Real Estate Funds Overview

December 2014 Please read Disclaimer on the back

The real estate market has been an attractive investment choice for fund managers in the kingdom. Both the number and size of real estate

Real Estate Funds Number of Subscriber Breakdown: 2011

funds witnessed substantial growth in the past few years. This report

2012

1H2013

2H2013

1H2014

explores the breakdown of real estate funds along with a look at the

Public

4,565

4,565

4,706

5,012

6,127

current relevant dynamics of the real estate market in Saudi Arabia.

Private

748

1,190

1,355

1,561

2,811

5,313

5,755

6,061

6,573

Total

8,938 Source: CMA

Statistical Overview: Real estate funds exhibited 15% growth YoY in number of funds, from 78 funds by the end of 2013 to a total of 90 funds by the end of the

Public Funds Breakdown (1H 2014):

first half of 2014. These funds range from private to public, with the majority of real estate funds in Saudi Arabia being private closed ended funds. Private funds stood at 77 while public funds remained

0.43%

59.57%

unchanged from last year at 13 funds.

32.80%

The number of subscribers in real estate public funds have increased

4.35%

by 30% in the period from the end of the first half 2013 till the end of

2.58%

the first half 2014. Private funds grew 107% in number of subscribers, compared to a mere 12.3% increase in the number of subscribers in Saudi equity funds on a YoY basis. The total value of Assets under management (AUM) for public real

0.12% 0.14% Equities

Debt instrument

Money market

funds ofFunds

Balanced

Others

Real Estate

Source: CMA, Aljazira capital research

estate funds grew 63% from SAR3.08bn to SAR5.04bn in the period from the end of 1H-2013 till the end of 1H-2014, while the value of private real estate funds’ assets almost doubled YoY, rising 75% from SAR17.73bn to SAR30.91bn during the same time frame. Total value of assets under management for real estate funds stand at SAR35.95bn.

Private Funds Breakdown (1H 2014):

It is worth noting that public real estate funds represent 4.3% of total value of assets managed by public funds in the kingdom, while private real estate funds represent around 64% of total assets managed by private funds; a large divergence worth noting.

0.01% 1.80%

64.10% 27.65%

It is important to note that due to the structural nature of funds where 5.23%

they cease to exist after the specified time frame or maturity, having accurate returns and size data on a historical basis can become a

0.10% 1.12%

challenging task and is susceptible to inaccuracies due to survivorship bias where unprofitable funds perish while successful ones continue to operate, leading observed fund returns to lean towards positive returns. Data on private funds returns is not publicly available.

1

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Equities

Debt instrument

Money market

Commodities

Multi-asset

Hedging& others

Real Estate

Source: CMA, Aljazira capital research

Real Estate Funds Overview

December 2014 Please read Disclaimer on the back

Growth Trends:

Real Estate Funds Total Assets Under Management (SAR mn):

Growth in the number of public real estate funds has been almost flat in the last few years while growth in the value of AUM (Assets Under Management) has been sound. Growth in the number of private real estate funds has been steady in numbers and massive in AUM.

2011

2012

1H2013

2H2013

1H2014

Private

7,359

16,506

17,733

21,437

30,917

Public

2,550

2,587

3,082

4,131

5,044

Total

9,909

19,093

20,815

25,568

35,961

Source: CMA, Aljazira research

In detail, the number of public real estate funds has been stable from the beginning of 2011 till the first half of 2013 at 10 funds. The second half of 2013 witnessed a 30% growth where public funds reached13 and remained unchanged since. On the contrary, private funds witnessed continuous growth throughout the last 3 years in both the number of

Real Estate Funds Average Assets Under Management (SAR mn):

funds and AUM. We should highlight that private real estate funds stood as the largest component of private funds in the kingdom since 2012, making 57% of total AUM then, and witnessing a 124% growth YoY in 2012 compared to 44% growth from the beginning until the end of 1H2014.

Private

2011

2012

1H2013

2H2013

1H2014

204.4

305.6

260.7

297.7

401.5

Public

255.0

258.7

308.2

317.7

388.0

Total

215.4

298.3

266.8

355.1

399.5

Source: CMA, Aljazira research

Looking at average AUM, real estate funds witnessed substantial growth by the end of 2013 and the first half of 2014. Average AUM went from

Real Estate Funds Total number of Funds:

SAR266.8mn to almost SAR400mn. There is a decrease in the average

90

AUM by the beginning of 2013; this is mainly due to larger growth in the

80

number of funds compared to AUM in that period.

