The legal changes around mortgages mean that the Kingdom appears poised for a real estate boom. Banks and other financial institutions have money to lend; there are plenty of homeowners, or would-be homeowners, eager to borrow. Meanwhile developers are falling over themselves to put one brick upon another. It ought to be a winning situation for everyone concerned, except that the reality is that, for far too many prospective property owners, their dreams of having their own home are becoming unaffordable.
In one respect, the high cost of property in the Kingdom is a function of the market. There are simply too many buyers chasing an inadequate supply of residential development. The legal clarification around mortgages and the almost inevitable significant boost to the funds available for housing borrowers is only going to compound the problem.
Demand will push up home prices. Demand has also been having a growing impact on the land bank that is available for residential construction. Indeed the developers themselves have been paying ever higher prices for land in prime development locations.
The upshot is that firms in the residential building business seek to maintain their margins by thrusting up what they charge the property buyer. And it is clear that they are pushing against an open door. Indeed it can be argued that in terms of domestic property, the Kingdom is very much a seller’s market. Buyers, it seems, are perfectly well prepared to pay top dollar, and then some, to get the property that they want. All too often this is a detached, villa type home. Apartments are not the residence of choice. One oddity has been pointed out here by a local economist.
There being low demand for them, the price of apartments ought not to be rising as fast as for high-demand villas. Yet this does not seem to be the case. By and large, both ends of the domestic property market appear to be appreciating at about the same rate.
Of course for those who can afford to be on the property ladder, there is a great deal of comfort to know that the home for which they are paying a great deal of money is likely to be worth even more next year and the year after. There is however an obvious danger. Property price inflation has clear risks in the face even of a mild economic slowdown. If credit becomes tight and homeowners need to release capital by selling their properties, they may discover that purchasers are no longer prepared to meet the asking price. New buyers may, after all, be under financial pressure themselves. What starts as a seemingly manageable market adjustment can all to easily become a rout.
This is what has happened in North America and much of Europe. The destruction of value through a property collapse can have long-lasting economic effects and seriously hinder recovery. Given the Kingdom’s strong growth and its extraordinary investment program, many will argue that there is little danger of a downturn.
This however is to ignore previous examples of investor exuberance, at a time of steady, in not indeed strong domestic economic growth. In the early days of the Saudi stock market, the Tadawul, investors got it into their heads that the steady rise in prices was a one-way street. Though many warned that the boom would end in tears, and intellectually market players could actually appreciate the risks, they persuaded themselves that the market would not collapse yet, and there was still chance to make some more good profits. It proved an illusion of course, which brought the threat of ruin to many. In 2006 the Tadawul index collapsed from over 20,000 to less than 7,000. It took some time for a more measured and sensible approach to be established to the important role of the stock market in capital formation and price discovery of Saudi assets.
The same challenge could yet confront homeowners and developers. The suggestion that state-funding be deployed to assist young people acquire their first home, is sound, provided the homes themselves are priced affordably. Such funds must not be used to further stoke property price appreciation. On average some 40 percent of earnings go toward housing costs, regardless of whether a property is rented or bought. It makes sense for young Saudis to spend that money actually acquiring an asset rather than seeing the investment go to a landlord.
Risks of property price appreciation
