Strategic Assessment of Residential and Real Estate Construction Industry in Saudi Arabia

Strategic assessment of residential and real Estate industry in Saudi Arabia

STRATEGIC ASSESSMENT OF

RESIDENTIAL AND REAL ESTATE

INDUSTRY IN SAUDI ARABIA

USING PESTEL AND SWOT MODELS

Mohiuddin Asad

MBA(UK), ACCA, CMA, CIA, CFE, FFA, CCSA

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Introduction

In the following article, the author has carried out a strategic assessment of residential

and real estate construction industry in Saudi Arabia. Beginning with explaining the

concept of strategy in different schools of thought, he has used PESTEL and SWOT

models to perform his assessment. The author has first scanned the external macro

environment of the residential and real estate construction industry in Saudi Arabia

using the relevant PESTEL factors and then highlighted the strengths and weaknesses of

major firms in the said industry with the help of SWOT model.

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SRATEGY IN DIFFERENT SCHOOLS

Whittington (2001) categorized strategy in four basic generic approaches namely,

Classical, Evolutionary, Processual and Systemic. According to classical approach,

strategy is a logical process of calculation and analysis, intended to maximise long term

benefits. For classicists, profitability is the ultimate objective of business, and rational

planning is the means to achieve it. As per Alfred Sloan: “the strategic aim of a business

is to earn a return on capital, and if in any particular case the return in the long run is

not satisfactory , the deficiency should be corrected or the activity abandoned” (Sloan,

1963) For evolutionists, strategy in the classical sense of rational deliberate future

planning is often irrelevant. In evolutionary approach, competition is not overcome by

detached calculation and analysis but by constant struggle for survival (Cuizon, 2009).

Processual approach is similar to evolutionary approach in the sense that it doubts the

value of rational long term planning but it does not leave the profit-maximizing

outcomes to the market since market is full of mess and confusion (Cuizon, 2009). For

processualists, strategy is an emergent process of learning and adaptation (Whittington,

2001). Systemic approach has a relativist position. It believes that a firm can plan and

act effectively. It is much less pessimistic than Processual approach about people’s

capacity to carry out rational plans of action and much more optimistic than evolutional

approach about its ability to define strategy regardless of market forces (Whittington,

2001). Systemic theorists view strategy under social context and argue that strategy

should therefore be undertaken with sociological sensitivity. In contrast to Whittington’s

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(2001) four approaches, Mintzberg (1990) classified strategy into ten schools of thought.

The schools are categorized as either prescriptive or descriptive. Prescriptive schools

deal in how strategies should be formulated (Mintzberg, 1990) whereas descriptive

schools focus on how strategy arises and emerges (Mintzberg, Ahlstrand and Lampel,

1998).

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PESTEL ANALYSIS

Saudi Arabia is rich and stable and enjoys good relations with neighbours and

international world. There is no threat of war, invasion or political instability and as such

general political environment is considered healthy and favourable for construction as

well as for all other businesses. Even the current flair of political uprising in the region

does not threaten Saudi Arabian government as the well being of its people have well

been taken care of.

Saudi Arabia had become 149th member of WTO in 2005. Since then, the country has

been undertaking a series of important steps to further loosen its trade system and

speed up its integration in the world economy, while offering a transparent and

predictable environment for trade and foreign investment in accordance with WTO

rules. Saudi Arabia has been ranked number 13 in business environment and investment

competitiveness according to a report by the International Finance Corporation of the

International Bank for Reconstruction and Development. The country has gone from

number 67 in 2005 to number 13 in 2009 on the index, which measures 183 countries

around the world (IFC-World bank, 2009). Saudi Arabia is also “rated as one of the top

20 most attractive countries in the World for Foreign direct investment” (SAGIA, 2011).

On the regional side, GCC’s decision in 2000 to adopt a common currency is an

important step towards opening new business opportunities for the region. Though still

ahead, a GCC monetary union is expected to boost intra-regional trade and investment,

lowering transaction costs, improving the efficiency of resource allocation, supporting

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economic diversification and attracting foreign direct investment. Although the absence

of a comprehensive Saudi mortgage law leaves a considerable gap for the investors in

the real estate and residential market (Global Investment House, 2009), the government

is moving fast to develop more clarity and comprehensiveness to the Saudi real estate

laws. After approval of the Shura Council in July 2008, the Saudi mortgage law is

expected to be implemented soon. This will unleash latent demand for housing as

majority of the Saudi population demands religiously permitted schemes for home

financing. Some of the major banks have already started to offer Sharia compliant home

financing credit in anticipation of the law’s implementation. The Kingdom’s foreign

investment law passed in 2000 changed the way foreign investment could be conducted

in the country. The law enabled foreigners to have 100% ownership of the projects

including permission for foreign investors to own real estate required for the project

itself or for employee housing of the licensed projects. (SAGIA, 2000)

Saudi Arabia’s economic performance had been outstanding until middle 2008 which

were mostly driven by strong private and public investment expenditure on the support

of record oil prices and plentiful liquidity. However, the economic growth position for

2009 has declined sharply due to global financial crisis and economic recession.

