Investment Opportunities in Saudi Arabia: Real Estate Funds Offer 13-15% ROI

Interview with Adil S. Dahlawi, Managing Director and CEO of Itqan Capital

Please tell us about the company, its history and some of its founding principles it is based on.

Itqan Capital was set up in 2007, started operations in 2008. But from our perspective it really started at the beginning of 2012 with the new brand of Itqan Capital and the new image. The company was established by the Dallah Al Baraka Group chaired by Shaikh Saleh Kamel. Over the years we saw a change in the company ownership, which demonstrates the backing of the shareholders. The Baraka Banking Group became a major stakeholder along with the Baraka Islamic Bank in Bahrain. Today, a majority of the Itqan Capital, about 83%, is owned by the Baraka Banking Group. Whereas the rest is owned by Baraka and Shaikh Saleh Kamel.

The company was set up to start a new market, the Saudi market, especially in asset management. They obtained several licenses from the Capital Market Authority, which was newly set up in 2006 in Saudi Arabia. Eventually, we grew our business. Since inception, we have launched about 7 funds, mostly in the real estate business. Today, Itqan Capital is known as the number one fund in the money market. We have several income-generating real estate funds, something we specialize in. We are about to launch our first private equity fund in the Saudi market, specializing in education.

How do you characterize your investment strategy? How do you identify investment opportunities in the market?

Looking at the Saudi market, you have to understand that it has a lot of inner dynamics. Most importantly, it is the population.  In a lot of our investment strategies, we focus on the demographics of the countries. 60% of the population is below the age of 30.

This puts a lot of pressure on a lot of industries, especially education, healthcare, food and beverage and other industries.

But these are the most important ones. There is a lot of pressure on these sectors to start to produce more for a country that is demanding more. So, we are pushing ahead with that strategy on certain fronts. We are starting with education and moving on to healthcare, food and beverage. We have already started with real estate, where we see a huge demand for residential properties in Saudi.

You mentioned that the real estate market has seen several major developments.  In 2012, there was the establishment of the Ministry of Housing, funds to build residential units, the mortgage law etc. What are the latest developments that make you think that this sector will remain very vibrant in the future?

These developments certainly improve the prospects of the industry or the sector itself. But you have to understand the fundamentals behind it. We have a large population, most of it is young. They are demanding for more of some specific industries like residential. There is a large percentage of Saudis, who don’t own their own homes. This is a fundamental reason behind this strategy. The government actions in recent years has been to emphasize the importance of this sector.

They are looking into the fundamentals and understanding them, trying to improve at least the investment prospects in these sectors, supporting the Saudi youth with housing loans, soft loans, improving the point system to get these loans earlier than later. In the past, people would wait for 10 to 15 years for their housing loans. Today, it is a lot faster and immediate and there are mechanisms to support Saudi as well with housing loans from banks. A combination of both can be attained. Mortgage law was approved to increase the number of investors and bankers in this market and invest more actively in it. Everything that you see is supported by the fundamentals of the sector.

How important is the real estate sector from the asset management point of view?

I think it is highly important. In the last 2 to 3 years, we have seen a significant increase in the number of investment funds in the real estate market. The volume of investments pouring into real estate development has also increased significantly. I guess that brings me back to the different aspects of government support in that area.

The Capital Market Authority itself set up the real estate funds regulations back in 2008. That’s when we started our first real estate fund. As you can see, there is fundamental support from the government, there is a significant demand from the market itself. We see a lot of more investment funds coming into the market, specifically in real estate development, more focused on residential projects.

In terms of returns of investment, what are the yields you are expecting?

So far from our own experience, from our research in the market, this ranges between 13% and 15% per annum.

This is not very attractive for the very simple reason that leveraging in the Saudi market through Saudi banks is not developed for real estate projects as yet. We are hoping to see more of the commercial banks jumping into leveraging of such investment vehicles, which will improve the returns significantly.

Also, recently we have seen opening up of the stock market for foreigners.

This of course is another important step. But we see that the Capital Market Authority is more cautious in their approach to that step. It is a very good first step for them to open up the market for direct investments. In this capital market, we are in need of institutional investments. This is what they are starting with and we think that it is an excellent first step. That should also improve the prospects of the capital market. We are hoping that on the regulatory side, it will build certain aspects of transparency and visibility of financial data and information on listed companies.

What are some of the challenges that the real estate market is facing? Do we see the emergence of a real estate bubble?

The biggest challenge is the land values. We understand that Saudi is a big country and it is divided into regions. Every region has its own dynamics. You cannot generalize here and say “real estate bubble”. You may have bubbles in certain regions, and even in certain cities within regions. But you cannot predict whether the whole of Saudi will find itself in the real estate bubble. It is too soon to do that. We haven’t satisfied the existing demands yet. So long as the demand is there, we can still see buyers out there for real estate properties.

