Stress Testing a Saudi Deal: Can It Survive a Genuinely Bad Year?

A worked stress test on a Saudi residential block, moving occupancy, rent, costs and a capital item together, and reading what is left of the cover and the equity.

A stress test asks a single question: what survives when several assumptions fail together. Moving one input at a time measures influence, which is useful, but bad years do not arrive one input at a time. The illustrative test below moves occupancy, achievable rent, operating costs and a capital item at once on a small Saudi block, then reads the cover ratio, the cash and the equity that remain.

The situation

An investor is considering a twenty-unit residential block and wants to see the deal under one combined downside rather than under a series of individual sensitivities. The stress is built from the building's own history rather than from a round percentage, and the purpose is to find out whether the structure holds or whether the facility needs to be smaller.

Assumptions (illustrative)

• Twenty units at an assumed achievable rent of SAR 50,000 each per year.
• Base case occupancy 93 per cent, with bad debt assumed at 2 per cent of billed rent.
• Assumed operating costs of SAR 280,000 per year, almost entirely fixed.
• Purchase price SAR 10,000,000, acquisition costs assumed at SAR 700,000.
• Debt of SAR 5,500,000 at an assumed all-in cost of 6.5 per cent, interest only, so service of SAR 357,500.
• The stress: occupancy 78 per cent, bad debt 5 per cent, achievable rent down to SAR 46,000, costs up 12 per cent, plus a capital item of SAR 220,000.

Step 1: The base case

Gross potential rent 20 multiplied by SAR 50,000 equals SAR 1,000,000. At 93 per cent, SAR 930,000. Less 2 per cent bad debt, SAR 18,600, gives SAR 911,400. Less SAR 280,000 of costs gives net operating income of SAR 631,400.

Equity committed is SAR 10,000,000 plus SAR 700,000 less SAR 5,500,000, which is SAR 5,200,000. Cash to equity is SAR 631,400 less SAR 357,500, or SAR 273,900, a cash return of about 5.3 per cent.

Step 2: Base case cover

SAR 631,400 divided by SAR 357,500 equals a cover ratio of about 1.77 times.

On its own this looks comfortable, and it is the figure most investors would quote. The whole purpose of the test is to find out what it becomes when the building has a poor year rather than an average one.

Step 3: Income under the combined stress

Gross potential rent becomes 20 multiplied by SAR 46,000, or SAR 920,000. At 78 per cent, SAR 717,600. Less 5 per cent bad debt, SAR 35,880, gives SAR 681,720. Less costs of SAR 313,600 gives net operating income of SAR 368,120.

Net operating income has fallen by about 42 per cent. No single assumption moved dramatically, and the combination removed more than two fifths of the income, which is the point the exercise exists to make.

Step 4: Cover and cash under stress

Cover becomes SAR 368,120 divided by SAR 357,500, which is about 1.03 times. Cash to equity is SAR 368,120 less SAR 357,500, or SAR 10,620.

The facility is just covered and the equity receives effectively nothing. If a covenant required cover above 1.10 times, this year would breach it while the building was still occupied and trading.

Step 5: Adding the capital item

Deducting the SAR 220,000 capital item from SAR 10,620 of cash leaves a shortfall of SAR 209,380.

The capital item was not a disaster, it was a scheduled replacement that happened to fall in a weak year. That coincidence converts a break-even year into a cash call, which is why the capital schedule belongs inside the stress rather than beside it.

Step 6: What happens to the value of the equity

Capitalising a normalised net operating income of SAR 560,000 at 7.5 per cent rather than the 6.3 per cent implied at purchase gives about SAR 7,466,667. Deducting SAR 5,500,000 of debt leaves equity value of about SAR 1,966,667 against SAR 5,200,000 committed.

Even using a normalised income rather than the trough year, a widening of market pricing removes a large share of the equity value. Income stress and pricing stress arrive together, and the equity absorbs both.

What changes the answer

• Reducing the facility to SAR 4,000,000 lowers service to about SAR 260,000, lifting stressed cover to about 1.42 times and leaving SAR 108,120 of cash before the capital item.
• Holding the capital item back to a stronger year leaves the stressed year at break-even rather than at a shortfall.
• A stress lasting two consecutive years rather than one is the case that actually threatens the structure, since reserves are consumed in the first.
• If occupancy recovers to 88 per cent while rent, bad debt and costs stay stressed, net operating income returns to about SAR 455,520 and cover to about 1.27 times.
• An amortising facility rather than interest only would push stressed cover below 1.00 times at the same loan amount.

What the numbers tell you

• A combined stress reveals far more than several single-variable sensitivities, because the inputs that fail tend to fail together.
• Cover of 1.77 times in the base case became 1.03 times without any assumption moving dramatically.
• The capital schedule must sit inside the stress, since a scheduled replacement in a weak year is the realistic case.
• The loan amount is the lever that most improves a stressed outcome, and it is the one fully within your control at purchase.
• A two-year stress, not a one-year stress, is the test a long hold should actually be designed to survive.

Limits of this example

Every figure above is an illustrative assumption used to show the method, not a quote, valuation or market rate. Costs, rates, fees and regulations change and must be confirmed with the relevant authority, lender or supplier before you commit.

Domira builds the numbers on a Saudi property with you before you commit: rent and cost evidence, condition and capital expenditure, the appraisal and the sensitivities that decide whether the deal survives a bad year. The investment decision stays yours, and so does the advice of your licensed tax and legal advisers.