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Part One: Net Operating Income ......................................................................................... 1

1 Introduction .................................................................................................................... 1
2 Analysis Process ........................................................................................................... 1
3 Specifications of Subject and Comparable Proprieties ............................................... 1
4 Data and Information Sources ...................................................................................... 3
5 Determining Net Operating Income (NOI) ................................................................... 4
5.1 Reconstructed Operating Statement...................................................................... 4
5.2 Potential Gross Income (PGI) ................................................................................ 4
5.3 Vacancy and Collection Loss (VC) ........................................................................ 5
5.4 Miscellaneous income (MI) ..................................................................................... 7
5.5 Operating Expenses (OE) ...................................................................................... 7
5.6 Capital Expenditures (CAPEX)............................................................................... 8
5.7 Net Operating Income (NOI) .................................................................................. 8
6 First Part Summary ....................................................................................................... 8
7 Next Steps ..................................................................................................................... 8
Part Two: Market Value ........................................................................................................ 9
8 Estimating Market Value ............................................................................................... 9
8.1 Using Direct Capitalization for Valuation ............................................................... 9
8.1.1 First Year NOI and Sale Price of Comparable properties .............................. 9
8.1.2 Going-in Cap Rate ......................................................................................... 10
8.1.3 Market Value Based on Direct Capitalization Approach .............................. 11
Using Discounted Cash Flow (DCF) for Valuation .............................................. 11
8.2.1 The Growth Rate ............................................................................................ 11
8.2.2 Pro Forma Statement..................................................................................... 12
8.2.3 The Going-out Cap Rate and Net Sale Proceeds ........................................ 13
8.2.4 Net Sale Proceeds (NSP) .............................................................................. 13
8.2.5 The Discount Rate ......................................................................................... 13
8.2.6 Market Value Based on DCF Approach........................................................ 14
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8.3 Final Reconciliation ............................................................................................... 14

9 Challenges ................................................................................................................... 15
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List of Figures
Figure 3.1: Subject Property ................................................................................................ 3
Figure 3.2: Comparable A .................................................................................................... 3
Figure 3.3: Comparable B .................................................................................................... 3
Figure 3.4: Comparable C .................................................................................................... 3
Figure 5.1: Examples of vertical and horizontal expansion in Irqah district near the location
of the subject property .......................................................................................................... 6
Figure 8.1: Large volatility of sale price per m 2 from Daal website .................................... 9

List of Tables
Table 3.1 Detailed information about the subject and comparable properties .................. 2
Table 5.1 Reconstructed Operating Statement................................................................... 4
Table 5.2 Market rent rates determination of the subject property .................................... 5
Table 5.3 Annual subscription amount of general services................................................ 7
Table 6.1 Summary of Reconstructed Operating Statement ............................................. 8
Table 8.1: Sale price and first year income of comparable properties ............................ 10
Table 8.2: The average of the three comparable c apitalization rates ............................ 11
Table 8.3: IMF s WEO forecasts for the Kingdom s rate of inflation as measured by
Consumer Price Index (CPI) at the end of the relevant year. .......................................... 11
Table 8.4: Parameters to build the pro forma statement .................................................. 12
Table 8.5: Five year pro forma NOI ................................................................................... 12
Table 8.6: Cash flow analysis ............................................................................................ 14
Table 8.7: Reconciliation of value indicators ..................................................................... 14
Page 1

This part of the project aims to identify an estimation of the first-year Net Operating
Income (NOI) that a residential with retail stores building (subject property) is expected to
produce. The analysis will depend on examining similar properties in the market
(comparable proprieties). The rest of the document will determine the details of the
subject and comparable properties and explain the methodology used to compute the
NOI.

The overall process for accomplishing the requirement of this part of the project and
defining the first year NOI is made up of five steps:
1. Finding a proper subject property and collect all relevant information.
2. Finding suitable comparable properties and collect all relevant information.
3. Make any needed adjustment to comparable properties.
4. Determining all elements of NOI.
5. Determining the NOI.

