Despite the country's size, available land for development is at a premium. Demand is being driven by overall population growth of 3.1 percent, and a Saudi national growth rate of 2.2 percent. The growth rate of young Saudi adults-defined as those aged 20-34-is estimated at 2.7 percent. Pent-up demand is considerable given an average family household size estimated at 5.7 (Jones Lang Lasalle-JLL). This in turn reflects the paucity of financing options for most young Saudis, many of whom continue to live with their parents for extended periods, the report said.

Migration is another important driver of demand. The high-end rental market (including compounds) tends to be dominated by two groups: high-income expatriates, and religious tourists. Blue collar expatriate workers drive demand for low-end rental accommodation. According to the 2010 census, the expatriate population is growing at an annual rate of 5.5 percent, the report said.
 
High-end projects

Supply has lagged, with developers tending to focus on high-end rather than lower- or medium-income residential units. Supply rollout has slipped further following the introduction of the escrow law in 2009, which prohibits most types of off-plan selling without approval from the Real Estate Commission. In Riyadh, few new projects have been announced over the past year, and many of the earlier-launched Masterplan developments such as Al-Wasl and Ajmakan, have yet to be delivered. For expatriates, there are a number of large compound schemes with 300-plus units in the planning stages, but not yet under construction. Most developers are providing houses priced at more than SR1 million ($270,000), but demand is strongest within the SR500,000-SR750,000 range. After all, the average monthly wage for the Saudi public sector (in which the vast majority of nationals are employed) is just SR5,200 (the 2009 median household income for Riyadh was SR6,000), the Samba report said.
 
Demand and supply

The Samba report said mismatch between demand and supply has pushed prices upward. The price of residential land in Riyadh increased by 20 percent per year in 2003-07, with average house prices rising by 16 percent, according to JLL. Residential prices dropped by 22 percent in 2009 according to Colliers International, though JLL says that prices for all types of property in Riyadh were up 12 percent in the first quarter of 2010, year on year; other research suggests that Riyadh apartment prices were up 6 percent in the first half of 2010, while villa prices were 3.9 percent higher.

In Jeddah, prices rose 16 percent in the first quarter, year-on-year, and have been partly supported by the flash flood in November 2009 which destroyed a sizeable number of homes.

In the Eastern Province the situation is somewhat different, with oversupply leading to a 10 percent fall in prices between mid-2009 and mid-2010, according to CB Richard Ellis.

Higher prices are clearly beneficial to owners of property, and this can have important positive economic consequences. However, in the Saudi context, higher prices both reflect the shortage of supply and further reduce the chances of potential first-time buyers being able to enter the property market.
 
Rents

Rents have also increased. Until recently, the rental component of the cost of living index had been trending down gradually on a year-on-year basis. However, it appears to have flattened out at around 9 percent, which is very high by historical and regional norms. The month-on-month rate has also been trending up over the past twelve months. With a weighting of 18 percent in the overall cost of living index, rental price increases are one of the principal drivers of overall inflation. High rental inflation also eats into the real disposable incomes of those who rent, and has the potential to deter foreign direct investment, with potentially serious consequences for economic growth.
 
Financing

The main reason for the current disequilibrium in the Saudi residential property market is the scarcity of mortgage financing, the Samba report said. Currently, Saudi property developers are reluctant to build middle- or low-end residential real estate because, although pent-up demand might be substantial, actual demand-that is individuals able to purchase these types of homes without benefit of a mortgage-is low.

Financing is available, but is generally limited. The Real Estate Development Fund (REDF) provides soft loans to Saudi individuals to build their own homes, but this has proved inadequate given the demand for housing, and the approval process is lengthy. Commercial banks do provide mortgages (on Islamic terms), but lending has been largely confined to those who can provide the large down-payments required. Thus, bank mortgage lending makes up only around 3 percent of GDP in Saudi Arabia1, compared with approximately 6 percent in Kuwait and 7 percent in the UAE, and well over 50 percent in many developed countries.

A mortgage law, which deals with default and other issues that have impeded mortgage lending by banks, is still under review. The bill apparently gives lenders the right to foreclose on properties in default, while lenders would gain the added security of reporting debtors through a central authority, rather than through a notary public as is currently the case. The bill is currently with the Shoura Council, but consideration of the bill has been delayed. Final approval by the council seems unlikely in the near term, given a number of issues relating to oversight and enforcement of the law that have yet to be resolved, the Samba report said.
 
Mortgage law

The passage of the mortgage law would be an important breakthrough in opening up housing finance to a large section of the Saudi national population - the low- and middle-income earners. The law would also open the way to tackle other constraints in the Saudi housing sector.

It is important to note that the details of the mortgage bill have not been revealed. However, the bank assumes that at the very least the final law will provide a remedy in case of default. By effectively providing collateral, the law should therefore provide lenders (primarily banks) with the comfort to expand mortgage lending significantly. Banks have been geared up to accelerate mortgage lending for a long time and are well capitalized with low loan-to-deposit ratios. A well-functioning credit bureau is in place, and salaries are paid directly into bank accounts, the Samba report said.