70

The most noticeable pattern is the substantial increase in AUM during the first half of 2014. Average AUM went from SAR297.7mn to SAR401.5mn per

60 50 40

fund for private funds in a span of 6 months; growing at a rate equivalent

30

to 35% during that period, and 70% annualized growth.

20

The above figures are highly encouraging; such growth is only possible if lucrative returns compared to other investments are expected either

10 -

2011

2012

throughout the fund’s life and/or at the end of the fund’s life.

1H2013 Public

2H2013

1H2014

Private Source: CMA, Aljazira research

Private funds are estimated to hold their growth pattern in both number and AUM in the short and medium term. The current trend in public funds is towards equities and fixed income. Attractive market returns in 2013 combined with high expectations for the year 2015 in both the number of IPOs and influx of foreign investment has steered interest towards equity funds in the form both regular equity funds and IPO funds. The inception of at least 6 IPO funds in the past 52 weeks is a clear indication of the current trends in public funds. Given the above trends, public real estate funds have been less attractive to the average investor. Uncertainty regarding upcoming developments in the real estate market along with higher returns in equities has weakened interest in public real estate funds over the past year. We observed that the average investor is generally attracted towards higher and quicker returns, making equities a more attractive asset class. This has contributed to the low growth rates in public real estate funds.

2

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Real Estate Funds Total Value of Assets Under Management (SAR mn) 35,000

300%

30,000

250%

25,000

200%

20,000

150%

15,000

100%

10,000

50%

5,000 -

2011

2012 Public

1H2013 Private

2H2013

1H2014

0%

Total Growth Source: CMA, Aljazira research

Real Estate Funds Overview

December 2014 Please read Disclaimer on the back

Real Estate Funds Prospects: The current state of the real estate market could potentially

payment requirements’, reflected in lower LTV (loan to value

open a temporary valuable window for both public and

ratio) tend to affect lower and middles income consumers

private real estate funds. Opportunities arise from the

the most, specifically, the younger segment of these income

potential drop in real estate prices for new entrants and

brackets. The kingdom’s demographics are highly skewed

higher inflow of liquidity in the form of mortgage and real

towards young and middle income citizens; the proportion

estate loans. Funds can also take advantage of the mortgage

of young Saudis to total population is high in all standards,

law; there are types of funds that invest solely in mortgage

standing at 65% of total population being between the age

related financial products. (Although the potential offered

of 15 – 64 and 32% under the age of 15. Young families and

by the mortgage law is challenged by the 30% down

individuals had less time to accumulate capital sufficient

payment mandate).

enough for a sizable down payment. The higher than

The real estate market is currently under pressure from different opposing forces in the form of regulatory changes forming a sense of uncertainty in the horizon. The first of which is the passing of the mortgage law in the kingdom along with administering mortgage and lending institutional licenses. Large inflows of liquidity to the market in a relatively short period of time could put prices of real estate under pressure; where surging demand outpaces current supply. Under this scenario prices of ready units are expected to increase. However, the recent changes in the regulatory framework mandating a significant down payment of 30% will decrease demand for mortgages and real estate loans, unless financial institutions could engineer a financial leeway around the mandate. Otherwise, the pressure from surging demand in the form of liquidity inflow will not have the substantial impact previously expected by real estate analysts.

3

average multiple of house prices (in terms of sqm and preferred housing size by Saudis) to annual income in Saudi Arabia further increases the total down payment amount burden on the average homebuyer compared to other nations. A report by the TD Economics examining certain housing policies in the Canadian housing market and how they affect demand and price volatility asserts that higher down payments as a percentage of housing prices have a significant negative effect on demand and prices. Another study by the OECD concluded that for every 10% increase in LTV, homeownership rates rise 4.4% in young households (OECD Journal: Economic studies – Volume 2011). From an overall perspective, we expect the increase in demand for housing to be pushed mainly by the availability of credit supplied by the recently licensed lending and financial institutions. However, the 30% down payment mandate will curb demand, placing a cautious outlook on previously estimated large inflows of liquidity. The loans made by the

Examining the higher down payment mandate from an

REDF (Real Estate Development Fund) along with the recent

economic perspective reveals potential underlying issues

introduction of the “additional loan” policy would also

that might arise as a result of this mandate. Higher down

contribute to the potential liquidity inflows to the market.

