Housing Finance Problem in the Kingdom of Saudi Arabia
Lack of housing finance at an affordable rate is the key factor that has resulted in the housing problems in the Kingdom of Saudi Arabia. In comparison to other major Islamic countries, KSA has a housing ownership rate of nearly 25% (Alkhabeer). The escalating land prices in major cities like Jeddah, Riyadh, Damam and others, and the rising prices of construction materials, together have made this chronic housing problem a very concerning issue. In Saudi Arabia the variation in income as well as the influx of people from across the world for job purposes, is also one of the major factors for the housing problems (Bhzad Sidawi, 2009). The land grant program did not perform up to expectation, especially where low income citizens were concerned. . A government enterprise, Saudi Real Estate Development Fund (REDF) lends money for this purpose which is interest free, but to avail this loan is a tough task. As it is across the world, the bank loans are infused with huge interest rate although the loans by banks can be paid over a long time, which goes in favor of the banks as it earns more interest (Almarzogi, pp.189-5]). The government of Saudi Arabia has initiated comprehensive development plans which included a housing policy directed at achieving both the numerical and qualitative objectives and expected to be executed especially by the private sector (Mead, Donald C., and Carl Liedholm. 1998). The passage of the mortgage law, awaiting its final approval which is soon imminent, would be an important catalyst for the sector. By turning pent-up demand into actual demand, the law would induce additional housing developers into the underserved segments of the market. Other service providers, as well as mortgage market innovation, would likely follow. The government of the Kingdom initiated comprehensive development plans which included a housing policy directed at achieving numerical and qualitative objectives to be executed for the most part by the private sector, but with government assistance (Soudi, K. and A. Teto.2004).
This research attempts to evaluate the Saudi Arabian urban housing policy by investigating the basis of the housing policy, primarily the rationales that guide housing investment. Another important item in this analysis is an evaluation of the obstacles faced by the prospective buyers in availing this finance and how best this demand could be met with a strategic policy and with government assistance. Housing policy shall be viewed as embracing issues such as government expenditures, loans and loan guarantees for investments, zoning regulations and building codes and legal provisions of property rights (Aaron,1972).Many Gulf region governments have adopted generous standards for their citizens’ affordable housing: large homes, often villas, and minimal repayments or householder contributions. Combine these high standards with typical subdivision regulations relating to minimum plot size, street setback requirements and building regulations prohibiting technologies that did not exist 20 years ago, and the result is per-home costs that are 30% higher than they need to be, according to the GRM paper presented by Naseej CEO Christopher Sims. These changes, all within the control of government, could drop the sale price of an affordable home to something lower-income households could, in fact, afford.
Research Objectives and Methodology
The research has a set of objectives; these are:
– To find out the housing problem in KSA and the reasons of low home ownership in Saudi Arabia
– To investigate what banks and REDF are doing/ planning to meet the demand
– To set recommendation on how to improve the banks and REDF role in order to meet the future demand and solve the housing problems.
In order to achieve the research objectives, it is argued that combinations of quantitative and qualitative research methods are needed. The use of mixed methods is required because the findings that relate to each method will be used to complement one another and at the end of the study to enhance theoretical or substantive completeness. To assess the banks’ views about the issue, it was suggested to use a survey questionnaire and hence a discussion group would be used as tools to examine the level of contribution of banks towards the affordable housing.
This chapter attempts to lay a foundation for evaluating Saudi housing policy. First it addresses the theoretical basis for government involvement with housing. which will then be used to question the existence of a ‘universally’ applicable set of rationales to guide housing policy in general. Second, it includes a review of strategies available to implement housing policy goals. A distinction shall be made between demand support and supply support strategies where the former implies assistance in the consumption of housing, whereas the latter involves assistance in the production and/or rehabilitation of housing.
Literature Review of Rationales
Several rationales have been explored as bases for government involvement with housing are presented and discussed below:
In the definition of housing utilized for this thesis, the allocation of dwellings is a central feature. A basic rationale is the existence of a “fair distribution of adequate housing” for a given population. The concept of fairness in distribution is not restricted to housing, but embraces a broad scope of services including food, clothing, medical care, education, etc.
Following studies were reviewed. From a political perspective, housing may be more attractive than other social programs because of its high visibility factor, i.e., housing projects such as public housing are more obvious than food or health programs. There is an additional argument that housing by the public sector, especially where home ownership is involved, will stabilize a prevailing socioeconomic system. Another spillover effect is the increase in desirability of an area. This is likely to be reflected in increases in property values of adjacent properties due to rampant housing investments. It operates by reducing the uncertainty to invest in a given area due to greater monetary returns. It could affect potential direct investors, the landlords, or the financial intermediaries whose outlook could further provide stimulus. However, subsidizing the poor in standard quality housing with the reasoning that surrounding property values will be improved does not have sufficient evidence.
