SAUDI ARABIA

ECONOMICS

March 2011

Dr. John SfakianakisChief EconomistTel: +966 1 289 1797Email: johns@alfransi.com.sa

Daliah MerzabanEconomic AnalystTel: +971 4 428 3608Email: dmerzaban@alfransi.com.sa

Turki A. Al HugailEconomic Research AnalystTel: +966 1 289 1163Email: talhugail@alfransi.com.sa

March 20, 2011

Under constructionSaudi steps up efforts to meet home, loan demand

Saudi housing market needs 1.65 million new units by 2015 to meet demand due to youth surge, smaller family size; shortfall of properties likely to persist

Mortgage law will catalyse housing market in medium term, but affordability a challenge as mismatch exists between pre-vailing home prices and salaries

State home loan fund REDF dominates 81% of mortgage lend-ing; risk aversion, lack of regulation limits bank growth in consumer mortgage space

Prohibitive land costs barrier to improving affordability in low- to mid-income bracket

Saudi Arabia’s housing market continues to wrestle with a shortage of supply and mounting demand which has placed home ownership affordability out of reach for many young Saudis. As upward pressure on asking prices for apartments and villas gains rather than loses momentum, there is an urgent need for new units where they are required most, to provide middle- and lower-income citizens with single-family homes. The government is working on several fronts to try to alleviate supply constraints, last month dedicating SR55 billion ($14.7 billion) to programmes assisting lower income citizens obtain funding for home buys. Over the weekend, the king made a considerable call to allocate SR250 billion to the General Housing Authority to finance immediate construction of 500,000 new units.

There are also signs the state is striving to expedite the passage of a long-delayed mortgage law which, by delineating the rights of borrowers and lenders, could over time encourage banks to expand the risk profile of their clientele, potentially heralding a wave of growth in consumer finance. Yet the short-term housing scenario is complex and puts young Saudis at a disadvantage. The law’s passage would have the immediate effect of spurring enthusiasm in Saudi property. But prevailing house asking prices and salaries place ownership out of reach for numerous public and private sector employees, especially those in the early years of their careers.

We estimate private and public developers will need to build about 275,000 units a year through 2015, for a total of 1.65 million homes over six years, to cater to demands of a population that has doubled in size since 1988 and grows more than 2% annually. The Saudi housing market is unique in the Gulf for an undersupply of units; our half-yearly surveys of Saudi real estate show the cost of apartments and villas climbed quickly in 2010.

Despite price constraints, the Saudi home ownership ratio is high at 60% according to the 2004 general census, and 2007 demographic data showed the rate remained consistent. The ownership rate had fallen to 55% from 65% between 2000 and 2004, over which period the ratio of average home rental costs to total income climbed to 30% from 26%, according to Ministry of Economy and Planning data. Some independent estimates put home ownership rates as low as 30%.

2

SAUDI ARABIA

ECONOMICS

March 2011

The government’s goal is to raise home ownership among citizens to 80% by 2024 by boosting supply of affordable housing and expanding financing options for citizens. Attaining this could prove problematic, however, as two-thirds of the Saudi population are below the age of 30, including 47% under the age of 20. The number of young people moving out of their parents’ homes and into independent dwellings as they reach marriage age in the coming decade is likely to surge. The size of Saudi families has, meanwhile, fallen since the 1980s to an average 5.65 per household in 2008 from 7.4 in 1987, creating a large pool of young-people on the hunt for mid-market detached, affordable homes.

Considering the housing supply-demand gap and the impending boom in youth demand for homes, we are bullish on the housing sector and confident the mortgage law will widen the scope of home ownership in the long term. Still, reforms to address the market’s structural deficiencies will need to complement the law. For one, developers must focus on building supply of affordable housing since prevailing salaries are largely not high enough to support a mortgage finance boom. Quality and energy efficiency must also be prioritised.

Land prices also pose a challenge. Plots of residential land have risen sharply in price over the past decade and some estimates say land accounts for more than half of total

building costs. The state’s move to grant some developers the right to sell units off-plan should encourage construction of large-scale projects and such reforms must continue. Barring a holistic approach to housing sector reform, many young Saudis could be compelled to rent instead of buy due to comparatively low rental yields, keeping a strain on already high rents and reducing ownership rates.

State steps in with home loan pushIn Saudi Arabia, as with many countries in the Middle East, citizens have traditionally bought homes using personal capital and family savings. Banks offer home loans on a limited basis and some public and private-sector companies have helped employees buy homes through in-house financing schemes. These options are usually reserved for wealthier Saudis, leaving a gap of financing among the mid- to low-income population. Banks have recently increased mortgage financing to large firms, which guarantee loan repayments, minimizing default risk while offering much-needed financing to citizens.

