S&P Global Ratings expects Saudi Arabia's investments in the non-oil economy as part of its Vision 2030 program will underpin the country's economic expansion and support GDP growth. The capital Riyadh is not only receiving a rising number of expatriate workers but also an influx of workers from other parts of the country. It's therefore no surprise that development of the real estate sector is a key priority. That said, demand for real estate in Saudi Arabia is sensitive to high interest rates and prices. In 2023, amid rising interest rates, the number of real estate transactions reportedly dropped by 16% and new mortgage lending also declined.

As the country accelerates on its growth and transformation trajectory, opportunities for developers are increasing but so are challenges. We expect to see a widening gap between large urban centers attracting populations and more remote areas where demographic developments are less favorable. Therefore, real estate developers' pricing power and sales will also vary depending on the regions.

Considering the high capital intensity of real estate development and listed Saudi developers' generally highly leveraged capital structures, we expect funding and refinancing needs to remain high. Increasing and broadening funding sources is therefore one of the key hurdles we foresee for property developers in Saudi Arabia.

Economic Growth Will Benefit From Increasing Activity

We forecast overall GDP growth in Saudi Arabia at 3.4% on average annually in 2024-2027 (see chart 1), supported by large public and private investments and robust consumption growth. We expect the non-oil sectors, which account for about 60% of GDP, will drive overall economic expansion of 2.2% in 2024, after a contraction of 0.8% in 2023. Overall growth outcomes have been moderated by cuts in oil production since 2023.

Chart 1

We see a risk of fiscal pressures related to the economic transformation program but expect the government's net asset position to remain relatively robust. For our forecasts, we assume the Brent price at a relatively high $85 per barrel (/bbl) for the rest of 2024 and $80/bbl in 2025-2027.

The government's announced real estate and infrastructure projects reportedly exceed $1 trillion in value. These include a wide range of initiatives, such as the construction of new cities like NEOM, Diriyah Gate in Riyadh, and many others. The ultimate objective is to increase home ownership by Saudi nationals to 70% by 2030 from 63.74% in 2023. At the same time, the real estate sector's GDP contribution is expected to rise to 10% by 2030 from 6% currently.

Real Estate Supply Needs To Catch Up With Demand

The government expects Saudi Arabia's population to increase and the share of expats to rise to 50% from about 42% by the end of the decade. We base our expectations for the real estate sector on our assumption of 3.0%-4.0% annual population growth over 2024-2027. Riyadh alone is expected to see population numbers rise significantly, further straining the city's already undersupplied real estate market, since the new supply will likely not meet the incremental demand. We think smaller cities that offer less opportunities to Saudi nationals and expats, may be negatively affected by an outflow of their populations to Riyadh or Jeddah.

Reliance on mortgage loans is relatively high: 30%-40% of Saudi nationals own properties secured by a mortgage. Mortgage loans are provided at fixed rates in Saudi Arabia. Consequently, higher interest rates are dampening new mortgage lending, while older mortgage loans are generally not affected. Tighter liquidity and interest rate hikes therefore led to a 33% drop in the number of new mortgage contracts in 2023, with mortgage lending growth slowing to 10% in 2023 from 23% in 2022 (see chart 2).

Chart 2

Mortgage loans totaled Saudi Arabian riyal (SAR) 607 billion at the end of 2023, up SAR57 billion from 2022, although overall growth was down 45% compared with the previous year. If, as we anticipate, the U.S. Federal Reserve Bank starts lowering its rate from December 2024, with rate cuts reaching a cumulative 250 basis points in the second half of 2026, the Saudi authorities might do the same, resulting in an uptick in demand for property. However, increasing demand and tight supply will likely keep pushing up residential property prices and rents, particularly in Riyadh and Jeddah. This would reduce the benefit of potentially lower interest rates on the overall affordability of housing. In the first quarter of 2024, the residential price index went up by 0.6%, according to the General Authority for Statistics.

Government Support And Bank Mortgage Loans Provide A Solid Foundation

We expect mortgage lending to continue to expand, although slower than in the past, due to the market's maturity, an expected rise in corporate lending as projects related to Vision 2030 are implemented, and tighter banking system liquidity.

The Saudi government has introduced various initiatives over the past few years via the National Transformation Program that support demand for mortgage loans.   It has also done so via the Ministry of Municipal and Rural Affairs and Housing (MoMRAH), such as the MoMRAH Sakani program, support from the Real Estate Development Fund (REDF) through interest-free mortgage loans, and the REDF's mortgage guarantee scheme. Other measures, such as reduced taxation of 5% on real estate and 2.5% tax on undeveloped land, further support real estate development.