Two considerations of spatial aspects are the regional extent and distribution of housing within the national context and the locational distribution within urban areas. Quality housing may be viewed as an influence on migration patterns. These strategies represent efforts to promote the development of lagging regions and can be achieved through investment policies that would enable a region to prosper through investments in social overheads (housing, education, health, etc.) to make the lagging area attractive for migrants (Hansen, 1975).
The rationale espousing the stimulation of the economy by utilizing instruments as housing investments as countercyclical well as job and income generators are a controversial one.
One of the very important roles by which governments have aided the housing market is through finance, i.e., to close the gap between the timing of given income streams and the prevailing shelter costs. Grebler and Burns (1977) conducted a more thorough analysis of the macroeconomic effects of housing investment. In addressing employment effects, the assertion was that housing would be a good employment generator because of the relatively large proportion of unskilled workers required, as well as the relative ease of entry into the industry. This issue tries to make a case
For the housing industry being a point of entry to the urban labor market, especially for recent migrants. It is justified to the extent that net increases in product result over other possible employment possibilities.
The extent of forward and backward linkages also determines the effectiveness of housing policy on the macro economy. Forward linkages are those linking housing to consumer-oriented industries such as furniture, carpeting, etc., whereas backward linkages are those linking the industry to raw material industries, such as concrete, lumber, etc. Empirical evidence for Mexico indicated that real estate development was one of the major employment generators, with low cost multi-dwellings being the highest (Renaud, B. 1987). On the national level, Weicher (1980), points out that due to the inverse relationship of housing construction activity to interest rate levels, government investment in housing may allow production expansion easily when interest rates are low, when other industries are declining and releasing idle resources, i.e., during recessionary times. The ex post facto record, according to Weicher, has yielded a different finding. The above discussion of the macroeconomic rationale for housing investment provides a mixed view. On the one hand, there are definite positive effects on the economy to be expected from housing programs; but on the other hand it does not appear that these effects by themselves would justify a housing investment scheme in lieu of other sectoral investments.
In a World Bank study, income multipliers for Columbia, Korea, Mexico, and Pakistan were found to converge on a value of two. Thus, for every dollar spent on construction, a net effect of two dollars was generated throughout the economy (Greb1er and Burns, 1977, p. 196).* The effect of housing on savings was also addressed. Home purchase or renovation was viewed as a powerful stimulus to savings, which would be a favorable condition toward improving capital shortages, especially in poorer, less developed economies. To the extent that saving occurs, reduction in current consumption results and that has a dampening effect on possible increases in consumer spending. This latter effect, regarding the level of prices, has been viewed as being subject to the source of financing leading to an increase in demand for housing as well as the strength of linkages between the final demand sector and the intermediate supply sectors. If the increase in demand for housing is financed internally or domestically, decreases in the demand for other non- housing goods should occur or else pressure would be put on prices. If the increase in demand is externally financed, e.g. through foreign aid, proportional reductions in non-housing goods and services need not necessarily take place in order to insure price stability.
Housing Policy Strategies
In very general terms, there are two types of policies by which governments can affect the quality and quantity of housing. The first group may be termed demand support policies and they refer to actions that influence the consumption aspects of housing. The second group are supply support policies and they refer to actions that influence the production of housing. Mususgrave (1976 ) set up the following typology regarding strategies and instruments for low income housing support.
These are subsidies given to the tenant or owner-occupant. General Income Maintenance. These involve direct payments with no strings attached, but suffer from two main features. First, a portion of the transfer may be spent on non-housing goods,* which is a drawback when merit good aspects are considered~ Second, to close a housing poverty gap (the amount of money needed to elevate households out of poverty) to a given defined poverty line would imply a difficult choice.
That choice will be in either imposing very high implicit marginal tax rates on those just above the poverty line or providing subsidies to households well above the poverty line, i.e., the technical structure of income maintenance programs in general has three components
In general terms, the arguments for demand support policies include the following:
(1) They are more equitable in that they provide recipients with units comparable to those households just above the income limits for low income recipients.
(2) They are usually less expensive than new construction type supply policies.
(3) They have the potential of being more accessible to a greater number of people.
(4) They do not suffer from spatial of concentration problems typical of supply type subsidies.
(5) Demand support policies that utilize the existing stock would encourage more maintenance and thus help preserve the investment sunk in the housing stock (Carlson and Heinberg, 1978, pp. 49-51).
Criticisms of demand support policies include:
(1) They have a tendency to inflate housing prices, especially where time lags or housing supply inelasticity exists.
