Property prices and rents in Saudi Arabia’s two biggest cities have started to rise again as confidence returns to the market and demand continues to exceed supply.

Prices in Riyadh were up 12 per cent and rents up 6 per cent during the first quarter of 2010, when compared to the same period of 2009, says US based real estate consultant, Colliers International.

In Jeddah, prices were up 16 per cent and rents rose by 7 per cent, but rose by as much as 15 per cent in areas affected by the flash floods in November 2009, which destroyed many houses in the city.

Analysts expect the upward pressure on property to continue. Another US-based property consultant, Jones Lang LaSalle, expects prices to rise by 5-10 per cent for the next two years, with the possibility of even greater rises should the kingdom’s long-awaited mortgage law be introduced.

Prices will be driven up by the continued undersupply of real estate. New supply onto the market has been delayed since the introduction of the Escrow Law in April 2009. The law, which forbids off-plan buying has increased end-buyer confidence, has forced many developers to put their projects on hold.

In Riyadh, no major new projects were announced over the last year, and many of the earlier launched masterplan developments, such as Al-Wasl and Ajmakan, are still not finished. Developers are currently focussing on the compound sector where little new supply has been released in the last 10 years. However, while more than 300 units are in the planning stages, none have yet been built, says Jones Lang LaSalle.

The low-cost housing market is the most undersupplied. Most private developers are providing houses priced at more than $270,000, the greatest demand lies between the $135,000 and $200,000 range. The government is taking action to provide low-budget housing, building 6,000 units over the past five years through charity organisations. Despite these efforts demand is still outstripping supply.

Riyadh’s office market faces different challenges. Demand is rising, but 140,000 square metres of office space was released in 2009 and a further 50,000 sq m has been completed in the first half of 2010, and supply now exceeds existing demand. The spike in supply has increased vacancy rates, which caused rents to fall by 10 per cent during the first half of 2010, report Jones Lang LaSalle.

This fall was most noticeable in the city centre as there has been growing interest in business parks such as King Abdullah Financial District (KAFD) to the north of the city. “Traffic congestion makes city centre offices unpopular so there is increasing demand for low density out-of-town locations,” says Mike Williams, senior director and head of Middle East research consultancy, CB Richard Ellis.

This demand will be met over the next five years by developments such as KAFD, Olaya Towers and Granada Business Park that will increase Riyadh’s office space by a third.

In Jeddah, the destruction caused by the 2009 floods has made the housing shortage even more severe. Jeddah Municipality currently estimates the housing shortfall to be around 300,000 units, which is estimated to rise to 570,000 in the next 20 years.  Contrasting with Riyadh, new office supply in Jeddah has been rapidly absorbed into the market.

In the Eastern Province, the market has performed poorly as the shortage of real estate is not as chronic as it is in Jeddah and Riyadh. Residential prices have fallen by 10 per cent from mid-2009 to mid-2010 as vacancies reach 13 per cent, says CB Richard Ellis.

The Eastern Province experienced the greatest fall in occupancy for office space as more than 166,300 sq m of new stock was released in 2009 on the back of the economic crisis. Consequently, vacancies increased to 14 per cent and rents dropped by an average of 10 per cent in the first quarter of 2010 compared with the previous year.

Although demand is increasing, especially for grade B office space, supply will continue to outstrip demand in the medium term. Al-Khobar and Dammam’s office supply is expected to increase by more than 196,900 sq m in 2010, followed by an additional increase of 261,000 sq m in 2011, causing rents to reduce further, predicts Colliers International.