Recourse to foreclosure should also encourage a significant increase in the tenor of mortgages, which in turn will allow more affordable debt-service-to-income ratios. The bank also assumes that the new law will provide a regulatory framework that will improve transparency and build quality in the residential real estate sector. For example, according to Samba, building standards to be raised since only qualified housing will be eligible for mortgage-backed financing. Greater transparency and standardized processes should also reduce administration costs for lenders, which would further encourage lending to the mass market.

Once the mortgage law has had time to operate, potential exists to liberalize the market, by allowing in non-bank providers. Competition in Kuwait and the UAE, for example, has led to a wide range of primary mortgage products, and features such as penalty-free refinancing, second mortgages on favorable terms, and fixed interest rate mortgage products. These are important advances: For example, the capacity to borrow against accumulated home equity allows households to tap their housing wealth directly and to borrow more when house prices increase. Similarly, the absence of early repayment penalties frees the borrower to refinance their mortgage debt in the event that interest rates decline.

A mortgage market could also open the door to securitization. Securitization gained a controversial reputation during the global financial crisis, but that should not obscure its inherent advantages. By allowing banks to deploy their capital more effectively, securitization encourages credit growth and helps to deepen financial markets. Deeper financial markets enable households and firms to liquefy assets quickly and easily, and, by putting downward pressure on interest rates, encourage long-term capital investments. Securitization also offers the potential for more accurate price indicators in an otherwise illiquid market.
 
Potential constraints

There are a number of potential constraints on the effectiveness of the mortgage law, were it to be implemented.

It may well be that the mortgage law will not encourage a significant increase in housing credit until it has been properly "tested". In practice, this would mean the legal authority ruling in favor of a lender in a case where the borrower was in default. It might also require actual foreclosure of a property before lenders have sufficient comfort to expand lending significantly.

In addition, the law will only cover property that has the proper permits. It is estimated that 30-40 percent of existing residential property in Saudi Arabia lacks proper licensing owing to a failure to obtain official planning approvals. It is therefore possible that this element will be "frozen out" and may become difficult to trade. This is not insurmountable: Similar situations in other countries have been resolved through a certification process that allows occupiers to claim title to their property, but it would likely take many years to work through.

Other issues center on the legal system for property. Valuation procedures are not standardized, and the valuation process is further complicated by the tendency to demolish homes on newly-acquired plots and build afresh. Nor is there a central electronic database to register transactions, with the current system of notaries public prone to recording error. The mortgage law is partly designed to remedy this situation, but in the early stages of its rollout, shortcomings in the current system might well weigh on the flow of transactions.

Related to this is the restriction on off plan sales. The law prohibiting off plan sales without prior approval from the government was designed to prevent Saudi Arabia from succumbing to the type of property price bubble witnessed in some other Gulf states in 2005-07. This is perfectly understandable and the law has indeed reinforced end-buyers' confidence. However, the flipside of the law is that developers are obliged to finance and build large-scale projects before offering them for sale. This has put a strain on their balance sheets and has contributed to the slowdown in new projects. Some encouragement is offered by the recent approval of off plan sales at TMG's Nasamat Al-Riyadh project, but it is not clear whether this is a one-off or the beginnings of a more widespread loosening of the Escrow Law.
 
Land remains scarce

A relatively static land market has also impeded real estate development. Land ownership patterns mean that the flow of buildable land to the market has been constricted. The price of land has therefore increased faster than the price of physical property, with the price of a quarter acre plot in a typical Riyadh suburb about SR1.5 million.

Encouragingly, the government has laid out plans to provide about 270 million sq meters of land for the development of housing projects by the public and private sectors under the terms of its latest Five Year Development Plan (2010-14). Yet the release of additional land to the market will be necessary to meet demand and increase the flow of properties available. A tax on land holding, or a legal requirement to develop vacant land within a certain period of purchase constitute potential solutions to this problem, though neither would be easy to implement.

A fully functioning mortgage market might also be hampered by the lack of a long-term yield curve. The current dearth of long-term bonds makes it difficult to price a 30-year mortgage.

Most crucial, perhaps, is the issue of affordability. Current property prices put most existing accommodation well out of the reach of ordinary Saudis, regardless of the availability of mortgage finance.

The structural problems indicate that the mortgage law will not transform the housing finance landscape overnight. The law should help to transform potential demand into real demand, but it does not - directly at least - address supply constraints.

Ultimately, the mortgage law could prove to be a catalyst for a number of positive developments in the Kingdom beyond the obvious boon to construction, downstream industries and securitization. There is enormous untapped economic potential in the middle-and lower-middle classes potential that could be released by providing them with the means to secure their own property. Home ownership provides security, wealth, and a basis for future borrowing. In short, it could provide the platform for a substantial and sustained increase in private consumption, giving breadth to the Saudi economy and providing the engine of growth for the long term, the Samba report said.