Saudis of lesser financial means are able to apply for home loans through publicly held Real Estate Development Fund (REDF), established in the 1970s with a goal of distributing non-interest-bearing home loans to citizens for construction and purchase of homes. REDF dominates the Saudi housing market, accounting for 81% of total home financing.

REDF loans double from 2005-09 versus prior 5 years

1.0

5.5 78

65

Source: SAMA, Real Estate Development Fund (REDF)

(Loa

ns d

ispe

rsed

, SR,

bn)

(Outstanding loans, SR, bn)

Outstanding loansLoans dispersed

200420032000 2001 2002 2005 2006 2007 2008 20091997 1998 1999

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

666768697071727374757677

3

SAUDI ARABIA

ECONOMICS

March 2011

From inception to the third quarter of 2009, REDF disbursed SR145.5 billion loans, which are repayable over 25 years. REDF’s mandate in recent years has expanded rapidly; the fund doubled home lending between 2005 and 2009 compared with the prior five-year period. In 2009, REDF dispersed some SR5.28 billion worth of home loans, up from SR4.99 billion in 2008, and more than SR3 billion in each of 2006 and 2007. These years were characterised by historically high inflation rates, raising pressure on the government to enhance financial assistance for citizens. In fact, the total loans distributed by REDF in 2009 virtually equally the value of loans granted between 2000 and 2004.

The huge rise in lending coincided with two trends: a rapid

jump in oil prices between 2003 and mid-2008, which considerably augmented government revenues and its store of foreign assets, giving it flexibility to fund social programmes; and a massive rise in house prices such that rental inflation soared from 4.5% at the start of 2007 to almost 24% by mid-2008.

Against a backdrop of elevated inflation spurred to a large degree by housing costs, REDF’s mandate has become more pressing. Part of the king’s SR135 billion support package for citizens unveiled last month was a pledge to inject SR40 billion of additional capital into REDF so it could grant a greater number of loans. The king also added SR15 billion to the General Housing Authority’s budget to build more affordable housing for state employees.

Still, the estimated waiting period for Saudis who apply for REDF loans has been 18 years due to pent up demand. The new capital could reduce this waiting period, but not as sharply as the state’s aim to bring it down to eight years. One cause of the long waiting period for REDF loans has been the body’s difficulty in collecting outstanding loans, according to the Ministry of Economy and Planning. Saudi Arabia’s finance minister said last month REDF would use the new funds to provide an additional 133,000 loans – adding to the 600,000 loans it has dispersed since 1975. Up to the first week of February, REDF approved new loans to build 54,000 homes valued at SR13.5 billion under the scheme.

REDF dominates Saudi home finance

Source: SAMA, REDF

Bank real estate loans19%

REDF81%

Source: SAMA

0.0

25.0

(YoY

% c

hang

e)

Saudi rents still high, point to supply constraints

2007 May Sep 2008 May Sep 2009 May Sep 2010 May Sep 2011

5.0

10.0

15.0

20.0

Loans dispersed Inflation rate

4

SAUDI ARABIA

ECONOMICS

March 2011

Even with a smooth-running state state-funded home financing scheme, a serious issue of price affordability remains. REDF loan recipients receive up to SR300,000, which is not adequate to cover land and construction-related costs of home building. In our H2 real estate survey, the median price of a large apartment in 12 Saudi districts in Riyadh, Jeddah, Khobar, Dammam and Dhahran was SR485,833, while for small villas it was SR1.06 million.Under new rules unveiled over the weekend, the maximum loan will be raised to SR500,000, which will go some way toward bridging the cost gap. Saudi families tend to prefer living in villas than in apartments, but affording detached homes has become

extremely prohibitive. In Riyadh, the median price for a small villa soared 19% in H2 compared with H1 to SR1.23 million, while in Jeddah prices rose 17% to SR1.54 million. Median prices for small villas in the Eastern Province were also a high SR768,000. Substantial gains in prices illustrate a cultural preference toward larger homes which must be taken into account by developers, although land prices pose a challenge to affordability. In 2004, some 12% to 15% of homes were unoccupied, up to four times higher than normal, economy ministry data show. The ratio of unoccupied homes has likely stayed at a similar level due to purchasing power constraints of large segments of the population.