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Real Estate Funds Overview

December 2014 Please read Disclaimer on the back

The ministry of housing (MOH) led the government’s efforts in easing what is deemed by many as a housing crisis in the kingdom. The

Loan to Value Regulation (LTV) & Ownership Rates:

distribution of the MOH’s products is based on criteria prioritizing the less

Typical Ownership maturity Rates (%) (years)

Regulatory limits on loan-to value

privileged using a points system to arrange applicants based on several conditions, ultimately ranking the families in need of housing on top of

Australia

other applicants. The ministry announced that the number of accepted

Belgium

20

68

application reached 690 thousand by the end of October, given that the

Canada

95% if insured

25

68

applications were open to families only, the assumption that the number

Denmark

0.8

30

49

represents households should be made. The ministry of housing’s efforts

Finland

None

17

59.2

in the market was, and still is, expected to have an impact on both

France

60% to be eligible for mortgage-backed securities

15

57

land and housing prices along with rental rates in the kingdom, where

Germany

60% to be eligible for mortgage-backed securities

25

43

distribution of housing units, land, loans, or a combination of land and

Ireland

80% (only for building societies)

20

79.5

a loan would eliminate a significant amount of consumers from the

Italy

80% (100% if guaranteed)

15

71.4

Japan

None

25

35.8

Korea

40-60%

3:20

-

Netherlands

None

30

57

Given the regulatory framework of the MOH’s offers, we believe that the

Spain

80% to be eligible for mortgage-backed securities

20

80

first few batches of land and unit awards will be to consumers who were

Sweden

None

25

56

technically not in the market for new housing or land. As a result, demand

Switzerland

None

15 - 20

-

for mid-level units and above along with land in the Saudi market would

United Kingdom 100% (only for building societies)

25

70

not be impacted. Prices are expected to continue at current levels and

United States 90% if guaranteed

30

68

not be affected by downward price pressure. In addition, the ministry will

Saudi Arabia

-

-

demand curve. This view is partially flawed; reading into the available information would reveal an alternative view.

100% if insured

25

None

70%

69.8

Source: CMA, Aljazira research

also offer loans; these loans will only contribute to higher demand for housing. If we take into consideration the number of families accepted in the housing program while assuming a certain percentage live in rental units around the kingdom, we can reach a tentative inference that the first impact would be on low to mid-level rental housing units. A certain percentage of these units will vacate, effectively lowering demand and eventually lowering rental rates.

Housing Price to Income Ratio1 (Housing is assumed as 90sqm Apartments): Country United States

sentiment is the possibility of imposing a form of tax on empty unused

Oman

2.95

land within municipalities (white land) around the kingdom. The debate

United Arab Emirates

5.26

on this issue is ongoing and government agencies are still in deliberation

Canada

5.57

regarding whether or not such a policy would be ultimately beneficial for

Germany

5.60

the general public. Lower land prices, if applicable, would open a window

Qatar

5.72

for developers (and real estate funds) as new entrants to acquire scalable

Ireland

5.74

land at lower prices for medium to large projects effectively increasing

Belgium

5.98

margins in the process.

United Kingdom

7.74

Turkey

6.86

Malaysia

8.04

Taking the above forces into consideration, we believe prices and demand for certain housing segments will remain attractive for real state funds to take advantage of in the short and medium term.

1 Price to Income Ratio is the basic measure for apartment purchase affordability. It is the ratio of median apartment prices to median familial disposable income, expressed as years of income

4

Price to Income Ratio

Another catalyst currently having an effect on real estate market

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2.43

Source: numbeo data

Real Estate Funds Overview

December 2014 Please read Disclaimer on the back

Real Estate Hospitality Funds Prospects: Real estate hospitality funds have been in existence for a while in Europe and the United States. They invest primarily in hospitality real estate including hotels, convention centers, residential properties offering hotel-style services,

visa schemes for both religious and regular tourism, tourism infrastructure and services development, promoting business and medical tourism through the development of economic and medical cities in the kingdom.

and residential and limited-time living facilities.