Despite of the severe impact worldwide, Saudi Arabia has been less affected by the

global financial crisis. The credit mainly goes to government for taking timely and

effective fiscal and monetary measures. Saudi Arabian monetary agency had injected

SAR6 billion and USD2.5 billion in the banking system through deposits. (SAMA, 2009)

Since most speculative flows have already left the region, disruptions in the money

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market have been limited and liquidity in the banking system already started to

normalize. In 2009 budget, projected revenues have decreased from SR450 billion in

2008 to SR410 billion in 2009, largely as a result of a decline in the price of oil, which

accounts for 88 percent of the Kingdom’s revenues. As such, the budget is estimated to

yield a fiscal deficit of SR65 billion, compared to a surplus of SR40 billion in 2008.

(Budget, 2009) However, as the budget was prepared on a very conservative oil price

basis, experts forecast the actual 2009 deficit to be much lower than budgeted (NCB,

2009). The 2009 budget includes a record SR225 billion for new projects (Budget 2009).

The budget represents a 36 percent increase in capital spending over 2008 and

demonstrates the Saudi Government’s focus on developing capital programs that will

generate huge opportunities, especially in the real estate and housing sectors (NCB

2009)

Saudi Arabia's GDP is among the largest 20 global economies which grew by around 3.4

per cent in 2007 and 4.5 per cent in 2008. Due to the global financial crisis and sharp

decline in oil prices, the 2009 GDP is expected to contract by 1.2 percent, however, 2010

is again expected to be a good year with around 4.4 percent GDP growth (SAMBA,

2009). According to a recent study by Global Investment House, Saudi Arabia's real

estate sector has been projected to sustain a growth rate of between 5 to 7% until 2012,

powered by a consistently strong domestic housing demand, expanding business

development projects and a burgeoning hospitality sector. The study further revealed

that the real estate sector's GDP contribution will reach 7.2% in 2009 up from 6.8% in

2004, as Saudi Arabia's real estate investments touch SR1.125 trillion in 2009 and are

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estimated to reach SR1.5 trillion by 2010. (Global Investment House, 2009)

Saudi Arabia's population growth rate over the past decade has held to a brisk 2.45%

per year, but the country is overwhelmingly young. Some 70% of its population is under

30 years old and 45% are under the age of 15. (Global Investment House, 2009)

Furthermore, traditionally, a Saudi couple has to live in a separate home after marriage.

These demographics along with Saudi Arabia's general wealth and well known

preference for single family villas over apartments is a recipe for a housing boom of

almost record size. The unmet housing demand in Saudi Arabia currently stands at

around 250,000 units with the highest demand expected from middle-income group. In

order to fulfil the growing demand, the government is expected to provide an area of

around 300mn sqm for residential land plots in urban areas (Global Investment House,

2009). Residential segment presents under supply situation for past several years and

expected to continue the same in the near future. According to official estimates, there

were 4.3 million occupied housing units in the kingdom in 2007. Around 44.5% of

households live in owner-occupied units while another 44.4% live in rented units.

Employer-provided housing units account for the remaining 11.1% of households.

(Global Property Guide, 2008) Saudi Arabia is witnessing an escalating demand from

young middle income group. Thus, if Saudi Arabia is to meet such demand it will need to

build 1.5mn new homes by 2015 (Global Investment House, 2009).

It is, however, crucial to remember that such a hike in real estate and housing

construction sector will demand for sufficient building material to supplement the

expected growth. The most important supplies are of course cement and steel. The

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kingdom has cement production capacity of more than 45 million tones a year and is set

to exceed 50 million by 2010. (BMG Advisors, 2008) Further, Saudi Arabia is one of the

largest steel producers in the region and has currently the capacity to manufacture 8.4

million tonnes of steel per year (Gulf News, 2009). Due to large exports during 2008; the

country witnessed soared prices along with threat of cement and steel shortage. In

wake of multi-billion dollar real estate, housing and infrastructure projects, the

government imposed a ban on cement and steel exports. The ban has now been lifted

by the government conditionally amid availability of sufficient stocks. Experts do not

foresee a shortage of building materials in near future however, considering the size of

expected growth, this could be a threat in the long run.