The subject property is a new residential with retail stores building located in Irqah district
in the west of Riyadh city, the commercial date of the building is yet to come, and it is
expected to be at the beginning of 2021. The choice of Irqah district for this project is
because several characteristic reasons listed in the following:
1. The ease of access to the district because of different road entries.
2. The ability to reach other districts and gathering centers outside Irqah (e.g. malls)
within an average of 15 to 20 minutes.
3. The fact that it is a recently developed area in the centerline of Riyadh.
4. The high demand for renting and housing, which means a high potential for
population growth.
5. High supply of housing choices, especially the vertical construction real estate.

For the sake of the valuation and analysis, three comparable projects were chosen. All
three properties are very similar to the subject property, as shown in Table 3.1 below
(some adjustments will be explained later in the document).
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Table 3.1 Detailed information about the subject and comparable properties

Subject Comparable Comparable Comparable

Item
Property A B C

Type Residential with retail stores building

Irqah, Manee Irqah, Manee Irqah, Manee Irqah, Manee

Almoridy St, Almoridy St, Almoridy St, Almoridy St,
Location and map Riyadh Riyadh Riyadh Riyadh
coordinates
24.691972, 24.692454, 24.692636, 24.692697,
46.592757 46.594499 46.600121 46.597479

Under Almost two

Age Almost a year Almost a year
construction years

Commercial date/ Built Jan 2021 Dec 2019 Dec 2018 Nov 2019

M ain income source Rents

Land Size 450 m2 480 m2 500 m2 420 m2

Street Width 60 m 60 m 60 m 60 m

Building Size 1040 m2 1100 m2 1150 m2 970 m2

No. of Floors 3 3 3 3

No. of Apartments 5 5 5 5

Rentable Size of
570 m2 600 m2 635 m2 535 m2
Apartments

Annual Rent Amount of SAR 175,000

SAR 160,000 SAR 208,000 SAR 155,000
All Apartments (Offer)

No. of Stores* 5 5 5 5

Rentable Size of stores 210 m2 220 m2 230 m2 195 m2

Annual Rental Amount SAR 250,000

SAR 240,000 SAR 290,000 SAR 235,000
of All Stores (Offer)
*Some stores are doubled space (i.e. equivalent to two stores).
Note: all owners are expecting to have fixed amount of rents for at least 3 years from
now.
Page 3

The following figures show real pictures of the subject and comparable properties.

Figure 3.1: Subject Property Figure 3.2: Comparable A

Figure 3.3: Comparable B Figure 3.4: Comparable C

This first part of the project depends on three sources of information:

Search and personal investigation.
Inquiries addressed directly to landlords.
Inquiries addressed to real estate offices in Irqah.
Daal website.1

1
https://daal.com/
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NOI will be determined using the following reconstructed operating statement described
in Table 5.1.
Table 5.1 Reconstructed Operating Statement

Operation Item Abbreviation

PGI Potential gross income
VC Vacancy & collection loss
+ MI Miscellaneous income
= EGI Effective gross income
OE Operating expenses

CAPEX Capital expenditures

= NOI Net operating income

Each element of the reconstructed operating statement will be described and quantified
in the subsequent sections.

Generally, there is no need for a transaction or physical adjustments made to comparable

properties since they bear much resemblance to the subject property. Moreover, in order
to compute PGI, we calculate the weighted rate of annual rent amount per square meters
of comparable properties. For example, the annual apartments rent (SAR/m 2) of
comparable A equals SAR 160,000 ÷ 600 m 2 = 267. We apply this calculation to all
comparable properties for both apartments and stores.
Furthermore, we assigned the same weight of 40% for properties A and C. However, less
weight was assigned to property B mainly because of two reasons: (i) it is older than the
subject property than A and C, and most importantly (ii) property B is located and have
direct access to Prince Mishaal Bin Abdulaziz Road and the other properties are not,
which makes the rent rates of B higher than the others. Table 5.2 illustrates the
determination of market rent rates per square meters of the subject property.
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Table 5.2 Market rent rates determination of the subject property

Comparable Comparable Comparable Weighted

Item
A B C Average

Weight 40% 20% 40%

Annual Apartments Rent

267 328 290 288
SAR Per m2

Annual Stores Rent

1091 1261 1205 1171
SAR Per m2

Using the information we have from Table 3.1 and Table 5.2, the PGI can be calculated
as follows:

Until now, there is no contracts rents

However, the owner is offering initial prices, which build up a total of SAR 425,000 for
annual rental amount of all units. Our determination of SAR 410,000 is very close to what
the owner is asking for and we consider his offer is fair although it is higher than our
analysis be almost 4%. However, we will account for the PGI to be SAR 410,000 based
on our analysis of the market.

