the primary reason for this is fairly straightforward: today roughly 38 per cent of the population is under the age of 14, and the average citizen is just 21 years old. (Compare that to Germany, for example, where the median age is 43, or Japan, where, by 2050, the average citizen will be 53.)
Current estimates indicate that Saudi Arabia will need to build around 1.5 million new homes by 2015 to cater to this young and rapidly growing population, which translates to around 250,000 housing units annually.
Until now, supply has simply not kept pace with demand, which is why prices have generally remained stable despite the impact of the global financial crisis.
Historically, rising land values and increased construction costs have outpaced incomes, leading developers to focus on the high-end and luxury segment of the market, rather than on affordable housing. Not surprisingly, middle-income housing continues to be the most underserved segment in Saudi Arabia.
A recent study by CB Richard Ellis suggests that the price of real estate in Saudi Arabia has risen at a faster rate than the average citizen’s disposable income, underlining the potential for affordable housing, especially in urban areas where the supply-demand imbalance is acute.
In this regard, it is important to keep in mind that a commonly accepted guideline for rental affordability is that monthly housing costs should not exceed 30 per cent of a household’s gross income. In Saudi Arabia, however, that ratio is currently estimated at more than 40 per cent — in striking contrast to North American and European markets, where the median rent-to-income ratio is below 30 per cent .
Developers in Saudi Arabia now have the opportunity to turn that pent-up demand in underserved segments into a growth engine for the future. Indeed, despite the long-term demand for low- and middle-income housing, few developers in Saudi have addressed this growing need. As a result, Saudi continues to see pent-up demand and very strong fundamentals, even in these difficult times.
In the commercial and hospitality sectors, demand also continues to outstrip supply — especially in major metropolitan areas such as Jeddah and Riyadh, as well as in Mecca and Medina, where demand for newer office space remains significant despite stagnant performance at older commercial properties.
A recent study by Global Investment House revealed that Saudi Arabia’s real estate sector is likely to sustain a growth rate of between 5 and 7 per cent until 2012. Real estate investments in Saudi are estimated to reach roughly $430 billion (Dh1,579 billion) by 2010, from about $322 billion this year .
In parallel, the sector’s total contribution to GDP is forecast to rise to 7.2 per cent this year, a significant increase from 2004 levels of 6.8 per cent. Meanwhile, the country’s Capital Market Authority recently said that it was currently examining some 20 requests to set up real estate investment funds in various regions of Saudi Arabia .
Generally, Saudi firms investing in real estate development are in a much stronger position than their regional peers — primarily because Sharia guidelines compel them to avoid raising debt. Indeed, among listed real estate companies in Saudi, debt-to-equity ratios average an extremely prudent 12 per cent .
Previous downturns have demonstrated that a counter-cyclical approach can provide the greatest rewards for those who take a long-term view. This is clearly the case in Saudi Arabia, where developers and investors who act today are likely to emerge strongest, especially once the global recovery provides a much-needed boost to the worldwide property sector.
The writer is Chief Executive Officer of Jeddah-based SEDCO Holding, a leading Sharia-compliant investment and wealth management firm in Saudi Arabia.