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SWOT ANALYSIS - Strengths and weaknesses

Though there are many small firms in the real estate and housing sector which mostly

serve the individual clients, the main real estate and residential construction industry in

Saudi Arabia is dominated by few big players. The market is thus of an oligopolistic

nature. All of these firms have been in the industry for over three decades and hence

are very well established. Their main strength is their huge resources which create big

barrier for the new entrants. According to Meed’s report, foreign contractors admit that

“The local construction companies are very strong. A company such as BinLadin Group

or Dar Al Arkan and Saudi Oger has such large resources that it is almost impossible to

compete with it on large residential projects”, (Meed, 2009). However, one strategy

which other foreign companies are pursuing is to compete these local giants on

technical grounds especially related to the high rise buildings.

The main strengths of these big local firms are:

Their reputation in Saudi Arabia and in the region

Huge existing set up

High expertise in the construction sector

Knowledge of the Saudi laws and systems

Long term relations with officers in related ministries and government departments

Approved contractor status for all government departments

Good skilled staff compared to rest of the market

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Well consistent and predictable Zakat system for local companies as compared to

taxation for foreign ventures.

The major weaknesses include:

Dependence on government for release of funds which can cause serious cash flow

problems at times

Long bureaucratic procedures

Lack of skilled Saudi workforce

High fixed cost

Lack of entrepreneurial culture

Risk of cement and steel shortage and their price hike

Routine kick backs

High dependence of every firm and industry as well as the whole economy on oil prices

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Conclusion

With global economic environment entering into recovery phase and Saudi

government’s firm commitment to boost development expenditure, demonstrated by

mega budget allocations for real estate, housing and infrastructure projects, as well as a

fast growing population of young people to guarantee future demand in housing, the

real estate and residential construction sector boasts a healthy growth profile. Being a

member of WTO, the country is undertaking important steps to further loosen its trade

system and speed up its integration in the world economy. With the approval of new

investment friendly laws and sharia complaint mortgage regulations, the real estate and

housing sector is becoming more attractive for investors. Easy liquidity and negative real

interest rate give investors a greater incentive to invest in real estate to benefit from

attractive rental yields. There is no doubt that big gap between demand and supply of

the housing units is a call for huge investment opportunities in the residential sector of

Saudi economy. Since the industry is in growth stage, competing firms do not need to

fight on capturing each others share; instead they should focus on improving their

weaknesses and grasp the opportunities by making best use of their competitive

strengths. Foreign companies should focus on their technical resources and should

exploit the abandon opportunities through that strength as that is their main edge

which give them a competitive advantage over local firms in the current Saudi real

estate and residential sector.

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References:

Whittington, R. (2001), what is Strategy - and Does it Matter? 2nd edition, Thomson

Learning, London

Sloan, A. P. (1963), My Years with General Motors, London: Sedgwick and Jackson.

Cuizon, G. (2009), Theories of Action in Business Strategy: Classical, Evolutionary,

Processual and Systemic Approaches

Mintzberg, H. (1990), “Strategy formation: schools of thought”, Harper Business, N.Y

Mintzberg, H., Ahlstrand, B. and Lampel, J. (1998), Strategy Safari: A Guided Tour

through the Wilds of Strategic Management, Prentice-Hall, N.Y.

IFC, (2009), “Doing Business 2010: Reforming through Difficult Times” International

Finance Corporation, World Bank, September 2009 Report

Saudi Arabian Foreign Investment Act, (2000), article (6), Saudi Arabian General

Investment Authority

Research and Statistics Department (2009), “Economic Developments 4th Quarter

2008”, Saudi Arabian Monetary Agency

Annual Budget (2009), Ministry of Finance, Saudi Arabia

Saudi Economic Perspectives, (2009), National Commercial Bank, Saudi Arabia

“Mid-Year Economic Review and Forecast”, (2009), Saudi American Bank (SAMBA),

Saudi Arabia

“Saudi Arabian Real Estate Market”, Global Investment House, Kuwait, Jan, 2009

“Oil fuels Saudi real estate market boom”, Global Property Guide, Aug, 2008

“Saudi Cement Sector”, BMG Advisors, June 2008

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“Saudi Steel Makers receive export Licenses” Gulf News, July 6, 2009

“Contractors focus on Saudi Arabia”, Meed, 20-26 March, 2009

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Documents

Strategic Assessment of Residential and Real Estate Construction Industry in Saudi Arabia