Special Report - Can Saudi Arabia fix its housing time bomb?

RIYADH (Reuters) - Like thousands of young Saudis, Nayef al-Nasser is trapped between love and a dysfunctional real estate market.

Nasser, 34, has been engaged for the past seven years. His job as a car salesman in the Saudi capital earns him 5,000 riyals (859 pounds) a month. When sales are good, he can make up to 4,000 riyals a month on top of that. He should be married and enjoying his life, he said, clean shaven and stocky in his traditional white thoub and head scarf.

There's a problem, though. Nasser does not own his own house and until he does his fiance's father insists that there will be no wedding. "Not an apartment, a house," said Nasser. "He doesn't like his daughter or her visiting sisters and mother to have to share a building with strangers; the neighbours, he means."

For a short time the couple wondered if they should live with Nasser's parents. "But the first question a future father-in-law asks you is: 'Do you have a house? It's not like before, you only needed a job, and before that you only needed to be a good Muslim," Nasser said.

Buying your first house can be fraught with anguish no matter where you live. But few countries present the same mix of financial and cultural problems as Saudi Arabia. The biggest hurdle: a next to non-existent mortgage market that seems designed to benefit existing property owners and well-off borrowers while shutting out middle class or poorer people.

Much of the housing problem is rooted in the country's fast-changing demography. Fuelled by a big rise in the number of foreign workers, the country's population grew almost 20 percent to 27.14 million between 2004 and 2010, according to a recent census.

The number of houses simply can't keep up. In total, the country has a deficit of two million housing units, a figure that's rising by some 150,000 a year, according to independent economist Saud Jleadan.

Industry experts including private Saudi-based mortgage lender Real Estate Financing Co (Refco) and U.S. consultancy Clayton Holdings estimate that just 30% of Saudis now own their home. That's down from more than half 20 years ago according to some estimates and a striking symbol of the uneven distribution of wealth in the world's biggest oil exporter.

Could the lack of houses one day lead to social unrest?

Nobody's going that far yet. But in a report issued in late July, state-owned National Commercial Bank said that rapid population growth and the huge number of young Saudis, two-thirds of whom are under 30, are "exerting enormous pressure on the country's infrastructure, while creating social and economic imbalances". The housing challenge, says John Sfakianakis, chief economist at Banque Saudi Fransi, is "undeniable."

ISLAMIC LAW AND A LAND CRUNCH

The crisis would not exist if Saudi Arabia had better developed mortgage and secondary real estate markets.

Banks do extend loans to wealthy Saudis. Indeed, contrary to popular belief, commercial banks even charge interest, while Islamic banks get around the Islamic sharia ban on interest by charging a set fee or agreed profit margin on a loan.

Crucially, though, Riyadh is yet to pass legislation to regulate mortgage lending, and in particular what should happen if a borrower defaults.

That leaves banks reluctant to lend more widely and forces average Saudis to rely on the state-run Real Estate Development Fund (REDF), which offers sharia-compliant, interest-free loans.

But REDF can only do so much. In 2008, barely 8 percent of Saudis who built new homes relied on the body, according to a spokesman. Critics say the government underfunds the agency, while the spokesman said a "substantial rate of default" hurts efforts to loan more money.

Even if it did loan more, people like Nasser might still miss out. The secondary market for residential property in Saudi is small; anyone in the market for a house often builds their own. But REDF does not lend money to build until a would-be mortgagee owns land to build on. The organisation does not lend money to buy land.

With both finance and land so tight, and demand growing fast, it's little wonder that housing is in such crisis. Mortgage lending makes up just 1 percent of gross domestic product in the kingdom according to Deutsche Bank. That compares with "well over 50 percent in most developed countries, and approximately 6% in Kuwait and 7% in the UAE."

Only just over a quarter of the 165 billion riyals spent on construction in Saudi Arabia in 2009 went to residential units according to the National Commercial Bank report. "Residential expenditure has been declining steadily over the past five years."

BRING ON A SOLUTION

The obvious solution -- a comprehensive mortgage law -- has been under discussion for the past decade without ever materializing.

It may not always look like it from the outside, but Saudi society is modernising. Driven by reformist ruler King Abdullah, the famously conservative kingdom has begun to tweak some of its laws. Housing was said to be a priority.

A draft bill seen by Reuters in February would give lenders the right to foreclose on properties in default, while lenders would enjoy the added security of reporting debtors through a central authority, rather than through a notary public as is currently the case.

Domestic and foreign banks have prepared ahead of a hoped for boom: an annual mortgage market worth up to $20 billion (12 billion pounds). Deutsche Bank launched a Sharia-compliant mortgage joint venture with Saudi-based investors. The finance ministry's Public Investment Fund took a 20 percent stake in private mortgage lender Refco, which was set up more than a decade ago by a group of Saudi real estate agents in anticipation of a mortgage law, and now plans to start offering home loans in 2010 and list in 2012.