By examining the market by looking at the data we have of the comparable properties ,
we found a vacancy rate in renting stores of 10% (i.e. 1 out of 5 stores empty for 6 months)
per year. Nonetheless, as an appraisal, we should see the market from a typical investor
perspective. By looking at this part of Irqah district, there is a forecast of substantial
incremental growth in the population. This reflects the fact that Irqah is in high demand to
live in as explained earlier, which is met by constructions work in progress of many
residential buildings. Figure 5.1 shows examples of residential buildings in the process of
construction.
Page 6

Figure 5.1: Examples of vertical and horizontal expansion in Irqah district near the location of the subject property

Definitely, this level of growth requires an equivalent growth of local stores; in particular,
basic stores like groceries and stationeries. As a result, a 5% vacancy rate for the subject
property (i.e. collection loss equivalent to a store is empty for 3 months) is
considered in this analysis.
On the other hand, this high growth of expected population has a negative impact on the
expected vacancy rate for the subject Currently, the apartments
vacancy rate is 10% (i.e. 1 out of 5 apartments is empty for 6 months) per year.
Nevertheless, the high growth will lead to a redundancy in available apartment spaces for
renting. Therefore, we would assume that the vacancy rate for o
apartments is 13.33% (i.e. collection loss equivalent to an apartment is empty for 8
months).
Therefore, the total VC rate is equal to 18.33%. To clarify any doubts, we assume that
the total VC rate include the delayed payments and any possible collection losses
generally.
Page 7

Based on the analysis of the comparable properties, we found that all of them offer
tenants an annual subscription for providing maintenance services of consumable parts
in the apartment (e.g. lambs); this includes AC routine checks, plumbing and electricity
services. Those services are offered indirectly through a property management office.
The annual subscription amount of those services are illustrated in the following table.

Table 5.3 Annual subscription amount of general services

Comparable Comparable Comparable

Item Average
A B C

Annual subscription
amount of general
3,420 2,220 1,140 2,260
services per tenant
(SAR)

We applied an equal weight for calculating the average because all comparable
properties are the same in this regard and provide the same level of service.
We also found that only three tenants are usually subscribed to these services. We use
the following to calculate the MI:

Now, we can quantify the Effective Gross Income (EGI) as follows:

When we investigate the comparable properties, we did not find that owners directly pay
fixed expenses. Nonetheless, the owners pay variable expenses for providing the
maintenance services mentioned above in section 5.4. In addition, the owners are
responsible for maintaining the building as a whole, which includes incidental repairs.
However, all owners have contracts with property management offices in which they
provide services includes for example, but not limited to, wage for cleaning common
spaces, rents collection, paying utility bills, elevator maintenance,...etc. There were no
exact data about this expense, but SAR 10,000 is considered a reasonable assumption,
which accounts for approximately 3% of EGI.
Page 8

Since the subject and comparable properties are new and each has a minimal age, there
is no need for CAPEX allowance. Moreover, the subject property owner may incur capital
costs to satisfy a particular tenant's needs. However, although this is hard to quantify, the
required improvement to some extent would be easy to make since the building of the
subject property is still under construction and assuming no improvement is needed after
the commercial date.

NOI can be easily calculated as follows:

A summary of the Reconstructed Operating Statement is shown in Table 6.1.

Table 6.1 Summary of Reconstructed Operating Statement

Item Amount
PGI SAR 410,000

VC 75,153
+ MI 6780
= EGI 341,627
OE 10,000

CAPEX 0

= NOI 331,627

Thus, the estimated net operating income over the next 12 months is SAR 331,627.

In the second part of this project, we will estimate the subject property market value and
discuss different approaches for the valuation and defining the indicated value of the
property.
Page 9

For this part of the project, we will use two valuation approaches to estimate the market
value of the subject property that are direct capitalization and discounted cash flow.
The rest of this section examines the details on the determination of the market value
based on the two approaches.

