Kingdom of Saudi Arabia CHANGING COMPOSITION Compound Sector Overview
Ian Albert Regional Director Middle East and North Africa ian.albert@colliers.com Imad Damrah Managing Director Saudi Arabia imad.damrah@colliers.com Like many industries and property sectors, the compounds sector in KSA has not been immune to the current economic downturn; a direct consequence of the drop in oil prices, which has affected many facets of the economy, particularly larger firms in oil & gas and construction related industries. Fouad Abou Rafeh Associate Director Saudi Arabia fouad.abourafeh@colliers.com With subsequent cost cutting and significant reductions in management level expatriates, the compound subsector of the real estate market has witnessed a fall in both rental levels and occupancies, a situation hardly conceivable until 2014 or 2015. Colliers proposes that the structure of the sector is changing and will need to adapt in the medium to long term to remain successful. Bilal Siddiqui Manager Saudi Arabia bilal.siddiqui@colliers.com In this paper, we will explore the drivers of the compound sector, performance comparison of KSA s three major markets (Riyadh, Jeddah and Dammam/Al Khobar) and conclude with the structural changes expected to take place along with their implications on existing assets. Faisal El Shami Senior Analyst Saudi Arabia faisal.elshami@colliers.com 2 Changing Composition Compound Sector Overview 2017 Kingdom of Saudi Arabia
Demand Drivers Target Segment The compound concept was introduced to KSA with the arrival of foreigners in Eastern Province, primarily from North America, for Aramco. Over time, they evolved into enclaves for foreign employees, which were either in the form of smaller compounds with tenants of a single organization or larger compounds with tenants belonging to multiple organizations. This was supported by the Government, which obliged organizations with more than 50 foreign employees to provide housing for their workforce. Typically, foreign employees were segregated in three groups and compounds associated with them had the following characteristics 1 : Labor Blue collar workers who were provided basic accommodation. Semi-skilled Unmarried white collar workers (technicians, engineers, nurses, etc.) who were provided better accommodation with limited amenities/services. Skilled executives Mostly married white collar workers in management positions. They were provided with a higher standard of housing often with landscaped common areas, support services, and finer facilities such as swimming pools and gymnasiums. 1 Glasze & Alkhayyal, 2002 Changing Composition Compound Sector Overview 2017 Kingdom of Saudi Arabia 3
This report focuses on the compound market traces within the third segment. With the arrival of expatriates in the later part of the 20th century, the private sector started developing residential compounds to cater to this demand. For most companies, outsourcing executive housing needs to the private sector was a better alternative than building their own and brought the benefits of economies of scale for developers. Until the late 1990 s, a majority of compounds were exclusively targeting Western expatriates. However, with the emergence of further supply and the decline of Western executives in the early 2000 s, many compounds expanded their target segment to include executives of non-western nationalities. Today, most compounds cater to an array of nationalities, while placing greater focus on those of Western origins. Western Non Western High Income Expatriates Demand drivers for compounds can be summarized into two broad categories: MACRO DRIVERS that provide incentives for developers to initiate compound developments: > Expat Population the small percentage of highly paid expat executives is the principal target segment for compounds, ideally creating demand for a home away from home concept > Land Availability right size land within attractive locations refers to sites with proximity to schools and work places rather than central city locations > Land Price a key determinant to a compound s financial viability, this is especially important as a significant part of the site is used in nonrevenue generating components (such as landscaping and facilities) MICRO DRIVERS that provide incentives for tenants (organisations and individuals alike) to select a compound residence: > Community compounds as a mode of accommodation are primarily driven by the community lifestyle they foster for households of similar backgrounds. This single aspect enables them to charge premiums over standard residential developments which typically do not encourage social interaction > Facilities and Amenities an important aspect of community lifestyle that promotes social interaction and acts as a major differentiator between standard residential developments and compounds > Security an essential element that provides ease of mind for tenants, who frequently travel for business. Acknowledging that their families are in a safe and secure environment, where they can interact with people of similar backgrounds, is one of the central rationales behind why compounds are preferred over standard developments 4 Changing Composition Compound Sector Overview 2017 Kingdom of Saudi Arabia