(2) They transfer wealth inequitably from the lower income households to their landlords if the above condition applies.
(3) Because demand support policies are usually not large enough to induce recipients to acquire new units, it was concluded by some that the supply of new units that are acceptable would not increase (Allen, Fitts, and Glatt, 1981).
These are justified where meritorious characteristics of housing consumption are concerned, as mentioned earlier. A special case of demand support are housing allowances which are basically payments made directly to low income eligible households to help them pay the costs of living in housing of their choice as long as it meets certain minimal standards. In general terms, a policy which sets and effectively enforces minimum standards will reduce the supply of housing available to low income families (Musgrave, 1970, p. 226). Standards naturally may serve a vital role in protecting tenants against inadequate rental contracts, as well as playing a vital role in assuring public safety.
This is perhaps one of the most controversial policy instruments. In a strict sense it may be viewed as being a tactic rather than a strategy, i.e., it has a short-term reactionary focus rather than a long-term planning one. Meeks (1980) cites an empirical study in the Washington, D.C, area which concluded that controls will dampen investment in new housing. However, it was also found that occupants of rent controlled units were poorer and that if removed, major rent increases occur for lower income households (Meeks, 1980, p. 1983). The difficulty in deciding to implement a rent control should weigh the concerns of weighing low income households’ availability and cost issues in the short run versus private sector investments in housing in the long run.
Relief through mortgage:
Five laws are enshrined in Saudi Arabia’s new mortgage law; these are the Finance Lease law, Real Estate Finance law, Law on the Supervision of Finance Companies, Registered Real Estate Mortgage Law and the Enforcement Law. This new mortgage law is directed towards the increasing the number of participating fiancé providers in real estate sector like financial solution providers and banks. Under this law there are several beneficiaries which are the banks, the real estate developers, the investors, the government and the consumers ((M Khan, 2013).
This law is expected to be of help in
– creating real estate mortgages and registering them
– taking action by the lenders in case of foreclosures
-greater transparency as there will be decrease in overlapping claims due to better documentation
-increase in the number of real estate financiers, lease financiers
-creation of a regulated market which in turn will help developing a secondary market
-development of long term Sukuk market
REDF and housing loans
REDF was established in 1974 to enable individuals to build their houses and the private sector to invest in, to enter into agreements with the municipalities to develop new residential areas, and to assist government institutions in setting up housing projects for their employees. From its founding in 1974 through 2003, the government’s Real Estate Development Fund (REDF) provided funding to build more than 560,000 housing units1. Through the year (2005-2006), the number of loans provided by Real Estate Development Fund was valued at more than (7032) million Riyals.
Toward An Applicable Theory
It appears that a universal framework to guide housing investment is difficult given the lack of generality of the rationales as reviewed, i.e., what may be applicable in one country may not be applicable in another, especially where cultures vary. Even though this finding may appear rather obvious, it has very serious implications. As far as strategies of housing support are concerned, it is likely that the prevailing sociopolitical framework in a given country will be the main policy determinant over and above some “rational” sectoral benefit/cost approach.
For example, in centrally planned systems, the greater likelihood is towards supply support strategies. This is because the size and capability of the private construction sector is likely to be relatively small. Even if construction inefficiencies were caused by public sector activity (or inactivity), likely actions would aim at tackling those issues utilizing public sector actions.
In response to employment and general business opportunities, which were enhanced by the development plans, the urban areas experienced an inflow of migrants from the rural areas and from abroad.
One of the main data problems in this category is that land ownership was not codified into a system which clearly defined property rights. Local government municipalities were not able to effectively regulate land uses due to the existence of “unquestionable land use” situations, i.e. the use of land was up to its individual owner. Growing land speculation especially close to the urban center led to an increasing demand for the usually less expensive outlying areas. This effect was catalyzed by declining transportation cost (low gasoline prices and low import duties on automobiles in Saudi Arabia.
As mentioned earlier, the indigenous work force was incapable of executing the development plans without assistance. This was due to several reasons: The qualitative requirements of the development projects were also mismatched to the available work force not only for professional white collar jobs, but also for skilled, semi-skilled and unskilled blue collar jobs in Saudi Arabia.
The increase in demand for building materials, throughout the world, led to delivery bottlenecks both for locally produced materials and for imported ones. Most of the construction material–primarily cement: steel reinforcing bars, aggregates, lumber etc, was imported. The constraint in this case was mainly the port system and the road capacity and ability to deliver materials once unloaded in the ports.
The demand for credit was satisfied by specialized government credit institutions, one of which specialized in long-term housing finance. For privately built housing, the source of financing was to be the Real Estate Development Fund. Public housing was to be financed through banks.
