| Saudi Arabia | Oct 10, 2017
The construction sector was hit hard by the fall in oil revenues in 2016, but the Saudi government's long-term development plans and newfound emphasis on PPPs bode well for the future of the sector.
It took an audacious amount of ambition to turn Saudi Arabia into what it is today. The Arabian Peninsula is dominated by shrubland and an expanse of sand and sky so devoid of anything the local name for it translates to “the Empty Quarter,” but today the country is home to 30 million residents and some of the world’s most impressive buildings. When you consider the determination needed for this to happen, it is little surprise that the Saudi construction industry is characterized by a vision without peer in the Middle East. Megaprojects like the Abraj Al Bait, the Al Faisaliyah Center, and the Bruj Rafal are markers of the Kingdom’s drive to turn its oil wealth into cultural and economic monuments and the role construction plays in developing a society. The fall in oil prices has led to decreased growth in recent years, but the government’s commitment to the industry has never been in doubt, and recent reforms have participants optimistic about the long-term health of the sector.
Like the rest of the oil-exporting GCC states, the drop in oil prices over the past year hit Saudi Arabia hard in 2016. The world’s largest oil exporter collected SAR329 billion (USD87.7 billion) from crude oil sales revenues in 2016, down from USD285 billion in 2014 and USD157 billion in 2015. As the petroleum sector accounts for over 90% of budget revenues and over half of all GDP, the ripple effects of this fall were unsurprisingly throughout the sector. Saudi Arabia posted GDP growth of just 3.48% in 2015 and 1% in 2016. In the midst of all this, the real estate and construction sectors saw uneven results. The real estate sector saw softer demand due to decreases in consumer and purchasing power, though well-established corporate and retail centers in Riyadh and Jeddah served as stabilizing forces. Construction, on the other hand, was more directly impacted by the drop in government spending and contracting. Research firm BMI estimated that the construction sector contracted by 1.9% in 1Q2016 and 3.1% in 2Q2016 en route to an overall 62% drop in contract rewards.
The Saudi real estate market is concentrated in Riyadh and Jeddah, the two largest cities in the country and the home of the majority of all commercial and economic activity. 2016 saw residential rents fall slightly in both cities (4% Riyadh and 1% in Jeddah), with prices remaining high in part due to a lack of new construction. Increasing the supply of housing in the country is a priority for the Saudi government, which is concerned about a lack of affordable homes. With Riyadh expected to add over half a million residents by 2020, increasing the housing stock is a pressing issue needed to secure human capital and contribute to the long-term growth of Saudi Arabia. With this in mind, 2016 saw the launch of a few programs designed at adding to the housing supply and creating a more stable housing infrastructure. In early 2016, the Saudi government debuted the National Transformation Program, a roadmap for meeting the goals of Saudi Arabia’s Vision 2030. One of the goals of the program is to raise the size and economic importance of the real estate sector; the plan calls for the sector’s share of GDP to go from its current 5 to 10% by 2020, and for the percentage of housing units given to subsidy-eligible citizens to rise from 10% to 50%. The emphasis on affordable growth bodes well for both future prices.
The Saudi government is also in the midst of implementing a new “white land” tax (WLT) to spur the development of underutilized plots of urban lands. The new policy calls for the owners of undeveloped urban land marked for residential or commercial use to pay a 2.5% tax on the value of the land each year, hopefully making it more expensive for landowners to sit on property and thus boosting the available stock of housing in the country. The tax is designed to target large-scale developers, as it only applies to plots larger than 10,000sqm. The WLT was only implemented in mid-2016, so its effects have not been fully seen, but government and industry leaders anticipate it achieving its primary effects. Changes are also underway at the Ministry of Housing, which is undergoing its own set of reforms to strengthen the financial and structural underpinnings of the sector to increase public investment in the sector and ensure more long-lasting success. Majed bin Abdullah bin Hamad Al-Hogail, head of the Ministry, told TBY that the scale of the current transformation is “unprecedented” but necessary for a strong Saudi future. “Today, the Ministry has transformed itself into an enabler and catalyst of housing,”Al-Hogail told TBY. “Previously, the private sector shied away from operating in the middle and lower class housing market… The Ministry today perseveres in working alongside the private sector in order to facilitate a business friendly environment and create investment opportunities in order to shift gears in the sector. The new strategic direction will inevitably result in higher supply of better quality housing at more affordable rates.”
