Industrial investors struggle to find land in Saudi Arabia

10 July 2014

Speculation and lack of infrastructure are making it difficult for industrial players to source land in the kingdom, apart from signing lease agreements for space in dedicated zones

Many first-time visitors to Saudi Arabia are struck by the large empty plots of land that often lie right in the middle of prime urban areas. The existence of these undeveloped tracts in a country experiencing a surge in demand for prime real estate may be counterintuitive, but reflects the realities of a market structure that is ill-equipped for the commercial or industrial development of land.

The people who decide whether the land is developable are also usually the ones who control the utilities

Gulf real estate manager

Official figures show real estate activity has been increasing of late in the kingdom. According to data from the Justice Ministry, cited by US property consultancy JLL, Riyadh was the most active market in Saudi Arabia in 2013 in terms of real estate transactions, with deals worth a total of SR99bn ($26.5bn) completed, exceeding the SR87bn seen in 2012.

Of the more than 43,400 real estate transactions recorded in Riyadh, the majority of these were in the residential sector, but there was also a number of large commercial transactions, which together totalled SR47bn.

Land speculation

Despite the compelling evidence of rising transaction volumes, analysts see the Saudi market as failing to reach its full potential. The chief obstacle is a preference for land speculation over land development. Land is speculated to a point to where it is not viable to be developed commercially, because the price ultimately paid for it is simply too high.

The kingdom needs a … mechanism that makes it difficult for people to hold on to land forever

Gulf-based economist

“When land is released for development, it is typically flipped by speculators for a profit,” says a Gulf real estate manager. “Land designed as suitable for development is first sold by the owners to people within their sphere of influence, and then flipped again until the last person holding the land is ultimately in no feasible position to develop it.”

That leaves industrial land – especially strategically located plots – in scarce supply. “Scarcity of land for any asset class results in price inflation and a general inability to show reasonable investor returns unless you are already the land owner,” says Jamil Ghaznawi, head of JLL’s Saudi office. “This has restricted industrial development especially and has resulted in many commercial schemes not being financially viable in a traditional sense.”

Even when land is found, it may be in the hands of someone who is content to sit on it, or only sell at 30-40 per cent above the market value, says another Saudi realtor.

Indicative land prices in Jeddah*
 Price lower limitPrice upper limit
Residential (for serviced land)2,5006,000
Commercial 8,00025,000**
*=SR a square metre; **=On the Corniche. Source: Colliers International

Swathes of land earmarked for industrial development have sat undeveloped because of this speculation. Another factor hindering private sector industrial projects is a lack of infrastructure. Many schemes, even if the land is acquired, lack adequate provision of water, drainage, electricity and roads.

“The people who decide whether the land is developable are also usually the ones who control the utilities,” says the Gulf real estate manager. “If they develop it themselves, then of course the utility services are available. But if it’s flipped to a buyer they don’t care about, electricity and water can take a long time to come.”

The generally prohibitive prices for commercial property make it a challenge for investors to make the economics of industrial projects work. According to estimates from JLL, prices of serviced land in Saudi Arabia have been increasing at about 15 per cent a year.

Although there are no reliable figures for land prices in a market that does not possess a central land registry, there are indications that prices for industrial plots are growing faster than for residential, office and retail.

According to JLL, land in the warehouse district of Al-Faisaliah in Riyadh, is worth SR1,300-SR1,700 a square metre, whereas in the new district Ring Road industrial zone, it is worth SR1,700-SR2,700 a sq m. The difference in price is due to better road network access and infrastructure.

Move to outskirts

As a result of these factors, finding vendors ready to sell land is proving a real challenge for prospective industrial users. In Jeddah, where prices are higher than in Riyadh, companies are heading north of the centre to find land for development.

“Outside the central areas, you can still find some new developments,” says Khalid Smadi, director of the Western Region office of property consultancy Colliers International. “The northern part of the city, for example, has a good infrastructure network, which supports the development of new masterplanned communities, such as Kingdom City, Al-Fareed and Al-Rayadah.”