Hope for a breakthrough seemed to be realized in May, when the secretary-general of the council of ministers, a congregation of government ministers whose meetings are chaired by the king, said the bill was about to enter its "final phase". But he quickly recanted and later denied having made the statement at all.

Four months later, Saudis are still waiting. "Despite the heightened anticipation, there are no clear signs that the law will gain final approval this year," said Samba Financial Group in a recent report. "Those who have seen the law say it lacks details about implementation mechanisms, among other areas."

PROTECTING THE STATUS QUO

Industry sources told Reuters that the delay is based in part on the reluctance by authorities to accept the idea -- common around the world but less acceptable in Islamic law -- that defaulters could be evicted from their property. But landlords in Saudi can already evict renters if they miss a payment, and regularly do. Why should eviction be so different when it comes to mortgage payers?

Saudi Arabia is an absolute monarchy and while its king may be relatively progressive, many in the royal family are not. It's possible that an influential arm of government -- royals control the country's ministries and 13 provinces -- has a religious or cultural reason for rejecting change.

It's also possible that the reason for the holdup is more mundane. Some analysts point to well-connected property investors who benefit from the current system and have lobbied the government to delay the bill.

Abdulaziz al-Dukheil, a deputy finance minister in the 1970s and currently head of the Consulting Centre for Finance and Investment, a financial, economic and management consultancy, told Reuters that government officials regularly give large parcels of land to VIPs and senior officials. The new owners then sell the land to speculators who in turn sell it on to property developers, he said.

Industry sources say the circle of land owners carefully limits the amount of land that comes onto the market. Combine that with the big influx of foreign workers over the past few years and the rental market is a good place to make a lot of money. Credit Suisse said in July that average residential rental yields in Riyadh and Jeddah are a healthy 8 percent and 10 percent respectively.

It also helps that Saudi clerics agreed about 30 years ago that capital gains on land should not be subject to tax. "We don't have a fair and transparent mechanism for land allocation," said Abdulaziz Al-Gasim, who heads a local law firm. "Not levying taxes on land has encouraged people to speculate, especially (when) the state spends money to equip it."

Saud al-Gusaiyer, director general of real estate developer Dar al-Arkan, blames the government's decision in the early 1970s to condition REDF housing loans on owning land. The result: land has become more valuable than houses. Gusaiyer estimates that land prices rose 40 times on average between 1973 and the mid 1980s, and 80 times in the main urban areas.

In the last 6 months of 2009 alone land prices increased by 30%. "Land owners repeat the same statement when you talk to them about selling 'I will wait'," Gusaiyer said. Gasim estimates that the cost of land now accounts for 60 percent of the total cost of a typical home in Saudi Arabia.

OUT OF REACH

Even if it is eventually passed, the mortgage law is unlikely to solve the housing deficit completely. "The core of the housing problem lies in affordability," said Sfakianakis. "The mortgage law will not create the sort of supply that will help fill the housing deficit for mid- and low-income Saudis if other problems are not dealt with."

Chief among those problems are low public sector salaries and high land prices. Official statistics show the average monthly salary of a Saudi public sector employee -- the 3 million or so people that Sfakianakis said are driving demand for new houses -- is no more than 5,200 riyals.

The Consulting Centre for Finance and Investment's Dukheil estimated that four out of five Saudis earn between just 2,500 and 8,500 riyals per month. "People who earn less than 10,000 riyals per month, and they are millions, cannot find a home," he said. Not when the price for a quarter acre block in an average Riyadh suburb is 1.5 million riyals.

Dar al-Arkan is by far the most sophisticated real estate developer in the country and recently launched a home finance firm to tap into the growing demand from middle class Saudis. Tellingly, though, the firm still generates 90 percent of its revenues and 96 percent of its gross profit from land sales.

And even if prices came down -- Dar al-Arkan's Gusaiyer said the government should consider subsidising housing for low income workers -- there's a dearth of property developers with the experience to build all the new houses so desperately needed.

"Who will build apartments blocks? And where?" Sfakianakis asked. "There is the issue of lack of public transportation. Solving the housing issue in Saudi Arabia will have to go through the development of suburbs, and this implies extending infrastructure and an efficient public transportation network."

A cultural shift is already underway. Gusaiyer points out that apartments were considered undesirable 20 years ago, but are now in demand in cities such as Riyadh. As the generation born in the oil boom years of the 1970s grows up, they'll have to learn to be content with the less.

For people like car salesman Nasser, change can't come soon enough.

"It's hard enough to find someone you really like to be your wife in this country," he said. "Now my fiance's mother keeps nagging her and tries to make her meet a more able suitor. I have applied for some jobs in Qatar and Kuwait. That is the only way out".

(Editing by Simon Robinson)

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