Saudi Arabia’s property market is on the cusp of a transformation as Riyadh turns to the private sector to try to overcome a worsening housing shortage.

The game changer will be the long-awaited mortgage law. After more than a decade of debate and discussion, the legislation was finally approved in July 2012 by the Council of Ministers. It is hoped the law will lay the foundation for a property market that will allow hundreds of thousands of Saudi nationals to buy a property for the first time.

The Housing Ministry is currently overseeing the construction of 27,850 housing units across the kingdom

“Sadly, [so far] this has not proven to be the case, with most focus applied to finance companies rather than banks, although several additional laws have yet to be published,” says US-based property consultant CBRE in a recent report of the kingdom’s real estate market. “It is hoped that [legislation] related to foreclosures will be specifically addressed in the execution law, but until this is published the issue remains unresolved.”

Housing shortage

Although there are still regulatory hurdles and practical considerations to overcome, a fully fledged mortgage system is moving closer to reality, and Riyadh is hoping to finally tackle its growing housing shortage.

In the past, inflated land prices have prevented the private sector from developing affordable housing projects because they could not deliver an end product that lower income segments of society could afford.

“High net-worth Saudis continue to favour land as a long-term investment vehicle, vastly inflating residential land prices and consequently excluding low-cost housing from vast areas of the kingdom,” says the CBRE report.

With a mortgage law and access to funding, that impasse is expected to end, making affordable housing projects viable so that developers can finally deliver the homes that so many nationals need.

The kingdom needs houses built quickly. In 2011, it was estimated that 1.1 million new homes were needed over the five-year period leading up to 2015 to meet the housing requirements of its rapidly expanding population, which is currently growing by more than 2 per cent a year. About 60 per cent of locals are estimated to live in rented accommodation, which equates to approximately 10 million nationals who do not live in properties they own.

Recognising the scale of the problem, King Abdullah bin Abdulaziz al-Saud announced in 2011 that the government would build 500,000 of those homes directly. He created the Housing Ministry to oversee the plan, which was expected to cost $70bn to deliver.

The new ministry initially embarked on a programme to build those homes directly and began to engage contractors and consultants to work on various large-scale schemes across the kingdom. It appointed the US’ Parsons in November 2011 to provide masterplanning, infrastructure design and the design of various housing types for the first phase.

Parsons was also tasked with providing construction supervision on all 11 developments. The first phase was scheduled to cover a total area of 32 million square metres divided between the 11 sites around the country.

Some progress has been made, with the ministry currently overseeing the construction of 27,850 housing units, most of which were started before the body was created in 2011. This approach, however, was abandoned earlier this year as the ministry turned to the private sector.

Change in housing strategy

In May, it emerged the Housing Ministry was preparing to hand over land to private developers and individuals to build the homes.

As the ministry prepares to engage the private sector, it has cancelled the first construction packages it had already awarded, including a deal to build 7,000 villas in Riyadh. Instead, it will focus on land improvement packages and infrastructure works, while encouraging developers and individuals to build their own homes on the proposed sites – something mortgages should make possible on a large scale for the first time.

In the meantime, more stock is being added to major population centres, such as Riyadh and Jeddah. In Riyadh, about 8,000 units were completed in the first quarter this year, according to US-based property consultant Jones Lang LaSalle (JLL).

This takes the overall stock to 917,000 homes, with most recent supply being added in smaller projects of fewer than 20 units, rather than the sprawling megaprojects first planned by the Housing Ministry.

In the near term, JLL expects another 129,000 units to enter the market by 2016, with an annual increase of 32,000 units. Despite this new supply, residential prices are rising. Average villa sales prices have rebounded from a slump during the second quarter of 2012. In the first quarter of this yearprices returned to early 2012 levels, of about SR4,250 ($1,133) a sq m. Average apartment sales prices have also risen since the beginning of 2012, and in the first quarter of 2013 were at about SR2,900 a sq m.

In Jeddah, 4,500 new units were completed during the first quarter of 2013, according to JLL. No major projects were finished and all the new supply came from small projects delivering 40-100 homes. A further 15,000 units are expected to be completed during 2013, again mostly from small projects. For pricing, in Jeddah the average sale price of villas was SR4,600 a sq m during the first quarter of 2013, while the asking price for apartments was SR4,150 a sq m.

Commercial property prospects

Away from the residential sector, the market for high-end commercial property has traditionally performed strongly due to limited stock in major cities. That is changing. According to JLL, Grade A and Grade B office space in Riyadh increased by 61,000 sq m during the first quarter of this year to stand just short of 2 million sq m.

More supply will be added with the completion of the initial phases of King Abdullah Financial District (KAFD), the IT & Communications Complex and the General Organisation for Social Insurance’s Olaya Towers at the intersection of Tahlia and Olaya roads. The addition of new stock away from the traditional central business district (CBD) has created some geographical confusion as tenants struggle to decide whether to locate in the existing CBD or KAFD, says CBRE.

When completed, KAFD will have 2 million sq m of prime office space. CBRE adds that there is growing concern that such a large volume of new supply will overwhelm the market.

In the longer term, Riyadh’s property market will change once its new metro network is completed in 2018, although the impact is expected to take several years to fully kick in.

In general, the price of real estate located close to metro stations will increase once the network is built and residents and businesses in the city begin to understand and value the benefits of improved mobility, especially near commercial properties.

There will be a slightly negative impact on residential use very close to metro stations due to environmental factors, such as noise, vibration, traffic and aesthetic impacts, although values and rental rates for residential use are enhanced a short distance from metro stations, says CBRE.

In Jeddah, the office market is more fragmented with no main CBD. As a result, there are variations in both the quality of stock on offer and the location, which makes meaningful price comparisons difficult. There are several major new developments currently being built and as those schemes are delivered they should improve the general quality of office space in the city.

The largest new project is Kingdom City, which is being developed by Jeddah Economic Company. The scheme includes the 1-kilometre-tall Kingdom Tower. It is intended to be the world’s tallest building, almost 200 metres taller than Dubai’s Burj Khalifa.

Mecca real estate projects

Away from Riyadh and Jeddah, another city attracting investment is Mecca. The holy city has a unique property market as it attracts more than 2 million religious pilgrims every year, making it an attractive proposition for mixed-use developments that offer hotel, residential and retail space.

Indonesian state-controlled construction company Wijaya Karya is considering plans to build a $1.1bn real estate scheme in Mecca. The seven-tower hotel complex will be developed with a local partner. Each tower will have 1,000 rooms.

If the project goes ahead, it will join several other $1bn-plus developments that have moved into the construction phase in recent years. This year, the local Saudi Binladin Group won an estimated $3.5bn contract to build the Abraj Kudai mixed-use development. The scheme, which involves building 12 towers ranging in height from 30 to 45 storeys, was the latest major real estate project to be tendered in Mecca. In 2012, more than $1bn of contracts were awarded for work on the Jabal Omar Development.

If the government can capture the enthusiasm that the private sector has for development in Mecca and apply it to projects across the kingdom, then its housing problem will quickly become a footnote in history. Before that can even start to happen, however, an active mortgage market needs to develop, and experience shows that in Saudi Arabia that will take years rather than months.