Affordable housing is key to Saudi Arabia's social development

NCB Capital, Saudi Arabia’s leading wealth manager, has issued a new report analysing the Kingdom’s real estate strategy and examining the key benefits and obstacles to affordable housing.

“Using a definition of affordability where no more than 30-35% of median income is spent on housing, we find that a lack of supply of affordable homes is a significant concern in the Middle East as a whole as well as in Saudi Arabia,” said Farouk Miah, Acting Head of Equity Research at NCB Capital. 

“Despite the important role the government is playing in the provision of affordable housing, we find there is a significant discrepancy between supply and demand of housing units in the kingdom. On one hand there is an oversupply in the market for luxury and upscale residential units, but a shortfall of affordable housing units where demand is high,” explained Mr. Miah.

Supporting the need to meet demand for affordable housing, NCB Capital highlights in the report the moral, social and economic reasons which make the provision of affordable housing central to the development of a nation.   

Commenting on these reasons, Mr. Miah said: “We believe affordable housing helps limits negative social outcomes in society. The lack of affordable housing can prevent people from meeting their other basic needs, such as nutrition and healthcare, or saving for their future and that of their families, potentially leading to social problems such as increased crime. If affordable housing is provided, this will lead to financial savings for governments as they will not need to pay for these negative consequences.”

Current supply/demand of affordable housing in KSA

According to NCB Capital, the high cost of land is the kingdom’s main barrier to developing the affordable housing sector, along with other key issues such as construction costs, lack of supply of land which can be developed, bureaucracy and limited financing options.

“Although the demand for housing in general in Saudi is high, in order to translate potential housing demand into actual demand which can be met, the obstacle of affordability must be considered. Given the prohibitively high cost of land in Saudi Arabia and the relatively low median income of most Saudis (we estimate SR5,900 per month per household), we believe this leads to a significant demand for housing which is affordable,” added Mr. Miah.

“However, due to various obstacles which restrict normal market dynamics, we believe the market left on its own cannot provide housing which is affordable for the lower income segment of society without government support.

Demographics suggest demand to remain high

Looking at demographics, NCB Capital notes that with approximately 58% of the Saudi population under the age of 25, along with the decline in average household size, there will be a continuously rising demand for affordable entry-level housing as these individuals leave to set up their own homes.

NCB Capital estimates that the country will need an additional 973,000 units over 2010-15E and a total of 2.1mn units over the coming decade (215,000 units per year). “We note that the government’s estimates are even more aggressive than ours. According to the 9^th 5 Year Development Plan, 1.2mn units are needed over the next 5 years, or 250,000 units every year,” added Mr. Miah.

Supply tightly controlled, leading to high land prices

The report observes that the Saudi real estate market is largely controlled by a relatively low number of individuals who wield significant power on market dynamics. This in its own right causes obstacles from the outset when trying to tackle the issue of affordable housing, the primary one being the high cost of land.

In Saudi Arabia landowners are not taxed, so in essence there is little incentive or pressure to sell a plot of land which will most likely appreciate in value over time. When land is approximately half the cost of developing housing units, significant governmental measures will be required in order to overcome this obstacle.

Giving an example, the report states that, currently, in Riyadh land prices per sqm are around 50% of the price of a villa per sqm for the upper end of the scale, and towards 20-30% for the lower end of the spectrum. The average price of land in Riyadh is around SR1,000-1,500 per sqm.

In terms of construction costs, a survey by the High Commission for the Development of Riyadh in 2009 indicated that the construction cost of a small villa (land 327sqm, built up area 320sqm) is around SR1,120 per sqm. NCB Capital estimates that costs have increased by around 10% over the past year to SR1,200 per sqm due to higher prices of material and labour.

Generally speaking, land prices are driven by the expected return from developing that land. For developers targeting a 30-35% return, land prices are the key determinants of return. In a 2009 survey by the High Commission for the Development of Riyadh, developers ranked cost of land at the top of the list when asked why many investors shy away from investing in residential developments.

Limited Financing Options

The NCB Capital report goes on to note that, currently, the government’s Real Estate Development Fund (REDF) is the Kingdom’s main provider of housing finance. With an increasing number of applications for home finance, alternative options need to be introduced to the market.

“The long awaited mortgage law will facilitate access to long term housing finance; however we do not believe that it will introduce a new product to the market which will allow people to own their houses. Currently, almost all banks in Saudi and other financing companies provide financing to individuals to purchase houses, although their criteria remain conservative,” explained Mr. Miah.

Government plays an important role in affordable housing

“When analysing the reasons behind the lack of affordable housing and looking at case-studies where this has successfully been tackled, we find governments playing a significant role,” said Mr. Miah. “Similarly, we believe in Saudi Arabia the government can play a major role to support the provision of affordable housing.”

Earlier this year, the Custodian of the Two Holy Mosques King Abdullah issued a series of royal decrees aimed at easing the burden of high property prices and housing market imbalances. The stimulus package included the provision of 500,000 affordable housing units across the market. This on paper is a significant initiative by the Saudi government in an effort to tackle the subject at hand. According to an official release, this caters to households with a monthly income of SR5,000 or less.

With the population of Saudi Arabia highly concentrated in three major cities (Riyadh, Jeddah and Dammam), creating affordable housing units around these cities will be a move in the right direction to help a high percentage of the population. One possible potential is replicating the UK experience and creating “commuter towns” outside the main cities from which people can travel into and out of the main city for work.

“From a birds eye view, it seems possible for Riyadh to implement a similar strategy, given the plots of raw land surrounding the city. However, active government involvement is crucial for this to happen; from ensuring adequate infrastructure and transportation systems to promoting an active mortgage law,” highlighted Mr. Miah.

According to the report, the government would need to focus on two key areas to promote the creation of commuter towns in Saudi Arabia. The first key area to focus on is Infrastructure, including adequate and affordable transportation routes to and from the commuter town, as well as within the main cities. The other key area to consider is subsidies. Government bodies should have the ability to subsidise the developer. Generally, government bodies subsidies real estate developers with land, material and construction costs to complete any given project.

According to NCB Capital, Public Private Partnerships (PPPs) are another area which the Saudi government can explore in order to deal with affordable housing. PPP involves the interaction between a governmental agency and a private entity. In such cases, the private body provides the government with a project for which it receives financial, technical and/or operational services from the government.