 The pricing of such products has to be reasonable for people to buy. If it is not, we will not see any actions. Corrections is necessary in certain cycles and sections, specifically in real estate. But because there has been a culture of speculative trading of land plots in the industry since a long time, we may feel that there is a certain real estate bubble. But it is not in all regions. Within cities, I can tell you that certain areas within cities can have investment bubbles, but they burst very quickly and they don’t have an impact on the industry on the whole.

One of the most important developments in Saudi Arabia is the price of oil, which has increased significantly in the beginning of the year. How is this going to affect the overall financial market? Will it trickle down to the real estate market itself?

This is country that relies heavily on government spending, which is derived from oil revenues. The government has done a very smart thing. They have accumulated reserves over the past 5 years. We have seen the country’s reserves at the highest level ever. This puts the government in a very comfortable place, where government spending will continue at the same space as we have seen in the 2015 budget, which is slightly higher than 2014. However, we don’t think that this decline in oil prices will last for long. Generally, it takes 12 to 18 months to rebound. The open question is, where it will rebound to. But we feel that this is still a reasonable price where the government spending can continue as strong as it has been in the recent years. We don’t see any short time impact on the Saudi economy at this stage.

I was reading a book by Stephen…, who is an economist at …. in Britain. He said that at $50 per barrel, Saudi will experience a crisis within 10 years, tied with the increase in entitlement, spending and so on. What is the outlook for the economy in your opinion?

 The outlook for the Saudi economy is still positive. Growth may slow down slightly. But as I said, without any major impacts. In 2002, when oil prices were growing up, some economists were saying that if oil hits a $100 per barrel, China will collapse. China still exists. So, I don’t really trust what economists have to say.

So, you remain optimistic about the future economy in Saudi. Talking about education, will you be launching the first fund for education? What makes you come up with such innovative vehicles?

We looked at certain sectors. In Saudi Arabia, there is a dire need for more capacity and quality education. It is a fragmented market. We see a lot of individuals taking initiatives on their own, trying to gather qualified individuals from certain countries, putting together a school and running after accreditations and so on. These are haphazard initiatives by individuals. They are regulated, but not as we expect. They are pretty much experimenting with options.

Instead of doing private equity funds that will go out and buy out certain schools and manage them or improve their status, this is a country that needs more capacity. So, we are going with a fund that will build more capacity. So, it is primarily green-fuel based. We are going out there and looking for the right operatives. We have signed with Al Khaleej Training and Education. It is in the public domain. They are our first partners to come in as an operative. We are hoping to build schools very soon. We are aiming at building 5 to 6 schools with the total capacity of 1500 to 2500 students per school. This is the very first step. If you look at the demographics of Saudi Arabia, you will see that the demand in this particular sector is never ending, especially with the growth rates. So, this is a dynamic sector, with a huge demand, but not enough supply. The government is spending a lot on education as you can see from the announcements last year. The budget allocations for education are quite significant today, 25% of the budget. But it is still not enough. We are looking for quality education. In my opinion, the Saudi government is doing that to emphasize the importance of education and building new capacity in education. But at the same time they are creating new jobs as they build new school. I am not sure if this is working, but it is still an important initiative. This pushes the private sector, alongside companies like Itqan Capital, to pursue such sectors with new ideas.  

Who are the institutional investors and individuals who respond to such initiatives of this kind?

Since we have announced our intension in October 2013 to launch the fund, we have had a great response from a lot of institutional investors. Al Khaleej led the list. They came to us immediately after the announcement and today, we are partners in this together. There are lot of people out there, who are very interested in the sector, but are not really sure of how to get into it. So, we have created a vehicle that will help them invest in such a dynamic sector with trustworthy partners.

 
What are the yields that this fund will be able to generate?

This is a long-term fund, because this is simply the nature of the sector itself. It is 15 years, could go up to 20 years. We expect to rope in mid-teens in terms of return on investment for this fund. But we are being conservative when we say that, because we are not accounting for leverage at this point. But if we do, the returns will definitely change. 

What investment area is your company most active in? Would you say it is real estate is your bread and butter? How about other areas?

Real estate is definitely our bread and butter. But we have proven our management skills in the money market. This is demonstrated by our Itqan Murbahat and Sukkuk fund, which is listed on Tadawul by the way. This fund has been number one in the Saudi market since May last year. I don’t think anyone will catch up at this stage, we are far ahead. Our yield is 50% higher than the number 2 fund in the market. This is now being implemented on a managed portfolio basis for certain institutions in the Saudi market. The first of which one was singed last year. For the sake of comparison, the Saudi Riyal interest rate today is slightly lower than 1%, our fund pays 2%. Our managed portfolios pay around 3%. We have an advantage there. We are playing on this advantage. A lot of institutional investors in the Saudi market with plenty of cash sitting around and they are unable to manage it properly or they don’t get their returns from the banks.

Can foreigners invest in your funds? What is the best way of investing?

Yes, they can. I think, if you are foreign investor and are not familiar with the Saudi market, this is one of the best ways of investing in Saudi Arabia. We followed similar strategies when we entered foreign markets as well. We opted to go with able, professional asset managers, who can do the job for us and achieve the required returns. We see that as quite a viable option for everyone to come into the Saudi market.

