DONNA RICHARDSON takes a look at the mortgage market in Saudi Arabia and the Middle East, including the use of structures such as Bai Bithaman Ajil, and how resilient they are.

As the Middle East’s commercial and residential real estate sector looks to finds its feet following the fallout from the financial crisis, the spotlight falls on financing through mortgages, in particular Islamic housing finance.

Saudi Arabia is to enact a new mortgage law within the next few months which has the potential to increase housing demand by as much as 50%. It is estimated that the country needs 1.2 million additional housing units by 2015. The Saudi real estate sector already offers strong fundamentals with the strongest population growth across GCC and a positive demand/supply equation.

Currently mortgage lending accounts for only 2% of the kingdom’s GDP, and yet only 35% of Saudi nationals own their homes. The new law, which many analysts believe will trigger the country’s second housing boom, complements real estate’s emergence as one of Saudi Arabia’s strongest and most reliable revenue generators. Around 47% of local businessmen agree that property is currently the most lucrative market in the country.

Mohieddine Kronfol, managing director of Algebra Capital, believes a conservative estimate for total property demand in Saudi Arabia is approximately SAR350 billion (US$93.3 billion) over five years, or SAR70 billion (US$18.7 billion) a year in revenue. “Both Saudi and Egypt have shown signs of a resilient real estate market,” he said. “The implementation of the mortgage market will underpin this demand. On the other hand, we expect the Dubai real estate market to remain weak as banks seek to address their existing exposures in the aftermath of the Dubai World restructuring.”

One sector the mortgage legislation will almost certainly benefit is first time buyers. Almost 49% of the kingdom’s population is aged between 20 and 34 but to purchase homes, they need long-term financing options such as mortgages. Saudi has a six-year framework for Islamic mortgage structures like Bai Bithaman Ajil — where a bank sells an asset to a customer and allows for repayment in installment of the purchase price (which includes a profit margin). However, such structures require large payments which many in the middle-lower income group — particularly first time buyers — cannot afford.

An innovative approach applied by some banks for home loans, called Musharakah al-Mutanaqisah, allows for a floating rate in the form of rental. The bank and borrower form a partnership, both providing capital at an agreed percentage to purchase the property. The partnership entity then rents out the property to the borrower and charges rent.

The bank and the borrower will then share the proceeds from this rent, based on the current equity share of the partnership. At the same time, the borrower in the partnership entity also buys the bank’s share of the property at agreed installments until the full equity is transferred to the borrower and the partnership is ended. If a default occurs, both the bank and the borrower receive a proportion of the proceeds from the sale of the property based on each party’s current equity. This method allows for floating rates according to the current market rate such as the base lending rate, especially in a dual banking system like in Malaysia.

When Islamic mortgages first hit the marketplace, they were truly revolutionary and for many years they have been the Shariah solutions to many Muslims in Saudi and the wider GCC.

The current situation in the market is that minimum finance amounts are now at 60% to 65% of the asset value, with a minimum deposit ranging from 35% to 40% %. The so-called profit rates are also relatively high, with some lenders like Alburaq (the market leader at one point) now requiring a minimum finance of GBP500,000 (US$768,000). For the average Muslim, these minimum requirements are far too high and thus exclude the vast majority from getting Islamic mortgages, which now tend to focus on the very top tier of professional Muslims. There is no Islamic product on the market which competes with the conventional products.

For the past six to 12 months the market did not see any dramatic change in the current situation or any radical change in the financial products of the Islamic banks. An analyst for Standard and Poor’s, Mohamed Damak, said: “In our opinion, there has been no impact on this [Islamic] specific kind of financing. The impact was more the general slowdown in the growth of the loan portfolios of Gulf banks (including Islamic) because of the less supportive economic environment and the more difficult access to liquidity that prevailed in the past 12 months.”

At present, a general consensus exists that banks are not willing to offer long-term loans or mortgages until the legal framework exists to guarantee debt in the case of a default, which is deemed an Islamic sin. With lessons being learned from Dubai, would Saudi want to risk the chance of high-profile defaults through offering conventional mortgages?

Caution has seemed to be the strategy. Being Islamic in nature or Shariah compliant is no longer a big issue for many Muslims looking at these products. What is now important is the level of competiveness of these products compared to the conventional market, and making them more widespread.

As confidence in Saudi Arabia is growing, so is the establishment of many Shariah compliant home financing institutions. One such institution is Deutsch Gulf Finance, a subsidiary of Deutsch Bank, which was launched in April. According to Deutsche Bank Research, the total outstanding home finance provided by the private sector in Saudi Arabia aggregates to less than 1% of GDP compared with well over 50% in most developed countries, and approximately 6% in Kuwait and 7% in the UAE.

