Saudi Arabia Real Estate Sector – Initiation of Coverage

• Saudi real estate equities are trading at a 55% discount to TASI on PBx basis versus a 4-year average discount of 48%

• Strong fundamentals owing to attractive demographics coupled with large undersupply of residential units, but financing is the key constraint

• Strong Buy - DAAR - TP:SAR11.37, Hold - EEC - TP:SAR7.20, Strong Buy - Akaria - TP:SAR30.40

Saudi real estate equities trading at a 55% PBx discount to TASI

As of March 2011, TASI is trading at 2.0x PBx versus 0.9x for real estate equities at a 55% discount. Real estate average PBx needs to trade at a target of 1.1x to be inline with the historical 48% discount to TASI between 1Q07 and 4Q10. The PBx discount of Saudi real estate equities can be justified by investors preference of real asset ownership and the sector’s low RoE and RoA. The market, however, is missing on the large premiums to land value reported at cost in the books of listed equities compared to their realizable fair values

Attractive fundamentals, but sluggish project financing strains developments

The Saudi residential market suffers from a large supply shortage, especially in the low-mid income segment. We estimate that a current shortage of 0.7mn units exist in the market and an additional 1.2mn new units will be needed by 2014, offering attractive potential for Saudi realtors. Off-plan sales are largely restricted leading to financing bottlenecks for developers who are forced to fully finance projects prior to realizing cash inflows from unit sales. Moreover, the dry credit market for real estate developers in 2009-10 has further substantiated the funding quandary and led to execution delays.

The mortgage law is an initial step in the right direction, but not the sole solution

The proposed mortgage law is critical to unlock part of the pent up demand for real estate in Saudi but it’s capacity to deliver an efficient solution to the sector vulnerabilities remains feeble. Our view is devised given low base effect and limited reach owing to the disparity between the strict financial requirements expected from lenders and the wide base of inadequate borrowers. We prefer saying more credit extended to developers, which should yield better results in the short to medium term.

Initiate coverage on Saudi real estate

Initiate on Dar Alarkan (DAAR) with a Strong Buy recommendation and a target price of SAR11.37, Emaar Economic City (EEC) with a Hold recommendation and a target price of SAR7.20 and Saudi Real Estate Company (Akaria) with a Strong Buy recommendation and a target price of SAR30.40.