To use the direct capitalization for the purpose of valuation, we will need to determine the
NOIs of the first years of the comparable properties and the recent sell prices.
Unfortunately, sales and income references for similar comparable properties in Saudi
Arabia are limited and not readily available nor transparent. Much if not all of the evidenc e
is informal and unreliable, which impact the values used in this project.

We seek Daal website, which is a new website dedicated to real estate in Saudi Arabia
and provide indicators of transaction prices. However, the website still in its beta launch
and does not provide reliable source. Figure 8.1 illustrates the non-reliability of recent
sale price data of comparable property similar to the subject property (the locations of the
properties are selected districts in north of Riyadh, Aqiq, Yasmeen and Malga).

Figure 8.1: Large volatility of sale price per m2 from Daal website
Page 10

When overlooking the unreliability and extremely limitation of Daal data, we found that
sale price of properties classified as residential & commercial averaged to be SAR 3193
per squared meters.
Defining the operating income of comparable properties is much harder than the sale
price because they are not publicly available. Moreover, we found difficulties contacting
the buyer and/or seller of each comparable property, or a broker involved in the
transaction, for revenue and expense information. Therefore, we will apply the same
parameters as we did in the subject property. Table 8.1 uses information from Table 3.1
and above conclusions to determine the sale price and first year income of comparable
properties

Table 8.1: Sale price and first year income of comparable properties

Item Comparable A Comparable B Comparable C

Estimated Sale Price (SAR)

1,532,640 1,596,500 1,341,060
(3193 Land size)

PGI 400,000 498,000 390,000

VC 18.33% of PGI 18.33% 18.33%

+ MI 6780 6780 6780
= EGI 377,452 466,654 368,369
OE 3% of EGI 3% 3%

CAPEX 0 0 0

= NOI 366,128 452,654 357,317

Again, we want to emphasise that this process is not correct but we are doing it to show
some sense of the numbers especially when using the DCF approach discussed later.

Building on previous section, the next table computes the going-in cap (overall
capitalization) rate.
Page 11

Table 8.2: The average of the three comparable capitalization rates

Comparable Comparable Comparable

Item Average
A B C

Cap rate (NOI Sale Price) 23.9% 28.4% 26.6% 26.3%

The estimated market value based on the direct capitalization approach can be found
by the following formula:

In this approach we will estimate the cash flows of the subject property assuming a
holding period of five years. The details are explained in the following subsections.

To determine the projected net operation income stream, the expected or forecast rate of
inflation is included in the determination of the growth rate of future cash flows of the
subject property to account for the general increase in prices.
The choice of an inflation index is determined by its reliability, timeliness, stability and
simplicity.
The International Monetary Fund (IMF) publishes its World Economic Outlook (WEO)
twice a year (in April and October)
developments during the near and medium term.
(Table 8.3) as measured by
consumer prices is used in the determination of the growth rate.

Table 8.3: IMF s WEO forecasts for the Kingdom s rate of inflation as measured by Consumer Price Index (CPI) at the
end of the relevant year.

Item 2021 2022 2023 2024 2025

Inflation Rates 3.7% 2% 2% 2% 2%

Page 12

Nevertheless, a closer look at the real estate market and renting rates (i.e. market
conditions) in Irqah district, will find that prices are not changing in proportion to the
change of CPI. For example, owners are willing to offer a fixed rent rate to tenants for
some period of time (i.e. period before current tenant decides to leave) then they increase
the prices; this period varies and maybe three to six years. Therefore and for the sake of
this project, we will assume that the owner wants the rent in 5 years to be 10% higher
than current renting rates, which means almost 2% per annum growth will achieve the
requirement [an approximation of: (1+ 1.92%)5]. In this way, we eliminate the effect of
high forecasted inflation in 2021 and actual higher inflation in the future.

Now, Table 8.4 summarized the parameters we determined earlier in this document,
which we use it to build the pro forma NOI statement in
Table 8.5.

