Saudi Arabia: Mortgages enter housing market

The landscape of Saudi Arabia’s real estate market is set to change with the ushering in of a slew of mortgage laws. However, things were challenging before the law, and the following data tells us exactly why.
 
Suppose, you are 20-something and draw SAR 6500-7700 a month. In that case, for two reasons, you will not be able to afford a decent home. One, the down payment for the house is approximately 14 months of your salary. If you habitually save 25% of your earnings, you will have to work for six full years to save this sum. Two, under the Regulations for Consumer Credit, 2006, your EMI on all borrowing (including credit cards) cannot exceed 33% of monthly salary. These straight away set the affordability level, which isn’t high as  the property prices are steep.  Little wonder, banks prefer to lend to the 30-45 years age-group who have stable jobs rather than the young ones, who have just begun their career.

Key features of the new law
Saudi banks have a strong balance sheet and extensive reach. This gives them an upper hand in the mortgage business over private finance companies due to which they are likely to corner a majority of the market. The law must help lay out a level playing field.
 
The new mortgage law comprises five laws: Real Estate Finance Law, Finance Lease Law, Law on Supervision of Finance Companies, Registered Real Estate Mortgage Law and Enforcement (Execution) Law. All these laws aim at enhancing the number of participants such as banks and finance companies in the real estate sector as well as providing regulatory power to government agencies like the Saudi Arabian Monetary Agency (SAMA).
 

These laws will provide a legal structure for mortgage registration, foreclosure, and regulation of financing companies, including those active in real estate. We will see an overhaul the kingdom’s home-finance market ranging from registering mortgages to allowing judges to prosecute police officers who fail to carry out eviction orders. The changes are expected to increase residential lending to about USD32 billion annually. There will be a creation of licensed private mortgage providers as well as a state-run company for refinancing resembling Fannie Mae and Freddie Mac in the U.S.

Happy days
Now on to the specifics. For the first time, the new laws will help create and register real estate mortgages. Lenders will be able to take on foreclosures, unlike the limited legal reprieve available earlier. Better documentation will help clear title deeds, which will help the long-term development of the real estate market. More real estate finance companies will be attracted to the market. A regulated market will induce the development of a secondary market through refinancing, and gradually introduce mortgage based securities in the Kingdom. Finally, the emergence of a long-term Sukuk market will infuse more liquidity into the market and create a long-term yield curve, which is currently non-existent.
 
The principal stakeholders will not be left behind. An entirely new business opportunity will open up for banks. For real estate developers, it will mean more liquidity and hence lowered turnaround time for construction. For investors, there will be clarity on the property market as more real estate data is made public. The listing of real estate finance companies will ensure better transparency and disclosures. A regulatory mechanism comparable with the best in the world would evolve. This will rid the government of inefficient subsidies and disbursal mechanisms. The consumers will benefit from increased supply that will meet rising demand. The best part: those earning a salary of SAR 25,000 onwards will be able to afford Villas!
 
Long road to walk
Hold on. The picture is not entirely rosy yet! The new law does not incentivize landowners or developers to utilize the undeveloped land (according to press reports, the Saudi cabinet recently approved a proposal to tax undeveloped land in urban areas). The absence of a clear legal framework, especially related to foreclosure, has led to restricted lending. Mortgage penetration rates (mortgage debt as a percentage of GDP) in Saudi Arabia are low at 2%, compared to 5-10% in the neighboring GCC countries. In contrast, developed countries like the US and UK, have mortgage penetration rates of more than 70%.
 
The law does not explicitly say that mortgage or finance companies will have the right to foreclose by taking outright ownership of the property in case the applicant becomes insolvent.  Under the Shariah law, judgments given by the judges do not set a binding precedent, due to which cases of similar defaults in mortgage payments could result in entirely different verdicts. There are no taxes on real estate transactions in Saudi Arabia except when it is held for speculative purposes.
 
Additionally, no pricing statistics of properties are available publicly. We have to see whether the new regulations will bring about any changes to control speculation.  There is no guarantee of standardization of pricing of mortgage products, as no long-term yield curve exists. Also, the health of the borrower is an important lending criterion. It is impossible to evict the dependents of a borrower, in case of his death, where usually the debt is waived off.
 
Outlook
The new law represents the first baby step in the right direction, which will benefit the Saudi real estate sector over the long-term. SAMA and the Saudi government should proactively remove gray issues to ensure the success of the new law.