Deutsche Gulf Finance is a Shariah compliant joint venture owned 40% by Deutsche Bank’s Riyadh branch and 60% by a group of prominent Saudi-based investors, led by Fahad Abdullah Abdulaziz Al Rajhi. “We are excited to partner with Deutsche Bank and benefit from its global experience in housing finance. Deutsche Gulf Finance will benchmark itself against international best practices and looks forward to contributing to the growth of home ownership in Saudi Arabia,” said Fahad Abdullah.

“We are certainly happy to finance both first time buyers and buy-to-let customers. However, our main customer segment is likely to be married people in their mid-thirties looking to climb the housing ladder.”

Deutsche Gulf Finance’s launch comes at a pivotal time for consumer finance in Saudi Arabia. The estimate that Saudi needs 1.2 million additional housing units by 2015 is bolstered by the fact that the Saudi real estate sector already offers strong fundamentals with the strongest population growth across GCC and a positive demand/supply equation.
Doug Naidus, managing director and global head of residential mortgage-backed securities lending and trading at Deutsche Bank, said: “We formed Deutsche Gulf Finance as Saudi Arabia is a key country in our emerging markets strategy. Islamic home finance continues to be an important part of Deutsche Bank’s global mortgage platform. Deutsche Bank’s global expertise coupled with the Al Rajhi family’s local prominence and experience makes this an ideal and complementary business relationship.”

The company has an initial capitalization of approximately US$110 million, and at first will provide Shariah compliant home financing for properties located in Saudi Arabia, with plans to expand its operations to Bahrain, Qatar and Kuwait over time. Deutsche Gulf Finance has commenced financing completed units as well as those under construction on individual lots or at real estate developments.

An established Shariah compliant mortgage provider, Badr al-Islami, the Islamic brand of Mashreq Bank, predicts that Islamic mortgages will soon outstrip conventional ones in the UAE as they become more attractive. Unlike conventional products, customers buying properties under construction with an Islamic mortgage do not have to begin servicing the mortgage until the building is complete. Badr al-Islami offers a diminishing Musharakah mortgage that will allow home buyers to accumulate equity in their homes.

The upcoming set of legislations will especially boost the under-served low- and middle-income markets by clearly outlining mortgage policies and introducing more mortgage options as well as allowing banks to further diversify their portfolios by engaging in property investments.

“Unlike other Gulf states, Saudi Arabia’s real estate sector is not undergoing a market correction as its housing demand remains very high. There is still so much room for growth and the new mortgage law will add much-needed order as the low- and middle-income sectors begin to gain more buying confidence,” said Deep Marwaha, event director at Cityscape Saudi Arabia.

“Initiatives such as the mortgage law are crucial for potential homeowners to make better choices and for industry players to properly plan for growth in this thriving market. Moreover, it is essential that a solid regulatory framework be put in place so that industry movements align well with the government’s broader development agenda,” he added.

According to Khalid Howladar, analyst at Moody’s Middle East, there is an extremely high potential in Saudi for increasing home ownership amongst the people as this is a key policy of the government. “The lack of home finance from the private sector has been a major constraint to this growth. Finance is a domestic market and the Saudi banking system, despite some recent shocks, is resilient and well-placed to serve domestic demand.

“However, in the early days it is likely that government initiatives will be required to help nurture and stimulate this key market until the private sector becomes more comfortable with the legal and financing environment.”

Mohieddine Kronfol added: “The MENA mortgage market offers huge potential, in Saudi and Egypt in particular. The key determinant in attracting foreign banks will be establishing confidence in the legal infrastructure and perfection of security interest in mortgages and other related securities.

We believe that the enforcement aspect of the proposed mortgage law will be particularly important as would the equitable and transparent treatment of foreign and domestic banks in resolving credit events. Given the right framework, we would expect that foreign banks will be major players in the long term, combining product technology with the distribution capabilities of domestic institutions.”

Before enactment, the mortgage law requires the approval of the Council of Ministers and then the Shura Council. The Shariah compliant mortgage law will consist of five parts —the terms of mortgages, how they are designed, how they are granted, how companies are licensed and how procedures will be enforced.

“Whilst it is too early to draw any concrete conclusions on the law’s impact, directionally we feel this would be a very positive development. The kingdom needs to enhance the way it finances housing purchases and how it uses financial instruments for such transactions if it wants to sustain its leadership in the regional property business,” said Ayedh Al-Qahtani, chairman of Sumou Real Estate.