Population 2 & Compound Target Segment Estimation (2016) Population 1.8 M Dammam/ Al Khobar Population 6.3 M Expatriate Population: 0.8 million, 44% of Total Population Target Segment: c. 34,700, 4,5% of Expatriate Population Population 4.2 M Jeddah Expatriate Population: 2.2 million, 52% of Total Population Target Segment: c. 34,100, 1.6% of Expatriate Population Riyadh Expatriate Population: 2.7 million, 42% of Total Population Target Segment: c. 39,300, 1,5% of Expatriate Population 2 General Authority for Statistics Macro Drivers Expat Population Micro Drivers Security Facilities Community Land Availability Land Price Changing Composition Compound Sector Overview 2017 Kingdom of Saudi Arabia 5
OPEX Operating expenditures (OPEX) vary in compounds and are a factor of developer experience and property grade. The range of OPEX can be between 15% and 25% of total revenues, and includes the following major expenses: > Management & Administration > Compound Staff & Security > Maintenance > Landscaping > Insurance > Provisions for Renovation Compounds are complex real estate assets requiring operational expertise of a skilled property manager. These managers have a broad list of responsibilities such as overseeing a large support team (i.e. security, cleaners, admin staff, etc.), ongoing maintenance, and tenant services. Compounds follow a more complicated operational model than typical residential developments, which is reminiscent of a simplified version of hotel operations. HIGH Operational Complexity MEDIUM LOW RESIDENTIAL COMPOUND HOTEL > Limited provision of facilities and amenities > Security is dependent upon the public sector > Property management restricted to principal activities only where one manager oversees multiple properties > Examples include; rent collection and common area cleaning (mostly remunerated by tenants) > Sizeable provision of facilities and amenities, which are in many cases comparable to hotels > Security under the supervision of the property > Sophisticated property management which handles maintenance, common tenant services, cleaning, etc. Each compound is typically managed by a single manager, with minor admin support > First rate facilities and amenities > Security under the supervision of the property > Complex property management with responsibilities ranging from bookings, sales, marketing, cleaning, concierge, etc. Handled by a general manager with the support of a team of specialist managers for each department 6 Changing Composition Compound Sector Overview 2017 Kingdom of Saudi Arabia
Compound Sector Performance Colliers Grading Matrix Colliers developed a grading criteria matrix to classify residential compound supply into different tiers: Premium Grade, Grade A, and Grade B. The grading matrix is based on the following elements: COMMUNITY SERVICES SECURITY DIFFERENTIATION Size, Community & Lifestyle Facilities, Amenities & Services Offered Security & Safety Measures Innovation, Quality & Location The following performance indicators depict price premiums of compound tiers across all units. The performance indicator is the result of categorizing and analyzing the performance of more than 120 compounds across Riyadh, Dammam/Al Khobar and Jeddah: The average market lease rate across all classified compounds is SAR 981/sqm based on GLA 20% 15% 10% 16% Premium Grade Grade A Grade B Base Line: Avg Market Lease Rate 5% -5% -10% 6% 981 [SAR/sqm] -15% -20% -22% Changing Composition Compound Sector Overview 2017 Kingdom of Saudi Arabia 7
Performance Indicator APARTMENTS VILLAS Unit mix Average Apartment Unit Price Premium % Over Villa Units Unit mix Riyadh Jeddah Dammam/ Al Khobar 44% 20% 56% 35% 16% 65% 41% 40% 59% Compound developers receive the highest possible lease rate (SAR/Sqm) from apartment units rather than from villas due to the size factor. In addition, due to multiple apartment units sharing the same land area, these units tend to absorb more land cost than villas and are more affordable for the tenant. 2015 vs 2016 Performance 1,300 1,256-3.4% 1,178 1,000-15.1% 1,148 941-18.1% 1,023 897-12.3% 903 827 962 879-8.4% -8.7% Riyadh Khobar Jeddah Riyadh Khobar Jeddah 2015 2016 % Change 2015 2016 % Change > The 2016 listed prices for villas and apartments in the above analysis have been discounted by 10% for Riyadh, 5% for Dammam/Al Khobar and 5% for Jeddah. Through our research, Colliers was able to ascertain average discounts in the market, which can be attributed to current economic conditions, decreased occupancies (approximately 75% for compounds in Riyadh, 90% in Jeddah and 92% in Dammam/Al Khobar), and the shifting bargaining power from owners/developers to tenants. > In addition to the typical annual payment term, new flexible payment terms in the form of periodic payments (semiannually, quarterly, etc.) have emerged in many compounds (especially in Jeddah). > Tenant profiling is becoming more flexible, which implies efforts by compounds in expanding the current target segment to maintain occupancy levels. > The emergence of residential complexes (a new breed of residential compounds) have been gaining popularity amongst tenants. These complexes are in line with Grade B compounds and predominantly offer apartment units, limited facilities & amenities and typically have small land areas. The operational mechanism of these assets is similar to compounds, but are not as complex due to their smaller size and limited service provisions. 8 Changing Composition Compound Sector Overview 2017 Kingdom of Saudi Arabia