Source: Corresponding development plans, Ministry of Economy and Planning * Estimated target and completion

100,000

1,300,000

(Uni

ts, 0

00s)

Huge targets for construction in current plan

4th plan (85-89) 5th plan (90-94) 6th plan (95-99) 7th plan (00-04) 8th plan (05-09) 9th plan (10-14)*

300,000

500,000

700,000

900,000

1,100,000

Units built Target

Source: Ninth Development Plan, Ministry of Economy and Planning

0

900

(Uni

ts, 0

00s)

Housing demand in Saudi 2014 development plan

New housing units(Saudis)

New housing units(non-Saudis)

Housing units tomeet unsatisfied

demand from eighth plan

Housing unitsrequired forreplacement

10% reserve unitsto ease rent

inflation

100

200

300

400

500

600

700

800800

200

70 70110

5

SAUDI ARABIA

ECONOMICS

March 2011

Supply on the rise, but not fast enoughAs prices spiral, urgent steps are needed to address shortages in housing supply. According to our calculations, Saudi Arabia should build 275,000 new housing units per year in the six years to 2015 to cater to demand –for a total of 1.65 million new housing units. The government’s demand estimate, outlined in its 2010-2014 Ninth Development Plan, is lower at 250,000 per year (1.25 million in total). The Ninth Plan is a wide-reaching economic and social development programme requiring estimated investments of almost $400 billion.

Anticipating population growth of an average of 2.23% through 2014, the state foresees Saudi households growing by 750,000, requiring 800,000 new homes be built. Another 200,000 housing units would be required to cater to the non-Saudi population, according to the plan, which also calls for 110,000 units to be built in reserve to ease rental inflation. Also, 140,000 new units are needed to replace existing units and “dilapidated housing units”, resulting from poor-quality construction. Most Saudi homes do not survive past 30 years, which has constrained the growth of a vibrant secondary market. Banks generally refuse to grant home loans toward the purchase of units older than 10 or 15 years – a restriction that would ease as quality improves.

By region, the greatest demand would come from the

Makkah province, which includes the Red Sea port city of Jeddah, at 370,000 units, followed by capital city Riyadh at 325,000 units, according to government estimates. These two regions, along with the Eastern Province and the holy city of Madinah, account for three-quarters of new demand during the five-year period, data show. Demand concentration in Jeddah is not surprising given occupancy rates in the city surpass 95% and, due to extensive flood damage plaguing many homes, demand for replacement units is higher in other parts of the country.

The government envisions being able to add one million units to the market by 2014, falling 20%, or 250,000 units, short of its demand estimate. To achieve 200,000 new units per year would require a massive 66% increase in the pace of construction compared with the prior five years. During the Eighth Plan (2005-2009), 120,000 new units were added annually, which in itself was double the number added in each of prior two five-year plans. In all three cases, construction targets set were not achieved.

We believe state momentum exists to come as close to the one million target as possible. The king’s massive SR250 billion allocation to the General Housing Authority this weekend calls for 500,000 new homes be built immediately.

Even if Saudi Arabia manages to achieve the one-million-unit target, we estimate a housing shortfall of 375,000

325

370

81.2

166.3

51

83.1

50.1 38.920.5 11.5 21.6 21.6 13.5

Source: Ninth Development Plan, Ministry of Economy and Planning

0

400

(Uni

ts, 0

00s)

Housing units needed by region up to 2014

Riyadh Makkah Madinah EasternRegion

Qassim Asir Jazan Tabuk Hail Northernborders

Najran Al-Baha Al-Jouf

50

100

150

200

250

300

350

6

SAUDI ARABIA

ECONOMICS

March 2011

units. A bulge in the young population has the potential to substantially ignite demand in the coming years, particularly in urban centres. According to our estimates, the biggest shortfalls will be in Riyadh and Jeddah.

The Saudi population has gravitated toward urban centres over the past decade. Between 2001 and 2007, Riyadh’s Saudi population grew 23%, the highest rate in the country, while its non-Saudi population expanded 24%. In smaller localities like Al-Baha, the Saudi population declined more than 22%, while in Asir and Hail, population growth was less than 5%. This trend, as it continues, will place a greater strain on housing supply in urban centres. More expatriates also places pressures on rents, further elevating

replacement demand. While it has halved in the past two years, rent inflation is still 10%.

The size of families also tends to be smaller in urban areas. According to 2004 census data, the average size of a Saudi household was 6.1 people, with smaller cities and villages far surpassing the country average. In Al-Jouf and Northern Borders, the average household size was 8.4 and eight members, respectively, compared with households of 6.2 people in Riyadh, 5.1 people in Makkah province and 5.8 members in Madinah. The Riyadh Development Authority expects the average family size in Riyadh will fall to 5.7 in the next decade. Details of Saudi Arabia’s 2010 census data are yet to be fully unveiled.