The government has also set up the Saudi Real Estate Refinance Company (SRC) to help attract alternative financing sources.   The SRC is fully owned by the Public Investment Fund (PIF), and its main mandate is to buy mortgage loans from banks and other financial institution and refinance them through sukuk issuance. As of year-end 2023, the SRC had bought mortgage loans totaling SAR26.7 billion, equivalent to about 5% of the banking system's mortgage lending book. We believe higher interest rates, possible unrealized losses, and good profitability on mortgage lending are the main reasons why banks are not aggressively divesting them. The SRC has refinanced these acquisitions by issuing sukuk guaranteed by the government.

The Saudi government has a direct financial interest in real estate developers operating in the country.   Via the PIF, the government owns stakes in certain real estate companies listed on the Saudi Exchange (Tadawul)--a 25% stake in Emaar Economic City and 64.6% of Saudi Real Estate Co--as well as in other unlisted companies. The most notable examples of the latter include PIF's fully owned ROSHN (not rated), one of the country's largest real developers with revenue of $1.8 billion reportedly in 2022, which is on track to build about 400,000 homes by 2030. ROSHN contracted SAR6 billion of bank financing last year, suggesting forward momentum on its projects. In our view, the government's direct involvement in real estate developers supports the successful achievement of its target for 70% of Saudi nationals owning their own home by the end of this decade.

Saudi Developers Will Keep Expanding Despite A Bumpy 2023

We expect that healthy demand will continue to drive Saudi developers' revenue and profits in 2024-2025, with marginal relief from expected lower interest rates. Also as projects scale up, we expect they will demonstrate steady profitability, following the improvement seen in 2023.

Although listed real estate companies showed mixed revenue performance in 2023, the sector's average profit margin improved, which should support further growth.  Real estate developers in Saudi Arabia operate in a relatively fragmented market, and no single entity has a dominant market share. However, a structural shortage of housing alleviates competitive pressures to some extent. The combined revenue of the 16 Tadawul-listed real estate management and development companies increased 15% in 2023, with 12 companies demonstrating growth and four showing revenue contraction (see chart 3). However, over 40% of these companies generate most of their revenue from leasing property, which we see as posing lower risk than real estate development because it is inherently more stable and profitable. Listed developers alone recorded a 10%-11% combined revenue increase in 2023. We expect healthy demand will keep driving their revenue and profits in 2024-2025, with some help from expected lower interest rates.

Chart 3

Reported EBITDA margin improvement in the sector was also uneven (see chart 4). On average, the S&P Global Ratings-adjusted EBITDA margin strengthened last year to about 46% from about 40% in 2022 across all listed real estate management and development companies (excluding negative values). However, the margin for real estate developers, specifically, improved on average to about 25% from 20%. This exceeds the average of 14%-15% for developers we rate globally, but is lower than the 37% average in 2023 (after our adjustments) for property developers we rate in Dubai, who benefit from strong momentum and double-digit price increases compounded over the past three years. In a downward trending real estate cycle in Dubai, before the pandemic started in 2020, EBITDA margins were closer to 15%-20% for smaller rated developers and 35%-40% for the dominant player, Emaar Properties, which also benefits from higher-margin leasing operations.

Chart 4

Projects Could Transform Developers' Funding And Capital Structures

Considering the unprecedented size of Saudi Arabia's announced real estate projects, and expected population growth, financing needs will be significant through the end of this decade.

We expect to see all market participants undertake new funding.   This implies significant annual debt issuances by the sovereign; various government agencies, including the PIF; and real estate companies. As a consequence, we expect Saudi corporates will continue diversifying their funding sources, thereby accelerating the development of Saudi Arabia's capital markets, another objective of the government. We also expect a rising contribution from international debt.

On average, listed Saudi developers have higher leverage than their counterparts in Dubai.   Based on publicly available information, listed Saudi Arabia-based real estate companies' cumulative debt exceeded $13 billion as of year-end 2023. The reported gross debt-to-EBITDA ratio for the listed real estate companies averaged 5.0x-6.0x, comparable to our 5.5x adjusted average for developers we rate globally. However, on average, real estate developers have higher leverage than real estate leasing companies, mirroring their capital-intensive and less profitable operations. Developers' gross leverage was 7.0x-7.1x at year-end 2023, as opposed to 4.6x-4.7x for real estate leasing companies.

In sharp contrast, Dubai-based developers' leverage ratios are much lower and have reduced significantly over the past few years, amid exceptionally favorable conditions that boosted their profits and cash flows. We estimated their gross leverage at 1.0x-1.2x. That said, companies we rate in Dubai include major market players--Emaar Properties, Damac, and PNC Investments (Sobha)--whose brand strength and pricing power are unmatched in that market. Therefore, the average ratio doesn't represent the diversity of profiles of Dubai real estate companies. Generally, Dubai-based developers benefit from off-plan operating models and a payment-collection cycle that has been significantly accelerated since 2021 amid favorable demand trends. Payment plans after the handover of properties are no longer common in Dubai, we understand they are still common in Saudi Arabia. Nevertheless, Dubai-based developers are currently operating in top-cycle conditions, which we expect to soften from 2025.