Potential in Economy and Branded Hotels:

We believe real estate hospitality funds have considerable

The surge in forthcoming supply of hotel rooms in the

potential in Saudi Arabia and the GCC market. It is worth

kingdom is an indicator of the expected growth in demand

noting that under European law, such funds are not

and the existing gaps in the market. Internationally

permitted to hold stakes in operating hotels, rather, they

branded economy/ budget hotels are expected to grow at

have to own the real estate under which the hospitality

a higher pace in the kingdom, from 1,320 hotel rooms in

facility is operating. This is not the case in US law.

Q1 2014 to 11,626 rooms by the end of 2018. The young

Reputable financial institutions including Black Stone group, Credit Suisse, and Carlyle Group all have large real estate hospitality funds fully dedicated to investing in hospitality related real estate properties and businesses. A

Saudi demographic is expected to gradually shift from the current preference for furnished apartment to economy branded hotels over time. Affordability is a major factor to consider for domestic tourism.

relatively new growing breed of funds in recent years are

Low market penetration for branded hotels in the kingdom

hotel acquisition funds; these funds raise a large amount of

is currently seen as an opportunity. As inbound tourism

capital in an effort to acquire underutilized hotels with the

is expected to witness strong growth within the next few

intention of revamping operations and selling the fund’s

years from 17.2 million in 2013 to 25.7 million in 2018; a

stake after a certain lockup period.

49% CAGR growth.

Government Initiatives:

There have been noticeable recent efforts towards

We believe that given the hospitality sector prospects in the kingdom along with the shortage of hospitality related services, hospitality funds have good growth potential. The sector dynamics are changing, government initiatives to drive demand along with a young demographic and a potential rise in business tourism all contribute as positive catalysts in a transforming sector. Government initiatives

5

expected to have an effect on the market include changes in

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developing and managing internationally branded hotels in the kingdom. Al Hokair group, al Tayyar Tourism group, and most recently Al Aqariya and Dur Hospitality group all have made announcements regarding future plans and JVs’ with international brands to develop and manage hotels in the kingdom.

Real Estate Funds Overview

December 2014 Please read Disclaimer on the back

Alternative Investment Approach: We have yet to see movement towards initiating long term hospitality funds for acquiring and managing underutilized hospitality real estate and developing hotels in the kingdom. We believe there exists significant opportunities in this approach within the kingdom and the GCC. Funds that follow this approach are known as opportunistic real estate hospitality funds, most notable of which is Blackstone Group hospitality

Real Estate Funds Total number of Funds: 14,000 12,000 10,000 8,000 6,000 4,000 2,000 -

86 577 658 2013

196 153 977 740 2014E

Riyadh

837 586

603 196

4,548

970 2015E

2016E

3,116

Makkah

837 988 6,048

1,555

Madinah

1,555 2017E

Eastern Province

1,237 988

7,848

1,555

2018E

Source: CMA, Aljazira research

fund. The United States have witnessed a surge in demand for such funds with a reported 59% of investors searching for real estate funds targeting opportunistic funds.

Real Estate Funds Total number of Funds:

The higher risk/return spectrum of opportunistic real estate funds sets them aside compared to the lower risk core strategy adopted by regular

65%

32%

real estate funds. A study by NCREIF concluded that opportunistic real estate funds had the highest annual net and gross returns compared to 3%

other real estate fund strategies during a studied time frame of 17 years. 0 - 14

The attractiveness of opportunistic real estate funds is demonstrated in

15 - 64

65 + Source: CMA, Aljazira research

the growth rate of AUM along with number of funds compared to regular core strategy real estate funds. According to Preqin intelligence data, as of the start of April 2014, there are 142 primarily opportunistic real estate funds on the road, targeting aggregate capital commitments of $49bn, an increase from the 117 such funds at the same time last year. Opportunistic real estate funds extend to sectors other than hospitality. However, the frequent operational deficiencies in hospitality facilities along with the potential in certain regions better suites the opportunistic investment approach relative to other sectors.