Source: 2004 Population and Housing Census

4.0

9.0

(Indi

vidu

als

per h

ouse

hold

)

Average Saudi household 6.1 people in 2004

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

Riyadh Makkah Madinah EasternProvince

Qassim Asir JazanTabuk Hail Northernborders

Najran Al-Baha Al-Jouf Totalcountry

Source: Banque Saudi Fransi forecasts

0

100

(Sho

rtfal

l, 00

0s u

nits

)

By 2014, housing market still likely to face deficit of 375,000 units

Riyadh Makkah Madinah EasternRegion

Qassim Asir Jazan Tabuk Hail Northernborders

Najran Al-Baha Al-Jouf

10

20

30

40

50

60

70

80

90

7

SAUDI ARABIA

ECONOMICS

March 2011

Private sector role crucial to new building

Meeting building targets will be a critical component to controlling the rise in property prices in the coming years, and the private sector is expected to shoulder the burden. According to the Ninth Plan, private sector firms would build a majority of new homes, including 61% of new homes in capital Riyadh and 62% of fresh units in the Makkah region. The state’s objective foresees:

The Public Housing Authority building 66,000 housing units

REDF financing construction of 109,000 housing units by providing 90,000 loans

Government agencies building 50,000 units for their employees

The private sector funding and constructing 775,000 residential units

Some 266 million sq m of land dedicated for housing projects

New homes should be affordable as well as relatively large in size and more ergonomic. In 2004 some 56% of Saudi households showed density of occupancy per room above the national average, meaning they were overcrowded.

The supply of affordable two- and three-bedroom villas and duplexes is therefore a vital area of focus. A 2007 demographic survey showed only one-third of Saudis live in apartments, and just a third of those own their flats, compared with ownership ratios of 85% for villas and 79% for traditional houses. In Jeddah, where housing costs are the most-expensive in the country, owning a home is a luxury reserved for a minority of Saudis. Some 41% of residents own their homes in the Red Sea city while 52% rent, according to data of the Jeddah Urban Observatory.

To encourage the private sector to dedicate more financing toward building large-scale housing developments

Source: CDSI Demographic Surveys

0

4500

(Peo

ple,

000

s)

Saudi population growth highest in urban areas

Riyadh Makkah Madinah EasternProvince

Qassim Asir JazanTabuk Hail Northernborders

Najran Al-Baha Al-Jouf

500

1000

1500

2000

2500

3000

3500

4000

2001 2007

Private sector seen building 60% or more ofnew homes

Source: Ninth Development Plan, Ministry of Economy and Planning

Ratio of totalPrivate sector

(Uni

ts, 0

00s) (%

of total)

0

250 63.0

60.0Riyadh Makkah Madinah Qassim Eastern Province

50

100

150

200

60.5

61.0

61.5

62.0

62.5

8

SAUDI ARABIA

ECONOMICS

March 2011

demands a more supportive regulatory framework. Saudi Arabia has begun to grant licences to developers enabling them to sell off-plan properties – referring to real estate still under construction – for the first time. Sales of off-plan real estate in the past decade largely fuelled speculative building booms in Gulf cities, especially Dubai, which subsequently suffered from a massive property market crash.

Off-plan sales potential boon for developers

In this context, Saudi Arabia’s wariness about allowing off-plan sales is understandable; until recently, developers could start selling units only after the completion of infrastructure. But this vigilance had negative knock-on consequences for the housing sector. With developers

unable to secure funding through banks until projects were at least half complete, they often could only afford to pursue smaller, higher-risk build and-sell housing projects. Restrictions on off-plan sales had the effect, then, of deterring the launch of large-scale residential property ventures, which has disadvantaged the property market as a whole. This scenario must shift to meet upcoming ambitious construction objectives.

Thabat Real Estate Development Co – jointly owned by Egypt’s Talaat Moustafa Group and Saudi Arabia’s Al Oula Real Estate Development Co – was the first company to obtain rights to sell off-plan. Thabat’s SR7 billion Nasamat al-Riyadh residential project in northeast Riyadh spans 3 million square metres and is expected to add 4,200 new

Source: 2007 data, 2007 Demographic Survey, CDSI

One-third of Saudis live in apartments

Other2% Apartment

33%

A floor in atraditional house

1%Floor in a villa

11%

Traditional house28%

Villa 25%

85.0779.43

32.65

11.4715.53

60.92

Source: 2007 data, 2007 Demographic Survey, CDSI

0

90

(%)

Apartment ownership levels low

Villas ApartmentsTraditional houses

Ratio owned Ratio rented

10

20

30

40

50

60

70

80

9

SAUDI ARABIA

ECONOMICS

March 2011

residential units when it is completed in about 2014. Dubai’s Damac Properties also secured a licence this year to develop and sell properties off plan in the kingdom.

If properly monitored, allowing off-plan sales will be a boon for developers, particularly since most of the pent-up demand is from the indigenous population seeking homes to live in, rather than from speculators. Saudi Arabia has also relaxed real estate and investment laws to allow expatriates living and working in the kingdom to buy properties in free zones, as well as in other districts with special permissions. But large-scale residential projects tend to be skewed toward serving the upper-middle income segment. Developers regard the underserved mid- and lower-income segment housing as offering lower margins.