We think off-plan property sales will rise, considering Saudi Arabia's housing supply needs and high funding requirements.   Off-plan development has the potential to reduce the sector's funding needs, since it offers the convenience of prefinancing construction by accelerating cash collection and hence also derisking for developers. In the first half of 2023, off-plan transactions increased by 52% and we expect the strong growth will continue, supported by a reported 9% increase in off-plan developer numbers over the same period. It's been over five years since regulation of off-plan sales has been introduced under Wafi program. Although this segment is expanding, it is not disrupting the market, owing to many buyers' preference for a fully completed home, lack of trust and awareness of the process, and rising interest rates.

Riyadh's Rising Prominence As A Regional Hub Is A Key Factor

Saudi Arabia's capital city has been attracting new residents, both from within the country and abroad. Although real estate transactions decreased in 2023 at the national level, Riyadh reportedly saw 7% growth, despite rising house prices. With about 2.27 million existing housing units (based on the 2022 population census) and significant population growth expected through 2030, the need for new residential units is quite high. In addition, authorities believe the number of international visitors will increase in view of a series of planned events, like the 2030 World Expo.

We expect a boost to office rental rates in Saudi Arabia as new businesses take up residence   As of January 2024, foreign companies with government contracts are required to establish their regional headquarters in Saudi Arabia. Riyadh will be a direct beneficiary, since we expect it will push up demand for office space. Demand from government-related companies in Riyadh is also boosting office rents. Riyadh's main rival regarding commercial (offices), residential, and retail real estate appears to be Dubai. And Saudi Arabia's new headquarters program, which offers tax incentives, could lure corporate interest from this well-established business hub. However, at the moment, we see no meaningful data indicating an exodus of companies out of Dubai. Rather, we observe that international groups tend to establish a second headquarters in Riyadh, rather than relocate. In 2023, there was a 34% increase in new company registrations at the Dubai International Finance Center (not rated) and a 15% rise in new customers of Tecom (not rated).

The Premium Residency program, introduced in January 2024, could stimulate demand from foreign buyers.  Residential real estate prices in Riyadh have been rising since 2020, supported by strong local demand (see charts 5 and 6). With the recently announced simplified ownership and residency rules for foreigners, demand from international buyers is set to increase, and could help real estate transactions return to growth after a weak 2023. Based on the population census of 2022, less than 5% of housing units in Saudi Arabia are owned by nonnationals, indicating ample growth potential. Under the new program, international buyers will be able to purchase properties across the country. We expect Riyadh to capture the bulk of international interest. However, a high SAR4 million (about $1.07 million) property investment requirement under the program may be prohibitive for many potential buyers and primarily targets high net worth individuals. By contrast, the terms of the long-term residency visa (Golden Visa) in Dubai include a lower UAE dirham (AED) 2 million ($0.54 million) investment requirement. The property acquired by foreigners in Saudi Arabia under the program cannot be mortgaged, while in Dubai the purchase can be financed through a mortgage loan. Only a few weeks after the new foreigner property ownership program was announced in Saudi Arabia, Dubai's authorities announced the cancellation of the AED1 million minimum downpayment requirement to qualify for its 10-year residence visa, further boosting Dubai's competitiveness in the Gulf Cooperation Council region. Demand from foreign investors has led to double-digit house price growth rates in Dubai for the past three years.

Chart 5

Chart 6

Funding The Property Sector's Growth Is One Of The Biggest Challenges

Securing adequate funding to keep growth on track to meet the 2030 target represents an important area of uncertainty. In our view, tighter liquidity in the Saudi banking system means that alternative funding sources will be required, particularly given the size of projects across the country and in various sectors. Real estate developers will increasingly need to tap local and foreign capital markets, amid still relatively high funding costs. For many of them, this scale of expansion is new and investor appetite is broadly untested, particularly for small privately owned companies.

By the same token, sustainable real estate development, still a fledgling concept, is also an objective of Saudi Arabia's Vision 2030 program. Bearing in mind high carbon emissions from buildings, we expect regulatory pressure on developers to intensify in the coming years as the country refines its strategy to achieve its net zero target in 2060. We therefore expect tighter regulations to encourage greener buildings, with a focus on energy, water consumption, and waste reduction. We also expect Saudi developers will increasingly use sustainable practices in construction and the choice of building materials, while also aligning with local and international certifications, such as the Mastadam Certificate and LEED, similar to the trend we observe in neighboring Dubai.

Navigating the rapidly expanding and competitive property market, adapting to sustainability standards, and securing adequate, affordable funding are the main challenges Saudi real estate developers will face in the next two to three years.

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