Blackstone Group Opportunistic Investment Approach: • Buy it – Acquire high-quality, income-producing assets at discounts to replacement costs. • Fix it – Rapidly and proactively address any capital structure, physical, or operating issues pertaining to the investment. • Sell it – Once issues are addressed, sell the investments, typically to core investors. Average hold period has been slightly more than three years; between 2005 and 2007 Blackstone sold more than $60 billion of assets. Source: Blackstone Real estate

6

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Real Estate Funds Overview

December 2014 Please read Disclaimer on the back

Healthcare Real Estate Funds Prospects: Favorable demography and economic outlook contribute to increasing demand for health care services in the kingdom. The evolution in the Kingdom’s healthcare industry was mainly associated with the increase in population. However, we cannot ignore the role of the Kingdom’s economic prosperity over time which allowed the government to increase spending on healthcare as percentage of GDP from 3.8% (SAR54.8bn) in 2007 to 4.0%

KSA Healthcare Spending Positioning: 140

0.0515

130

0.049

120

0.048

110 100 90

0.044

0.043

0.044

60 50

0.0495 0.0475 0.0455 0.0435

80 70

0.049 0.049

0.0415 0.04

0.0395

2009 2010 2011 2012e Healthcare spending (SARbn) - LHS

0.0375 2013e 2014e 2015e 2016e Healthcare spending % GDP - RHS

Source: EIU – Saudi Arabia Healthcare Industry report 2012

(SAR86.5bn). According to EIU1, the Kingdom’s spending on healthcare is expected to reach 4.9% (SAR135.2bn) of the GDP in 2016; indicating an increase in spending on healthcare sector at 2011-16 CAGR of 9.3%. Over the years, most of the healthcare spending in the Kingdom has been government funded. Government agencies have been increasingly focusing on creating more public-private health partnerships. It has identified healthcare as one of the key sectors to target in its wide-ranging privatization program. The country’s increasing investment and focus on encouraging private participation in the healthcare system along with the promotion of healthcare tourism is expected to drive the demand for medical services. The shift towards public-private partnerships unlocks several opportunities within the sector for funds to enter the market for Healthcare real estate in the activities of developing, acquiring, and managing assets in a growing discounted sector. There are different investment strategies held by healthcare real estate funds most of which invest in the acquisition, full ownership, management, and lease of healthcare real estate assets. These include medical office buildings, specialty hospitals elderly residential/ nursing homes, outpatient clinics, , learning disability and specialist care homes, and private hospitals l

7

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RESEARCH DIVISION BROKERAGE AND INVESTMENT CENTERS DIVISION RESEARCH DIVISION

Senior Analyst

Analyst

Abdullah Alawi

Syed Taimure Akhtar

Sultan Al Kadi

+966 11 2256250 [email protected]

+966 11 2256146 [email protected]

+966 11 2256374 [email protected]

Senior Analyst

Analyst

Analyst

Talha Nazar

Saleh Al-Quati

Jassim Al-Jubran

+966 11 2256115 [email protected]

+966 11 2256046 [email protected]

+966 11 2256248 [email protected]

General manager - brokerage services and sales

AGM-Head of international and institutional

AGM- Head of Western and Southern Region Investment Centers & ADC

Ala’a Al-Yousef

brokerage

Brokerage

+966 11 2256000 [email protected]

Luay Jawad Al-Motawa

Abdullah Q. Al-Misbani

+966 11 2256277 [email protected]

+966 12 6618400 [email protected]

AGM-Head of Sales And Investment Centers

AGM-Head of Qassim & Eastern Province

AGM - Head of Institutional Brokerage

Central Region

Abdullah Al-Rahit

Samer Al- Joauni

Sultan Ibrahim AL-Mutawa

+966 16 3617547 [email protected]

+966 1 225 6352 [email protected]

+966 11 2256364 [email protected]

AlJazira Capital, the investment arm of Bank AlJazira, is a Shariaa Compliant Saudi Closed Joint Stock company and operating under the regulatory supervision of the Capital Market Authority. AlJazira Capital is licensed to conduct securities business in all securities business as authorized by CMA, including dealing, managing, arranging, advisory, and custody. AlJazira Capital is the continuation of a long success story in the Saudi Tadawul market, having occupied the market leadership position for several years. With an objective to maintain its market leadership position, AlJazira Capital is expanding its brokerage capabilities to offer further value-added services, brokerage across MENA and International markets, as well as offering a full suite of securities business. 1.