Currently, prospective homebuyers must first buy a plot of land, arrange for the design of the property and liaise with a contractor and other experts. This is a lengthy, expensive and inefficient process that fails to encourage economies of scale. Standardising construction through larger-scale building would reduce price and improve quality.

Banks must step up real estate finance

Banks could also play a greater role in supporting construction of much-needed supply. Up to the third quarter of 2010, building and construction loans accounted for only 6.7% of total credit extended by Saudi banks, the lowest ratio in the Gulf; real estate and construction loans comprise about a third of total credit in the UAE, Kuwait and Bahrain. There is thus room for upward growth without excessive risk of over-exposure to property.

Saudi banks exhibit abundant liquidity, their net foreign assets have more than doubled in the last two years. Still, real estate finance, while picking up, remains limited. By the third quarter of 2010, home loans accounted for only 2.8% of total credit extended by Saudi banks. The SR22 billion of home loans in Q3 represented a 42.2% surge from the first quarter of 2009.

Comparatively speaking for the region and globally, Saudi mortgage lending is undersized. At 6.8%, Saudi mortgage debt to GDP in 2009 was below 15.5% in the UAE, and more than 30% in Malaysia and many European countries, and

More than 60% of Saudi families own their homes

Source: 2007 data, 2007 Demographic Survey, CDSI

Providedby employer

5%Other1%

Rented32%

Owned62%

Saudi mortgage lending picks up, penetration low

10

22 3.0

0.5

Source: SAMA

(Loa

ns, S

R, b

n)

(%)

Ratio to total credit Ratio to GDP of yearReal estate finance

Q22007

Q32007

Q42007

Q22008

Q32008

Q42008

Q12008

Q22009

Q32009

Q42009

Q12009

Q22010

Q32010

Q12010

12

14

16

18

20

0.8

1.0

1.3

1.5

1.8

2.0

2.3

2.5

2.8

10

SAUDI ARABIA

ECONOMICS

March 2011

rates of 87.6% in the United Kingdom and 81.4% in the United States. If oil GDP is stripped from the equation, the mortgage penetration ratio rises to 13% of GDP, bringing it more in line with regional norms.

Expanding the scope of financing for home purchases would form a critical component of housing market reform measures, especially as the young population mushrooms in size. Youth below the age of 30 accounted for 66% of the Saudi population in 2009 and this pool of new potential homebuyers will most likely seek mortgage loans from banks and mortgage finance companies to purchase their first homes in the coming decade.

Source: European Mortgage Federation Hypostat; SAMA; UAE central bank; Asian Development Bank; Bank Negara Malaysia

0

90

(%)

Saudi mortgage loan penetration exhibits vast potential

Turkey SaudiArabia

India China United ArabEmirates

Germany UnitedStates

UnitedKingdom

Italy Malaysia Greece France

Mortgage debt to GDP, 2009

10

20

30

40

50

60

70

80

Building code application key as quality lags

One of the goals of the 2010-2014 plan is to ensure that the Saudi building code is applied to all stages of home building, underlining the state’s awareness of the need to improve the quality of properties. Enforcing high building code standards is crucial to promote energy-efficient construction. At present, 70% of homes suffer from inadequate insulation, for instance. This strains the electricity grid as residents turn to air conditioners which, in turn, exhibit one-third the efficiency of those used in advanced economies. Some 52% of power is consumed by Saudi households, and 65% of household consumption goes toward air conditioners.

Source: SAMA

0

2500

(200

9 po

pula

tion,

000

s)

Youth under 30 account for 2/3rds of Saudi population

0 to 4 4 to 9 10 to 14 14 to 19 20 to 24 24 to 29 30 to 34 34 to 39 40 to 44 44 to 49 50 to 54 54 to 59 60 to 64 64 to 69 70 to 74 75 to 79 80+

500

1000

1500

2000

11

SAUDI ARABIA

ECONOMICS

March 2011

The mortgage law catalystThe enactment of Saudi Arabia’s long-awaited mortgage law will act as a catalyst for the domestic real estate sector. The law should enhance the market’s sophistication and widen funding options for middle and low-middle income groups if applied and enforced. Earlier this month, chairman of the advisory Shura Council said the law’s approval had been prioritised on the council’s agenda at the recommendation of King Abdullah. As such, we anticipate it will come into force by next year following a number of delays.

Until now, someone hoping to buy a home would either dip into family savings or get a bank loan–options reserved for those who could afford substantial down payments, repayment schemes of 15 years or less, and high interest charges. Mortgage recipients thus fell into a relatively low– risk profile for banks. A mortgage law could change the entire equation, but it would do so at the expense of some social protections which safeguard tenants against eviction from their homes. The law could challenge this norm by allowing banks to repossess properties and evict owners who default on loan repayment.