 Now you are a part of the Al Baraka Group?

We have been a member of the Al Baraka Banking Group since December 2012 and briefly this group is based out of Bahrain. We have presence in 15 countries, including Saudi Arabia, Itqan Capital. Most of the others are the Middle East and North African region. These are mostly commercial banks. So we are the first investment bankers in this Group. So we see ourselves as the central investment banking arm of the Group. We are building on that. We have a very clear strategy for the Group, where we can enforce the investment product initiatives in these countries, more specifically in countries that are growing at a faster rate than others. We see this as an opportunity for Itqan Capital.

So you are not only focused on Saudi Arabia?

We are a Saudi company focused on the Saudi market. However, we are venturing out. You will see our first announcement for a global initiative in the news very soon.

What is the outlook for the capital market in Saudi Arabia?

It’s very hard to predict the outlook for the capital market in Saudi Arabia. We never ventured into that. Our own reading of the Saudi market in 2014 is that of an overvalued market. We got out of the market in March 2014. Since then the market improved a little bit and then there was a big crash. We are now back into the market. Now, we are waiting to see where it will go. In general, if the market continues steadily and more cautiously, it will see fantastic results this year.

Which sector will see the highest growth? Petrochemicals? Real estate? Education?

Let me put it this way.

I think there is a lot of emphasis on very vital sectors, but I would rank healthcare as the top, followed by education probably.

We will see big changes in healthcare and education soon. I think the new cabinet is pushing ahead very aggressively on those funds.

Do you think that the spending on health and education will just result in building new universities and infrastructure, and focus less on the quality and the core of education itself?

I think the involvement of the private sector will at least help in getting the required quality. At this stage, everyone realizes that the quality of graduates from the universities today is not up to the standards required by the private sector and the private sector is looked upon as the primary employer of the Saudi youth. As they push further for this, the demands of the private sector for higher quality of education is going to get higher and higher. We are going to see a bigger participation of the private sector in education specifically and healthcare.

In what way is the investment landscape different here in the Middle East, especially in Saudi Arabia when compared to Western Europe or United States or Asia?

It is difficult to compare. Because we are comparing developed markets with emerging markets like Saudi. With emerging markets there are more opportunities and higher returns to be achieved than developed markets in general. So, we see more opportunities in the Saudi market. We see a lot of emphasis on bringing FDIs into the Saudi economy. We see it implemented in so many different areas. The establishment of SAGIA was the first step. The economic cities initiatives was an important step to bring FDIs into the country. To some extent, so far they have worked well – not as fast as we would have liked, but it is working and it is still functioning. Now we are seeing more steps into opening the market for foreign investments. This is to tell you that there are opportunities in the Saudi market. It represents 60% of the GCC economy as a whole. It is the largest country in the region with a huge economy and a lot of potential.

What are some of the main challenges you are facing? What keeps you up at night?

In general, the biggest challenge is human capital. In our industry, it is very difficult to find qualified people, who are willing to come to Saudi Arabia. Besides this issue, I think it is a very competitive market. There are close to 90 companies in the Saudi market. It is a very young market with a large number of active investment firms. Focusing primarily on two main cities like Riyadh and Jeddah makes it very crowded. We rub shoulders with our competitors in so many different areas. It is a very competitive market.

But you do have a competitive advantage. Your fund is the best yielding one.

Everyone is looking for a niche. We have found ours. Now, we are venturing into new niches. Hopefully with the private equities, we can push on to become one of the leading private equity firms in Saudi.

Is there anything you want to add? Advisory?

This is one of the things we shouldn’t mention. I don’t know how this will fit within the context of the interview.

We are the advisors of Saudi Airlines on treasury aspects. This is one of the challenges that we took up to build on our expertise and skills in cash or liquidity management – with the funds to start with and moving on to customized solutions for institutions. We were appointed by Saudi Airlines to help them with their cash management and treasury aspects. They asked us to come up with certain solutions. That’s one of the things that we have achieved last year.

Are advisory services needed in the market? Because each company has a family base. It’s a conglomerate and the family wants to keep things private. What is the market situation for advisory field?

This is the most competitive market in our industry. We have a lot of independent advisors, licensed and active in the market. So, when it comes to financial advisory, there are the core financial advisors on capital markets. We count HSBC, NCB Capital as the top 3 in Saudi. They dominate the market when it comes to IPOs and Sukuk issues. What is left is financial advisory on capital structuring, certain aspects such as strategy and so on. You will find a lot of players who are willing to offer their advisory services in these areas. We have a core strength in cash management and in banking relationships. Those are the areas we are focussing on to differentiate ourselves from the rest of the market. It is a very competitive market out there. It is not easy to get these mandates. You mentioned family-owned businesses and conglomerates and they are very private. But you will be surprised to see the number of these conglomerates that want to go public. They are unable to do that due to some regulatory aspects or financial restructuring that is required, or because they cannot meet the corporate governance requirements. It is very important for them to hire such advisors to help them go public.