RATING TERMINOLOGY

AGM - Head of Research

2. 3. 4.

Overweight: This rating implies that the stock is currently trading at a discount to its 12 months price target. Stocks rated “Overweight” will typically provide an upside potential of over 10% from the current price levels over next twelve months. Underweight: This rating implies that the stock is currently trading at a premium to its 12 months price target. Stocks rated “Underweight” would typically decline by over 10% from the current price levels over next twelve months. Neutral: The rating implies that the stock is trading in the proximate range of its 12 months price target. Stocks rated “Neutral” is expected to stagnate within +/- 10% range from the current price levels over next twelve months. Suspension of rating or rating on hold (SR/RH): This basically implies suspension of a rating pending further analysis of a material change in the fundamentals of the company.

Disclaimer The purpose of producing this report is to present a general view on the company/economic sector/economic subject under research, and not to recommend a buy/sell/hold for any security or any other assets. Based on that, this report does not take into consideration the specific financial position of every investor and/or his/her risk appetite in relation to investing in the security or any other assets, and hence, may not be suitable for all clients depending on their financial position and their ability and willingness to undertake risks. It is advised that every potential investor seek professional advice from several sources concerning investment decision and should study the impact of such decisions on his/her financial/legal/tax position and other concerns before getting into such investments or liquidate them partially or fully. The market of stocks, bonds, macroeconomic or microeconomic variables are of a volatile nature and could witness sudden changes without any prior warning, therefore, the investor in securities or other assets might face some unexpected risks and fluctuations. All the information, views and expectations and fair values or target prices contained in this report have been compiled or arrived at by Aljazira Capital from sources believed to be reliable, but Aljazira Capital has not independently verified the contents obtained from these sources and such information may be condensed or incomplete. Accordingly, no representation or warranty, express or implied, is made as to, and no reliance should be placed on the fairness, accuracy, completeness or correctness of the information and opinions contained in this report. Aljazira Capital shall not be liable for any loss as that may arise from the use of this report or its contents or otherwise arising in connection therewith. The past performance of any investment is not an indicator of future performance. Any financial projections, fair value estimates or price targets and statements regarding future prospects contained in this document may not be realized. The value of the security or any other assets or the return from them might increase or decrease. Any change in currency rates may have a positive or negative impact on the value/return on the stock or securities mentioned in the report. The investor might get an amount less than the amount invested in some cases. Some stocks or securities maybe, by nature, of low volume/trades or may become like that unexpectedly in special circumstances and this might increase the risk on the investor. Some fees might be levied on some investments in securities. This report has been written by professional employees in Aljazira Capital, and they undertake that neither them, nor their wives or children hold positions directly in any listed shares or securities contained in this report during the time of publication of this report, however, The authors and/or their wives/children of this document may own securities in funds open to the public that invest in the securities mentioned in this document as part of a diversified portfolio over which they have no discretion. This report has been produced independently and separately by the Research Division at Aljazira Capital and no party (in-house or outside) who might have interest whether direct or indirect have seen the contents of this report before its publishing, except for those whom corporate positions allow them to do so, and/or third-party persons/institutions who signed a non-disclosure agreement with Aljazira Capital. Funds managed by Aljazira Capital and its subsidiaries for third parties may own the securities that are the subject of this document. Aljazira Capital or its subsidiaries may own securities in one or more of the aforementioned companies, and/or indirectly through funds managed by third parties. The Investment Banking division of Aljazira Capital maybe in the process of soliciting or executing fee earning mandates for companies that is either the subject of this document or is mentioned in this document. One or more of Aljazira Capital board members or executive managers could be also a board member or member of the executive management at the company or companies mentioned in this report, or their associated companies. No part of this report may be reproduced whether inside or outside the Kingdom of Saudi Arabia without the written permission of Aljazira Capital. Persons who receive this report should make themselves aware, of and adhere to, any such restrictions. By accepting this report, the recipient agrees to be bound by the foregoing limitations.

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