Globally, foreclosure rules enable banks to demand repayment if a homebuyer fails to pay instalments. In the event of a default, a judge appoints an agent to sell the property in a public auction to pay off the mortgage. This practice is often regarded as inconsistent with the values of Islamic law, so it will be crucial to monitor how the law handles this issue. Mortgage finance regulations have nonetheless, been applied successfully in other predominately Muslim countries such as Egypt and Malaysia.

The draft Saudi law contains five components, including regulations on mortgage registration, enforcement, financial leasing companies, real estate financing companies and general finance companies. It is crucial that the law set up a central body to register title deeds, replacing the current system of having notaries public record deeds in a less-standardised way.

Under Islamic mortgages, banks buy the property on behalf

of the borrower and re-sell it to them at a profit, allowing the buyer to pay them back in instalments. Another “lease to purchase” method involves the mortgagee renting the property from the bank, while paying down the principal and gaining equity.

The absence of a clear mortgage law framework to govern property ownership, property repossession, enforced eviction and asset liquidation in the case of delinquency has deterred banks from expanding lending in this segment. If protections for banks are adequate, they will in the long run be willing to increase the risk profile for borrowers, which could create greater loan opportunities for lower-income Saudis. With a mortgage law in place, borrowers would also eventually be able to secure loans at lower costs because of the legal backing involved in mortgage financing.

Curbing lending risks

It will take time before the benefits of the mortgage law will be fully felt as banks will need to test the legal system’s ability to enforce evictions. Banks, meanwhile, would slowly need to restructure mortgage financing schemes to eliminate charging interest on the principal amount recurrently throughout the loan’s duration rather than on the reduced amount.

The law’s passage coincides with a period of continued risk-aversion among Saudi banks in the aftermath of the global financial crisis. Many banks have nonetheless cited retail banking as a key growth segment, and once mortgage financing rules are entrenched, banks will lend more. But they will be cautious not to support the creation of a sub-prime market comprising individuals barely able to keep up with instalments, particularly if interest rates begin rising as is likely to happen starting next year. To curb lending risks, banks should apply reasonable income caps such that any borrower cannot take a mortgage of more than one third to 40% of their total income. The law should also maintain a “safety ratio” of around 50% of gross income to prevent lenders from over-extending themselves.

Mortgage standardisation would further improve efficiency

12

SAUDI ARABIA

ECONOMICS

March 2011

Villa prices out of reach for common SaudisProperty costMedian asking price of small Riyadh villa SR 1.23 millionMedian asking price of small Jeddah villa SR 1.54 millionMedian asking price for small Eastern Province villa SR 768,333Mortgage termsAssumed down payment 20%Monthly mortgage instalment vs salary ratio 36%Loan profit/interest rate 6%Tenure of loan 15 yearsMonthly salary requirementsFor Riyadh villa SR 22,972For Jeddah villa SR 28,879For Eastern Province villa SR 14,408Typical Saudi monthly salary SR 8,000

Source: Banque Saudi Fransi research

and reduce transaction costs of home loan providers. Banks could carry out due diligence on master developments only once, enabling them to concentrate on assessing the credit quality of individual borrowers.

While it is hoped the law’s passage will allow much wider access to property ownership, such a reality could take time. Egypt passed a mortgage finance law in 2001 and, a decade later, the sector is still in its infancy. A key hurdle has been the discrepancy between the high cost of financing and the low incomes of the largest pool of possible home buyers. Saudi Arabia’s challenge will be to expand the base of beneficiaries from the system. Apart from banks, the mortgage law is poised to pave the way for independent home financers, such as Real Estate Finance Co (REFCO), partly owned by the Saudi Public Investment Fund, which plans to offer mortgages once the law is in place.

The affordability challengeFor the mortgage law to have a meaningful impact on the market, financing terms would need to become attainable for common Saudis. An obstacle to this is prevailing wages in the public and private sectors, which in many cases are not conducive to home ownership. Interest rates, too, are sometimes prohibitive, currently ranging between 3% and 7% for personal loans in Saudi Arabia, depending on the tenure and type of loan.

Mortgage loan schemes typically reduce the initial down payment homebuyers require to make a purchase, which opens the door to greater home ownership among youth. In many countries, borrowers can take 25-30 years to repay a mortgage, but we anticipate among Saudi banks, mortgages repayment periods would likely span 15 to 20 years at the onset.

An evaluation of prices for villas and apartments against average public and private sector wages illustrates the affordability challenge facing the kingdom. Assume a Saudi buyer, a man who relies on his income alone to support a wife and three children, purchases an apartment of 190 sq m in size for SR574,167 in Riyadh (the median price in our H2 housing survey). Prices in Jeddah are higher than this while those in the Eastern province are lower.