Another big obstacle for industrial developers is the uneven playing field, with land tending to be held by senior figures who wield considerable political and commercial influence. This can create some challenging situations. In early June, the government seized about 1.1 million square metres of land in the Al-Faisaliah district held by state-owned Saudi Telecom Company (STC).

It is unclear why the land was seized or to what extent the government will compensate STC. But for many potential commercial developers, the apparent ease with which the government was able to appropriate land from a commercial entity – even one it ultimately controls – must be a concern.

Plans for a new court to deal with real estate disputes may provide some reassurance for investors.

Reports from the kingdom indicate the Justice Ministry is preparing specialised courts to settle property disputes, with authority over land appropriations, deed ownership and disagreements between landlords and tenants. The aim is to speed up dispute resolution.

Transparent system

More needs to be done to reassure industrial developers that the real estate market is fair. Developing a transparent system based on proper zoning regulations that provide clarity on the true market value of land would enable better price formation than the primarily speculative model that persists.

“The kingdom needs a land market and a mechanism that makes it difficult for people to hold on to land forever,” says a Gulf-based economist.

Two years ago, the kingdom’s Majlis al-Shura (Consultative Council) was considering imposing a tax on holders of unused land, with a proposal to collect zakat (Islamic tax). This would involve imposing a 2.5 per cent fee on landholders, providing a greater incentive to sell or develop it themselves. The measure has been pre-approved by the council, but it is uncertain when it will take effect.

There are signs the land situation is improving, albeit slowly. “Speculation is lower compared with the situation two years ago and the developers we are working with are more serious,” says Smadi. “A few years ago, they were mainly just doing studies. Now, they are trying to do something with the land they have.”

However, the pressing demographic challenge confronting Saudi Arabia means affordable housing, rather than industrial development, will be the top priority. That leaves much of the onus on the government-owned Saudi Industrial Property Authority (Modon) to incentivise industrial developments via the provision of zoned industrial land.

Modon is already the kingdom’s third-biggest project owner, with more than $40bn-worth of projects planned or under way. The authority has built more than 300 ready-made factories to cater to the growing manufacturing sector.

Modon’s offer of subsidised rental rates as low as SR1 a sq m makes it a competitive challenger to private sector land developers.  Supervising more than 30 industrial cities, it exerts a massive influence on the market.

Land is typically leased on 30- or 50-year terms at nominal ground rents. Annual rental fees differ between each industrial city, but range from SR1-SR2 a sq m a year, including a fee for operation and maintenance, security, fire and road maintenance.

Lease agreements

Modon is on course to double the 75.8 million sq m it held in 2010 to more than 150 million sq m by 2015.

In one of the biggest deals in recent years, Germany’s Siemens signed a land lease agreement with the authority in 2012 for the construction of a manufacturing and service facility in Dammam Industrial City, where it is leasing a 220,000-sq-m plot of land that comprises facilities to manufacture gas turbines, compressors and heat recovery steam generators for the local market.

Much of Modon’s current focus is on the Dammam-3 industrial city, covering an area of 48 square kilometres. The site is located south of the city of Dammam and is set to house petroleum, mineral, plastic, automobile, food and other industries, in addition to factories producing building materials.

With the Dammam-1 and 2 industrial cities now almost at full capacity, the Saudi authorities are eager to encourage industrial users to set up in Dammam-3, with tenants in Dammam-1 being invited to relocate to the new city.

Modon’s leased land model is a convenient means for foreign industrial investors to bypass some of the industrial real estate restrictions in the kingdom. Yet for investors seeking to set up industrial facilities outside these zoned complexes, the market will remain difficult.

Despite recent attempts to unblock the land market through proposals for a tax on unused land, players will continue to struggle to secure developable land at reasonable prices in the private market.

In numbers

SR1,300 Minimum cost of a square metre of land in Riyadh’s Al-Faisaliah district

SR1 Minimum lease cost of a square metre of land in one of Modon’s industrial cities

Modon: Saudi Industrial Property Authority. Sources: JLL; MEED

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