Table 8.4: Parameters to build the pro forma statement

Parameter Value

First Year NOI SAR 331,627

Operating expenses of EGI 3% (SAR 10,000)

Holding Period 5 Years

Growth Rate 2%

Table 8.5: Five year pro forma NOI

Year 1 2 3 4 5 6
PGI 410,000 418,200 426,564 435,095.3 443,797.2 452,673

VC 75,153 76,656 78,189 79,753 81,348 82,975

+ MI 6,780 6,916 7,054 7,195 7,339 7,486

= EGI 341,627 348,460 355,429 362,537 369,788 377,184

OE 10,000 10,200 10,404 10,612 10,824 11,041

CAPEX 0 0 0 0 0 0

= NOI 331,627 338,260 345,025 351,925 358,964 366,143

Page 13

At the end of the holding period (i.e. 5 years), an estimation of future sale price needs to
be computed. This is done by converting the annual net cash after the fifth year into a
sale price using the ratio of the estimated net operating income in the year following the
sale (sixth year) to the overall value of the property at the time of sale (fifth year). This
ratio is the going-out cap rate.
The going-out cap rate will define the capital gain of the owner. The owner will achieve
capital gain if the going-out cap rate is lower than the going-in cap rate and vice versa.
The going-out cap typically depends on the conditions of the property such as the location,
current rent contracts agreement, and the quality of the property. We believe Irqah district
represents a high investment value for any typical investor. In a normal market, the going-
out cap rate usually reflects the declining productivity of the property due to aging, which
means less income the property can produce in the future leading to investors paying less
for older properties than newer properties. As a result, the going-out cap rate is usually
assumed to be approximately 0.25-0.75% higher than the going-in cap rate. The problem
is that the going-in cap rate that was determined in section 8.1.2 is based on not true and
not reliable data that we do not trust. Based on this situation, we are of the opinion that a
fair going-out cap rate for the subject property is 10%, which we think a typical investor in
the market will ask for.

To estimate the selling price of the subject property at the end of the holding period, we
will apply the direct capitalization (perpetual) method using the going-out cap rate and the
inflation rate. The following formula is applied:

The net sale proceeds at the end of the expected holding period are obtained by
subtracting selling expenses from the selling price calculated above. The selling
expenses are any transactional costs, taxes and fees that are directly related to the selling
of the property and it is estimated to be 5% of the selling price. Then, the net sale
proceeds in year 5 is computed as follows:

The discount interest rate is equivalent to the opportunity cost of investing in the subject
property. In other words, it is the rate of return that the owner could make from investing
the money elsewhere at the same risk. By using the discount rate to determine the return
on the investment, the intention is to ensure that the owner is adequately compensated
for the risks associated with investing in the subject property. In addition, the discount
Page 14

rate should allow the owner to receive compensation for inflation. Moreover, the owner
may ask for a liquidity premium on top of the discount rate as real estate investments
usually have less frequent trading than other types of investment. By comparing with
different properties with similar risks, we found that a total return of 12% is considered
adequate and fair, and we will use it as a discount factor of future cash flows.

Table 8.6: Cash flow analysis

Year 1 2 3 4 5
NOI 331,627 338,260 345,025 351,925 358,964

NSP 4,347,948

Total Cash flow 331,627 338,260 345,025 351,925 4,706,912

Present Value Factor 0.89286 0.79719 0.71178 0.63552 0.56743

Present Values 296,096 269,658 245,582 223,655 2,670,828

Discount Factor 12%

Present Value SAR 3,705,819

Rounded Present Value SAR 3,700,000

A summary of indicated market values based on the two approaches presented in the
previous two sections is shown in Table 8.7.

Table 8.7: Reconciliation of value indicators

Parameter Indicated Value Weight

Direct Capitalization Approach SAR 1.300,000 0%

DCF Approach SAR 3,700,000 100%

As Table 8.7 shows, we are of the opinion that the Market Value of the subject property
must solely be based upon the Discounted Cash Flow (DCF) approach with assumptions
Page 15

and details expressed within this project report. Therefore, we may be fairly stated that
the market value of the subject property is as follows: SAR 3,700,000.

Data availability and reliability, there remains a lack of transactional evidence in

the KSA market.
Difficulty to reach property owners.