Assume he places a down payment of 10%, or SR57,417, with a bank and receives a flat-rate mortgage of SR516,750 to cover the remainder of the loan. Rules specify this loan must be repaid over 15 years at an interest or profit rate of 6%. The family’s home loan payment would amount to SR4,361 per month, requiring a monthly wage of at least SR12,113 (SR145,354 per year), supposing the instalment represents 36% of the buyer’s income.

The same family’s monthly income would need to be almost

13

SAUDI ARABIA

ECONOMICS

March 2011

double that to finance a villa purchase. The median cost of a villa 300-400 sq m in size was SR1.23 million in H2. Assuming the same interest/profit rate and a down payment of 20%, the family’s monthly instalment would be SR8,270, requiring a salary of SR22,972 (SR275,660 per year).

According to this rough guideline, the minimum salary required to mortgage villas and apartments is out of reach of a vast number of state and private sector employees, most of whom earn less than SR8,000 per month, for an annual salary of SR96,000 ($25,000). Even if loans were payable over 20 years, the minimum salary required for the above apartment would be SR10,284 and SR19,503 for the villa.

General public service personnel with five years on the job are paid according to 15 grades ranging from monthly wages of SR2,185 to SR20,250, all of which are too low to afford the Riyadh villa in question. In changes this month, the king ordered the minimum public sector wage to be raised to SR3,000. The average public service wage is SR8,644, although most employees earn an average wage of SR5,699. A substantial proportion of wage earners would thus also be unable to finance a large apartment. Many higher-skilled public sector professions such as pharmacists, doctors, professors and court presidents are able to afford properties, although they may also demand higher down payments. The mismatch is even more evident in the case of private sector wages, generally lower than public sector pay.

1,831 2,066 2,679 3,016 3,156 3,321 3,6404,850

7,281

12,113

22,972

Source: Ministry of Labour, Banque Saudi Fransi estimates

0

26,000

(SR/

mon

th)

Average private sector wages fail to match home loan demands

2,0004,0006,0008,000

10,00012,00014,00016,00018,00020,00022,00024,000

Services Sales Engineeringsupport

Clerical work Farming andagriculture

Technicians inscientifc,

technical &humanities

fields

Industrialprocesses,chemical &

food industries

Specialists inscientific,

technical &humanties

fields

Managers &businessmanagers

Minimumsalary for

largeapartment

Minimumsalary forbasic villa

2,770 3,205 3,855 4,5905,450

6,4707,520

8,8009,810

11,870 12,113 12,780

15,550 16040 16,330

18,55520,250

22,97224,530

14,415

11,23012,805

8,855

2,185

Source: Ministry of Civil Services, Banque Saudi Fransi research

1,000

25,000

(SR,

mon

thly

)

Home ownership out of reach for many govt employees

Grade1

Grade2

Grade3

Grade4

Grade5

Grade6

Grade7

Grade9

Grade8

Grade10

Grade11

Grade12

Grade13

Investigationassistant

(Degree 5)

Firstinvestigator(Degree 5)

Minimumsalary

forlarge

apartment

Pharmacist Residentdoctor

Judge(Degree 5)

Grade14

Professor(Degree 5)

Minimumsalary

forbasic villa

Courtpresident(Degree 5)

Grade15

* Shows monthly salary of public sector employees with five-years in position. Numbers 1-15 refer to salaries by grade of general personnel

* Minimum salary assumes 15-year mortgage with fixed 6% interest rate

3,0005,0007,0009,000

11,00013,00015,00017,00019,00021,00023,000

14

SAUDI ARABIA

ECONOMICS

March 2011

Incomes typically rise as productivity per capita increases, but this will happen only as a greater number of Saudis participate in the private sector and salaries offered by private sector firms climb. At present, there is only one Saudi employee for every nine expatriates employed in the private sector. This needs to change to enable improvement in per-capita multipliers. We discussed the dynamics of the labour market and the demands for reform in a report issued last month. Consumer appetite is also shifting and demand for apartments is bound to rise in the next two decades due to their relative affordability.

Mortgage rates, meanwhile, will need to be gauged versus rental yields; lower rental yields could entice prospective buyers to rent rather than borrow to build a home. Yet, if given the right financing opportunities, most Saudis are most likely to opt to own a home, even in a low-rental-yield environment.

Analysis: state cash alone won’t rectify sector strugglesTaking these factors into consideration, widening the pool of eligible homebuyers through the introduction of the mortgage law would require a number of supplementary factors take place. For one, banks should offer longer tenures for loan repayments – perhaps 25 years – to reduce

the monthly instalment burden. Most banks currently require repayment in 15 years, although there are limited loans carrying maturities of as high as 30 years.

