JEDDAH — Saudi Arabia's economy expanded by 3.5% last year (faster than the 2.7% increase seen in 2013) - underpinned by the oil sector re-entering positive territory after two years of decline. Meanwhile, growth in the non-oil economy eased in 2014 - however, the pace of expansion remained robust. On a sector-by-sector basis, the finance, real estate & business services and the government services sectors - together accounting for almost 24% of total GDP in Saudi Arabia - saw weaker growth last year, of 4.1% and 3.3% respectively (in 2013, the former grew by 9.2% and the latter by 4.9%). Year-on-year, office take-up continued to increase in Riyadh and Jeddah in the 12 months to June 2015, a report by Knight Frank LLP, a London-headquartered leading independent global property consultancy, said. In both cases however, higher levels of demand were offset by new office completions - as a result, vacancy rates were broadly stable over the same period. Perhaps unsurprisingly then, rents were also unchanged in the two cities. In H1 2015, Grade A and B office rental values in the capital stood at SR1,300 and SR900 per square meter per annum, respectively. Meanwhile, Grade A (SR1,200 per square meter per annum) and Grade B (SR700 per square meter per annum) rents in Jeddah were also flat. Current supply of Grade A and Grade B office stock in Riyadh stands at 3.5 million square meters, the majority of which is concentrated in the central and northern parts of the city. Demand for commercial space continues to be focused on headline schemes such as Kingdom Tower, Business Gate and Granada Business Park which are all enjoying in excess of 90% occupancy. The average vacancy rates across the city remain unchanged indicating that demand for office space has kept pace with new supply that has come to the market through H2 2014 and H1 2015. Grade A and Grade B office rents have also remained stable throughout the period and currently stand at SR1,300 and SR900 per square meter per annum, respectively. The potential oversupply following the release of successive phases of King Abdullah Financial District (KAFD) and the handover of the Information and Technology Complex (ITCC) has not materialized, partly as a result of historic lack of international quality Grade A stock as well as the gradual phasing of KAFD. As a result of these two government backed schemes, the capital will see an additional 1.2 million square meters of GLA come into the market in the next two years. Due to current dynamics we do not expect the market as a whole to see increased vacancy rates or a reduction in achievable rental rates as demand for quality commercial spaces that are well located and benefit from good floor plates will remain strong in the short to medium-term. Meanwhile, supply of office space in Jeddah currently stands at 820,000 square meters of GLA with over 100,000 square meters of office supply due to be added to the market in the short-term. As a result of construction delays, H1 2015 saw few completions which resulted in market wide vacancy rates remaining stable at 10%. Total stock is expected to exceed 1 million square meters of GLA in the medium-term as new supply comes online. H2 2015 will see additional supply coming from a number of small to medium sized projects, the largest being Al Khair Tower which will add circa 30,000 square meters of office space to the market. Whilst H1 2015 saw the completion of the Headquarter building on the Corniche, the majority of space in the development has either been leased already or sold to individual investors, reflecting the strong pent up tenant and investor demand for good quality office space. Rental rates for Grade A and Grade B space remained unchanged in H1 2015 due to continuing demand from the nonoil sector. Grade A and B rents currently stand at SR1,200 and SR700 per square meter per annum, respectively. Due to the historic lack of Grade A stock in the market, we see robust demand for good quality offerings in the short to medium term as tenants look to upgrade to better quality premises and the non-oil economy continues to show healthy growth. As primary and secondary commercial centers across the Kingdom continue to develop, the location, positioning and delivery of future office product will become increasingly important. To date commercial stock has been provided on main arterial routes rather than within dedicated areas or zones where synergy can be created between real estate uses such as ancillary retail units and F&B provisions. With the handover of KAFD at the end of 2015, Riyadh will benefit from a dedicated commercial led, mixed use scheme. We believe that schemes such as KAFD will be able to drive value over the medium term and respond to an increasingly sophisticated demand profile as occupiers seek premises that offer more than standalone office space. Going forward we believe that mixed use master planned developments will be able to command premium rents and benefit from robust occupancy, while standalone, poorly located commercial developments will see increased vacancy rates and falling rents. In Eastern Province, demand for office space was flat in the 12 months to June 2015. What's more, there is little to indicate that demand will rise in the near-term - suggesting that the completion of new office projects will exert upward pressure on vacancy rates. It is difficult to see rents budging from their current levels (in H1 2015, Grade A and B office rents stood at SR1,050 and SR700 per square meter per annum, respectively). Knight Frank has a strong presence in the Middle East with offices in Abu Dhabi, Dubai and Saudi Arabia. The Group advises clients ranging from individual owners and buyers to major developers, investors and corporate tenants. — SG