RETAIL & OFFICE
In the retail sectors, rents fell slightly in the face of lower consumer spending, but the imminent arrival of some new developments has been delayed as developers wait out the current economic slowdown. Jeddah saw retail rents fall 3% YoY and Riyadh 2%, but the Kingdom’s position as a centerpiece of the global luxury shopping sector means that the sector still expects strong performance in 2017 and the near future. Areas for future growth can be split into two categories: in the luxury sector, the arrival of delayed megaprojects projects like the USD1.6 billion, 250,000sqm Al Diriyah Festival City Mall will solidify Riyadh’s position as a luxury hub, and developers see untapped potential in the lower- and middle-income markets. Similarly to housing, the continued growth of the Saudi population will likely create new opportunities in the mid-range sectors. In the office market, rents remained stable, rising by 1% in Riyadh and falling by 1% in Jeddah, according to JLL research. The impact of the fall in oil prices could be seen in the vacancy rate, which rose to 13% in Riyadh and remained stable at 6% in Riyadh. 2017 is expected to bring more of the same, with corporate downsizing resulting in continued decreases in prices and increases in the vacancy rate. The lack of major new developments to market will is expected to keep vacancies lower, however, and should help prevent any dramatic fall in rents.
The lack of new projects has its silver linings for the real estate sector, but it speaks to the difficulties the Saudi construction sector is facing. The government has traditionally been responsible for over two-thirds of all construction activity, meaning that the industry was directly impacted the fall in revenues and corresponding tightening of the government budget. The fall in revenue led to a spate of late payments, with French credit insurer Coface reporting that payments in the construction sector were delayed by an average of 123 days. The government began a repayment system that disbursed SAD140 billion in delayed payments in the final two months of the year, but the uncertainty still took its toll. The UAE overtook Saudi Arabia as the largest construction market in the region, and some of the country’s largest contractors were forced to cut staff in the face of decreased activity. The Council of Economic and Development Affairs announced in late 2016 the cancellation of USD226.7 billion in projects; while none of the core Vision 2030 growth projects were cancelled, the decrease was another hit to a sector that could hardly afford it.
Yet despite these issues, there are a number of reasons for optimism in 2017 and beyond. The downturn has removed some superflous firms from the market, giving those that remain a better chance at success. Government spending is likely to increase throughout the year, leading to better performance in the second half of the year. The aforementioned white land tax and Vision 2030 housing developments should provide a stable new source of contracting work over the next decade, and there are a number of major projects underway that should provide an additional boost. More importantly, the current downturn has made the government realize that some structural changes are needed to stabilize the industry. Increased partnerships with the private sector to strengthen the non-government share of industry is a priority moving forward, and steps are already being taken to increase the interchanges between the two. Hassan Al Qahtani, CEO of Technical Development Company, believes that this change in strategy is key to the recovery and continued development of the construction sector. “The government reorganized its vision with a new philosophy,” Al Qahtani told TBY. “Now, the private sector is also involved.” This collaboration has taken the form of PPPs and passing some contracts onto private developers, and continued progress in this regard bodes well for the sector.
Infrastructure is one of the current focuses of Saudi Arabia’s development program, with massive transport projects planned in Mecca, Jeddah, and Riyadh. Aside from providing the sector with much-needed economic activity, the projects are key to increasing efficiency and transport options for a population that expected to add 15 million people in the next decade. The Mecca Metro project is an illustrative example of the future of the Saudi construction model and new collaborations between the government and the private sector. At USD16.5 billion, the Mecca Metro plan calls for 182km of track and 88 stations to be built over six years, but financing issues led to delays in 2016. In early 2017, the Saudi government announced that a PPP would be used to fund the project, with a tender to be awarded later in the year. The size of the project, will give the sector a boost and help return construction spending to pre-oil price decrease levels, but more promising is the use of PPPs to move construction forward even in the face of decreased public sector spending. “We need to double what the government spent [on infrastructure] over the last 30 years,” Qahtani told TBY. “The government started doing joint projects with the private sector, and this has helped us.”