What contributions do the banks make to ease the financing problems faced by the residents for affordable housing in Saudi Arabia is not divulged by the banks. This scenario is undergoing a change with the implementation of real estate mortgage law. Many banks have been permitted by the Saudi Monetary Agency SAMA for real estate and housing finance and the banks are now bringing out new products and innovative schemes for this purpose. According to Rehan Khan, the chief financial officer at Saudi British Bank (SABB), “Mortgage lending is around 6 percent of our overall loans, which is very small by international standards,” Khan told Reuters in a telephone interview, it is expected that these ratios to undergo changes quite a lot over the next five years.”
Banks should work out and quickly introduce various kinds of mortgage loans so that it helps the needs of the residents’ housing problems. Banks should also extend the repayment period of loans which is now 11 and 20 years so that it benefits the poor segment of the society. The percentage of population demanding affordable housing facilities is increasing. For everyone in the Kingdom the housing affordability would decline in future due to the fact that housing prices are rising higher than the incomes. It is estimated that housing prices would rise by approximately 50% and purchasing power by approximately 30%. The Saudis power of purchase is approximately 25% as against a 50% housing price. The numbers of citizens buying houses will shrink. By 2020, it is anticipated that the population of the Kingdom will reach 33.44 million while the size of the family will fall to 5.3 while nearly 2.32 million units of housing will be added. A report from Samba, the Saudi American Bank) predicts that nearly 2.62 million new housing units should be built to face the housing challenges (Bhzad Sidawi, 2009).
Private sector developers often pay import duties of around 5%in MENA region, while public sector developers pay nothing for identical materials needed for affordable housing. Private sector developers are often charged up to 15 of the cost of land for registration, while public sector developers are charged no fee. Governments could readily address costs by decreeing that PPPs for affordable housing are considered public sector, because they are serving the public interest. Similar reasoning should allow developers to use more modern building techniques when they can be shown to have worked in other MENA regional countries.
The high cost of ownership of home is a big hurdle. Normally a Saudi national earns nearly $30,000 a year (Bhzad Sidawi, 2009), while the cost of a modest home in the outskirts of a city like Riyadh is not less than $200,000. Even though land prices seem to be declining yet it alone accounts for more than 60% of the total cost of home ownership.
By the replies to the questionnaire it was revealed that there are certain hindrances that affect the flow of loans for affordable housing, and these can be summarized as:
– Unwillingness of few banks to begin financing schemes
– Just a single kind of mortgage loan offer by most banks and hesitation to offer new products
– A very limited span for repayment, usually 11 and 20 years
– Limited loan disbursement activity by the banks
– Banks dither from offering flexible loan packages
Housing assistance from the public sector specifically directed at the poor was relatively weak. Private sector contributions, however, were relatively substantial. One of the most important findings is the large effectiveness gap that exists between public and private housing construction. The private sector, with government support, has shown a capability to respond to conditions of rising demand with a considerable degree of effectiveness. Public housing projects have been, as the record indicates, historically troubled. Billions of riyals have been spent on miscellaneous projects which have to this date (1984) been unoccupied. The effectiveness gap between the public and private sector implies that resource utilization could have been improved had the private sector been more involved in public sector projects. Furthermore, the low income land grant program has not been successful. One of the most important outcomes of the poor performance of public housing is that the sector of society that bears the greatest burden is the less advantaged one, i.e. low income households. These households were to be the beneficiaries of public housing, and are deprived the most due to the delays and/or indecisiveness about ‘who will live where’ problems of public housing. The greatest potential for improvement is identified in those policy components that involve direct involvement in the housing sector by the public sector, namely public housing and the land grant program. A long run perspective of housing should consider the need for additional and more affordable units as well as the potential effect of cyclical downturns in the economy, which could have very negative effects on housing and other linked markets. A greater reliance on private sector activity appears favorable due to demonstrated effectiveness of private sector, as well as its being more in conformity with the traditional norms of the country. Regarding home finance, a wider scope of financing instruments be considered. This would provide an incentive for maintaining the existing housing stock as well as being a potential source of capital growth of the RDEF. Finally, the issue of housing the poor was not very effectively handled. The status of public housing and the delays in the land grant program were the main reasons why policy outcomes did not provide housing for the poor. The widening gap of effective demand over affordable housing is not arising because governments do not care; rather, it is proof that governments’ existing frameworks are being asked to do much more than they were ever designed to deliver. It is time for governments to make step changes in their delivery models and, in particular, to shift into a more outsourced, public-private partnership oriented approach on both the supply side (new homes) and the demand side (financing products).
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