Kingdom of Saudi Arabia CHANGING COMPOSITION · drop in oil prices, which has affected many facets of the economy, particularly larger firms in oil & gas and construction related

CHANGING COMPOSITION Compound Sector Overview

Kingdom of Saudi Arabia

2 Changing Composition | Compound Sector Overview | 2017 | Kingdom of Saudi Arabia

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.

With subsequent cost cutting and significant reductions in management level expatriates, the compound sub-sector 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.

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.

Imad DamrahManaging Director | Saudi Arabia

[email protected]

Fouad Abou RafehAssociate Director | Saudi Arabia

[email protected]

Bilal SiddiquiManager | Saudi Arabia

[email protected]

Faisal El ShamiSenior Analyst | Saudi [email protected]

Ian AlbertRegional Director | Middle East and North Africa

[email protected]

1 Glasze & Alkhayyal, 2002

3Changing Composition | Compound Sector Overview | 2017 | Kingdom of Saudi Arabia

Demand DriversTarget SegmentThe 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 characteristics1:

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.


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.

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

Western Non Western

High Income

Expatriates

2 General Authority for Statistics


Expatriate Population: 2.7 million, 42% of Total Population Target Segment: c. 39,300, 1,5% of Expatriate Population

Riyadh

Expatriate Population: 2.2 million, 52% of Total Population Target Segment: c. 34,100, 1.6% of Expatriate Population

Jeddah

Expatriate Population: 0.8 million, 44% of Total Population Target Segment: c. 34,700, 4,5% of Expatriate Population

Dammam/Al Khobar1.8 M

Population

Macro Drivers

Land Price

Land Availability

Micro DriversSecurity Facilities Community

Population2 & Compound Target Segment Estimation (2016)

Population

4.2 M

6.3 MPopulation

Expat Population


RESIDENTIAL COMPOUND HOTEL

Operational Complexity

LOW

MEDIUM

HIGH

Base Line: Avg Market Lease Rate

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.

> 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

OPEXOperating 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


Compound Sector PerformanceColliers’ Grading MatrixColliers 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:

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:

Base Line: Avg Market Lease Rate

981 [SAR/sqm]5%

-20%

10%

-15%

15%

-10%

20%

-5%

COMMUNITY

Size, Community & Lifestyle

SERVICES

Facilities, Amenities & Services Offered

SECURITY

Security & Safety Measures

DIFFERENTIATION

Innovation, Quality & Location

The average market lease rate across all classified compounds is SAR 981/sqm based on GLA

Premium Grade

Grade A

Grade B16%

6%

-22%

2015

vs

2016

Per

form

ance


Riyadh Khobar Jeddah

2015 2016 % Change

1,023

897

903

827

962

879

-12.3%

-8.4% -8.7%

Riyadh Khobar Jeddah

2015 2016 % Change

1,300

1,256

1,178

1,000

1,148

941-3.4%

-15.1%

-18.1%

Riyadh

Jeddah

Dammam/ Al Khobar

44% 56%

35% 65%

41% 59%

Average Apartment Unit Price Premium %

Over Villa Units

20%

16%

40%

Performance Indicator

APARTMENTS

Unit mix

VILLAS

Unit mix

> 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 (semi-annually, 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.

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.


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%.

Compound Economic Indicators

Target Land Prices[SAR/sqm]

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

City Land Area (Sqm)

Target Density

(Du/Ha)Unit Mix Villa Lease

(SAR/Sqm)Apartment Lease

(SAR/Sqm)

Construction Cost (SAR/

Sqm)Riyadh

50,000 50

56% Villas - 44% Apartments 897 1,2563,500

for Residential BUA

Jeddah 65% Villas - 45% Apartments 879 941

Dammam/Khobar 59% Villas - 41% Apartments 827 1,000

1600

450

2100

800

1500

400

Jeddah

Riyadh

Dammam/ Al Khobar

450

500

1000

1500

SAR/sqm

SAR/sqm

SAR/sqm

2000

2500


The changes in key market demand profiles encourages and sometimes forces innovation and deviation from the original compound goal consequently targeting other segments. The ex-hibit 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 SegmentsThese qualities are generally associated with high income segments, student housing, staff accommodation, etc.

The Key for Residential OfferingEmphasis on facilities & amenities and security under the umbrella of a community lifestyle

The Type of Real Estate AssetThey are residential assets. The residential segment has one of the highest demand levels

The Most Basic Property of CompoundsQuintessentially, compounds are real estate assets

Structural Changes & Their Implications

> 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


> 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


> 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


> 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


> Depending on the objectives of each compound, existing assets might be better suited for exiting (potentially through sale of land) or through price competition

Premium Grade Grade A Grade B


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.

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:

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).

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

Riyadh Jeddah

Dammam/Al Khobar City Averages

operating from 68 countries on 6 continents

$2.6 billionin annual revenue

2 billionsquare feet under management

over 15,000professionals and staff

For further information, please contact:

Ian AlbertRegional DirectorMiddle East and North AfricaMAIN +971 4 453 [email protected]

Imad DamrahManaging DirectorSaudi ArabiaMAIN +966 11 273 [email protected]

Fouad Abou RafehAssociate Director | Valuation & Advisory ServicesSaudi ArabiaMAIN +966 11 273 [email protected]

Bilal SiddiquiManager | Valuation & Advisory ServicesSaudi ArabiaMAIN +966 11 273 [email protected]

Faisal El ShamiSenior Analyst | Valuation & Advisory ServicesSaudi ArabiaMAIN +966 11 273 [email protected]

Colliers International | Saudi ArabiaRiyadh | 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.

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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.

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Kingdom of Saudi Arabia CHANGING COMPOSITION · drop in oil prices, which has affected many facets of the economy, particularly larger firms in oil & gas and construction related