Compound Economic Indicators To arrive at a target land price, the following variables were assumed based on average market data of Riyadh, Jeddah and Dammam/ Al Khobar. Assumptions such as land area, density and construction costs were standardized to allow for comparison. This exercise intends to provide an indication of land prices for compounds aiming to generate a project IRR ranging between 8%-12%. City Land Area (Sqm) Target Density (Du/Ha) Unit Mix Villa Lease (SAR/Sqm) Apartment Lease (SAR/Sqm) Construction Cost (SAR/ Sqm) Riyadh 56% Villas - 44% Apartments 897 1,256 Jeddah 50,000 50 65% Villas - 45% Apartments 879 941 Dammam/Khobar 59% Villas - 41% Apartments 827 1,000 3,500 for Residential BUA Target Land Prices [SAR/sqm] Riyadh Jeddah 2500 2000 1500 1600 Dammam/ Al Khobar 2100 800 1500 SAR/sqm SAR/sqm SAR/sqm 400 1000 450 500 450 Riyadh has higher target land prices due to higher lease rates, which allows developers to target feasible projects with higher land costs. The analysis is indicative and highly subjective to the following factors: > Compound Market Conditions > Inflation and OPEX > Area Program, Design & Associated Product Mix > Facilities Amenities & Differentiation Factors > Construction Cost & Quality of Development > Leasing Strategy & Marketability > Project Timing & Initiation Changing Composition Compound Sector Overview 2017 Kingdom of Saudi Arabia 9
Structural Changes & Their Implications The changes in key market demand profiles encourages and sometimes forces innovation and deviation from the original compound goal consequently targeting other segments. The exhibit below indicates that compounds could start targeting other segments through a revised operational model. For example, compounds may target Saudi nationals who are looking for a semi-gated community by offering units for sale. Implications on each compound tier, based on these factors, are as follows: Potential Segments These qualities are generally associated with high income segments, student housing, staff accommodation, etc. The Key for Residential Offering Emphasis on facilities & amenities and security under the umbrella of a community lifestyle The Type of Real Estate Asset They are residential assets. The residential segment has one of the highest demand levels The Most Basic Property of Compounds Quintessentially, compounds are real estate assets Premium Grade Grade A Grade B > New Developments (in the pipeline and those with less than 10 years of operation): > There is limited room for growth in this segment, especially within the short to medium term. Due to high construction costs and strong competition, higher investment risks (as opposed to previous years) is expected > Performance for an asset is highly dependent on quality leadership and differentiation factors both of which are costly to offer > Hence, exit strategies should be thoroughly considered for developments in the pipeline > Older Developments (more than 10 years of operation): > Existing assets would compete with Grade A and could likely succeed due to better quality > New Developments (in the pipeline and those with less than 10 years of operation): > Limited opportunities for success, hence newer investments have low potential > Likely to compete with both premium and grade B compounds, with limited success > Grade B compounds offer better pricing, while Premium compounds offer better quality > Older Developments (more than 10 years of operation): > Many assets could target a different segment or operational model > Some might find selling the compound (if applicable) a better alternative due to price appreciation of their land > New Developments (in the pipeline and those with less than 10 years of operation): > Expansion to target a larger variety of expats through price leadership > In achieving this objective, unit size efficiency and facilities offered play a critical role. Furthermore, cost structures would likely require a revisit to reduce expenses, where possible > Older Developments (more than 10 years of operation): > Depending on the objectives of each compound, existing assets might be better suited for exiting (potentially through sale of land) or through price competition 10 Changing Composition Compound Sector Overview 2017 Kingdom of Saudi Arabia
