The Al Qasr residential home project, built by Dar Al Arkan Real Estate Development Co., stands in the Al-Swaiyadi district of Riyadh. Strong Saudi economic growth last year, estimated by the finance ministry at 6.8 percent, and increased government spending have helped Dar Al Arkan A flood of money into the bonds of Saudi Arabian property developer Dar Al Arkan is due to renewed confidence in the company's ability to repay its debt, but also to a general scramble to buy Saudi assets as the economy booms. The yield on the company's $1 billion, 2.817 percent floating rate sukuk, due to mature this July, has plunged from above 25 percent at the start of January to around 8 percent now as it became clear the Islamic bond would be repaid on schedule. That drop has probably run its course now, traders say, but the yield on the company's 2015 maturity may have further to fall. It has already dropped to 10.7 percent from 14 percent at the start of the year. But the yield on the 2012 sukuk has returned to its 2011 low; a similar move by the 2015 sukuk would bring it to 10 percent. "While there are concerns surrounding the development of the Saudi Arabian housing market, the sukuk offers one of the highest profit rates in the region at 10.75 percent, which makes them visible to investors," said John Bates, head of fixed income at London-based asset manager Silk Invest. The recovery in confidence in Dar Al Arkan, the Kingdom's biggest private property developer, has been dramatic. When the 2015 sukuk was issued in 2010, investor demand was sluggish and the company had to settle for raising $450 million instead of its target of $500-$700 million. Like other Saudi real estate firms, the company is now benefiting from a range of factors. One is government support for the industry; although Dar Al Arkan is not explicitly backed by the government, official action has convinced investors that authorities would like to see the company succeed. Last October, the country's Public Investment Fund approved a SR4 billion ($1.1 billion) facility to finance one of Dar's biggest projects, the Qasr Khozam development in Jeddah, estimated to cost SR12 billion. Strong Saudi economic growth last year, estimated by the finance ministry at 6.8 percent, and increased government spending have also helped Dar Al Arkan. The company reported a strong liquidity position at the end of 2011 with almost SR2.5 billion of cash reserves. It said this month that it would rely on expected sales of about SR800 million per quarter to help repay its SR4.6 billion of debt maturing this year. "Dar generated almost $150 million in free cash flow in the fourth quarter alone, similar to what it added in totality in the past two years," said Ghassan Chehayeb, research analyst at Exotix, an investment bank specializing in frontier markets. Business is likely to remain strong this year. The government has set aside SR250 billion from its 2011 budget surplus to build 500,000 homes in the next few years; a shortage of supply for a young population-Jones Lang LaSalle estimates annual demand for housing to be between 150,000 and 200,000 units, much of it in the lower- and mid-income segments-means construction should be absorbed comfortably. "The Saudi government's initiatives to build homes and support infrastructure have further pushed positive sentiment in the name," said Thomas Christie, fixed income trader at Rasmala Investment Bank in Dubai. Economists polled by Reuters in December predicted Saudi Arabia's gross domestic product growth would slow to a still-robust 4.0 percent this year. But the recent climb in global oil prices, and the possibility that Saudi crude production will expand to compensate for diminishing supply from sanctions-hit Iran, mean that growth estimate may well be too conservative-and that the government's budget will stay comfortably in surplus, allowing it to continue financing real estate projects. This ideal combination of factors is supporting a surge in Saudi equity prices, which may spill over into other assets such as real estate. The main stock index is up 12 percent so far this year at a 41-month high; Dar Al Arkan's shares are up 29 percent but have not yet regained last year's peak. Some analysts argue there is an additional two to three price points of upside in Dar Al Arkan's 2015 bond, which is rated BB- by Standard & Poor's, and that the sukuk could rally further after the repayment of the 2012 bond, which will reduce leverage and ease the company's debt maturity schedule. A comparison with other big real estate developers in the region appears to support the case. Dubai's flagship developer, Emaar Properties has a $500 million, 8.5 percent sukuk maturing in 2016 which is rated B1 by Moody's, one notch below the Dar sukuk. That bond is yielding 7.2 percent. Abu Dhabi's largest developer, Aldar, has a $1.3 billion, 10.75 percent conventional bond, rated B3 by Moody's, maturing in 2014. It is yielding 6.4 percent. "Compared to Emaar 2016s, the Dar 2015s offer almost 4 percent extra yield," said Chehayeb. He added that Z-spread analysis, comparing the relative value of the bonds, showed value in the Dar Al Arkan sukuk. "While a 300 basis points differential is acceptable, the current differential of 400 bps is still too wide." Each developer has its unique strengths; Dar Al Arkan has the demographic advantage of Saudi Arabia's young population, which is expected to sustain strong demand in coming years, while Emaar is owned 32 percent by the government of Dubai and Aldar benefits from strong sovereign support. Home loans currently exist in Saudi Arabia, but many are salary-based with payments taken out of the homebuyer's salary when it enters his bank account, said Khan Zahid, chief economist at Riyad Capital. If passed, a mortgage law could increase activity greatly while stimulating the real estate market, he said.