Developers & Investors: As market dynamics shift and undergo changes, some market practices are already adapting to cope with the changes. This includes more flexible payment terms, innovative product offering, targeting niche markets, or expanding the current target segment. Reassessing the compound segment may provide insight to potential opportunities and innovation in the compound target segment. It is worth noting that a small percentage increase of the target segment from the total expat population can double the market and increase demand. However, determining the full implications of an expanded target segment is premature. The target segment can expand due to mainly monetary incentives such as the introduction of lower priced units in residential complexes or lowering of lease rates in older properties. The latter can make residential compound units accessible to certain segments that aspire to live in compounds but cannot afford it at current prices. Government initiatives and changes in regulation can also have a strong impact on the market. For instance, the recent advent of Home Owners Association (Ettihad Al Mullak) may make the sale of individual units viable for properties. The rising quality of standard residential units and the offering of residential complexes may result in substitutes for the existing supply. Currently, the introduction of premium grade and grade A compounds are not recommended, however, exceptions could be considered depending on their differentiation factors and exit strategies. Real Estate Investment Trusts (REITs) may provide opportunities for investors and developers. However, a sustainable income source would be a basic requirement, where high occupancies should take priority over higher rental rates. Riyadh Jeddah Dammam/Al Khobar City Averages Newer Developments: Exit strategies should be thoroughly considered for the recently introduced and forthcoming developments. The bargaining power of customers and price sensitivity should be taken into consideration by offering differentiation factors (quality and/or price). Older Developments: Expatriate population is 46% of total population Average target segment is 1.9% of total expat population Small increase in the current target segment (2% for high income expats) will double the market for compounds Developers and investors would likely consider opportunity costs associated with the running of their property and the sale of their land, as a majority of the older developments are situated in locations that have witnessed an appreciation in value over the past years. Compound developments older than 10-15 years, specifically those attributed with poor performance, can change their strategy and be repositioned to become stable income generating assets. This can include increasing the density of the development in popular product types (such as apartments). Changing Composition Compound Sector Overview 2017 Kingdom of Saudi Arabia 11
operating from 68 countries on 6 continents $2.6 billion in annual revenue 2 billion square feet under management over 15,000 professionals and staff For further information, please contact: Ian Albert Regional Director Middle East and North Africa MAIN +971 4 453 7400 ian.albert@colliers.com Imad Damrah Managing Director Saudi Arabia MAIN +966 11 273 7775 imad.damrah@colliers.com Fouad Abou Rafeh Associate Director Valuation & Advisory Services Saudi Arabia MAIN +966 11 273 7775 fouad.abourafeh@colliers.com Bilal Siddiqui Manager Valuation & Advisory Services Saudi Arabia MAIN +966 11 273 7775 bilal.siddiqui@colliers.com Faisal El Shami Senior Analyst Valuation & Advisory Services Saudi Arabia MAIN +966 11 273 7775 faisal.elshami@colliers.com Colliers International Saudi Arabia Riyadh Jeddah +966 11 273 7775 +966 12 610 5900 About Colliers International Colliers International is a global leader in commercial real estate services, with over 15,000 professionals operating in 68 countries. Colliers International delivers a full range of services to real estate users, owners and investors worldwide, including global corporate solutions, brokerage, property and asset management, hotel investment sales and consulting, valuation, consulting and appraisal services and insightful research. The latest annual survey by the Lipsey Company ranked Colliers International as the second-most recognized commercial real estate firm in the world. In MENA Colliers International has provided leading advisory services through its regional offices since 1996. Colliers International currently has offices in the region located in Dubai, Abu Dhabi, Egypt, Qatar, Riyadh and Jeddah. colliers.com/saudiarabia Copyright 2017 Colliers International. The information contained herein has been obtained from sources deemed reliable. While every reasonable effort has been made to ensure its accuracy, we cannot guarantee it. No responsibility is assumed for any inaccuracies. Readers are encouraged to consult their professional advisors prior to acting on any of the material contained in this report. Accelerating success.