Furthermore, interest or profit rates on mortgages would need to become less prohibitive. A rate of 3.5% would bring the Riyadh villa mortgage instalment down by almost SR1,300 per month and the apartment instalment down by almost SR700, broadening the affordability band. Mechanisms to help buyers place larger down payments would also be beneficial, but current wages pose an impediment to this. One Saudi bank already offers home loans with no down payment, which could capture low-income clients but must be closely examined.

Other schemes geared toward specific segments of the population could help pave the way to greater home ownership. The Public Pension Agency and Dar Al Tamleek have set up a real estate finance venture known as Masakin to offer public sector employees earning at least SR4,000 per month with competitive home finance schemes. The sharia-compliant company has more than SR1 billion of committed capital, and says it could offer a loan of SR500,000 repayable over 25 years at an instalment of SR3,346 per month – which would be exceptionally affordable for Saudi employees.

4,360.63

3,702.16

3,329.433,098.18

2,320.44

2,586.97

3,694.16

2,996.94

Mortgage loan repayment tenure, interest rate key to affordability*

2,000

4,500 13,000

7,000

Source: Banque Saudi Fransi research

(Mon

thly

inst

allm

ent,

SR)

(Salary, SR)

Minimum salary requiredInstalment (6% interest/profit rate) Instalment (3.5% interest/profit rate)

15 years 20 years 25 years 30 years* Data reflect median price for large Riyadh apartment

8,000

9,000

10,000

11,000

12,000

2,500

3,000

3,500

4,000

15

SAUDI ARABIA

ECONOMICS

March 2011

Institutions have also helped employees buy homes through in-house schemes. Saudi Aramco, for one, introduced a home ownership programme for employees in 1953 whereby it encouraged employees to build and buy homes in the Eastern Province by providing them free building plots or grants for land purchases, as well as subsidising home loans. Such programmes should be made more widely available.

The mortgage law should trigger growth in Saudi Arabia’s home finance industry in the medium term, although short-term implications will be minimal unless the government increases the availability of land, pushing down prices to levels more affordable for common people. Land prices rose exponentially in the past 10 years and, while there was a reprieve in 2009 during the economic downturn, the cost of a plot of residential land began accelerating again in 2010. The median price per sq m of land in Jeddah was up 9.8% in H2/2010 compared with the year earlier, while prices rose almost 6% in the Eastern Province, our housing survey showed. Riyadh land prices climbed almost 3% in H2 from H1.

It is therefore imperative in any housing market reform to consider providing residential land, supplemented with basic services and facilities, at reasonable rates in major urban centres to cater to these potential homebuyers. According

to estimates of the Riyadh Development Authority, some 77% of land plots in Riyadh are undeveloped.

The government could allocate large parcels of land for development with basic infrastructure. If land becomes more affordable, more people will be able to build and own a home, putting to use REDF loans. This would reduce the burden on prospective homebuyers and give the government more time to address shortfalls in the labour market and the need to raise the wage equilibrium. Public funds such as the Public Pension Agency, GOSI and the Public Investment Fund could also be granted plots of land and become developers of affordable housing, shouldering the risk of mortgage financing along with banks.

The mortgage law will over time push out the limits of major cities; 40 years ago, Riyadh spanned just 64 sq km and now the city occupies more than 1,000 sq km. Even if land is made more affordable rates on the periphery of cities, there are currently few public transport alternatives to accommodate for this suburban expansion, which will need to be rectified as horizontal sprawl continues. It is crucial, therefore, to recognise that while the state’s big cash injection in state-run REDF this year signals its commitment to facilitating greater home ownership among citizens, structural issues facing the housing sector cannot be resolved by state spending on its own.

Source: Banque Saudi Fransi H2 2010 Real Estate Survey

400

2,600

(Med

ian

pric

e pe

r sq

m)

Residential plot prices gain, Jeddah and Khobar in focus

Jeddah Makkah Dammam Dharan KhobarRiyadh

600800

1,0001,2001,4001,6001,8002,0002,2002,400

H2 2008 H1 2009 H2 2009 H1 2010 H2 2010

16

SAUDI ARABIA

ECONOMICS

March 2011

Key Saudi Arabia Economic Indicators

2002 2003 2004 2005 2006 2007 2008 2009 2010e 2011f 2012f

MACRO-ECONOMIC INDICATORSNominal GDP (USD bn) 188.6 214.6 250.3 315.3 356.2 384.7 476.3 372.7 434.7 478.6 519.3Nominal GDP (SR bn) 707.1 804.6 938.8 1,182.5 1,335.6 1,442.6 1,786.1 1,397.5 1,630.0 1,794.9 1,947.5YoY % change 3.0 13.8 16.7 26.0 12.9 8.0 23.8 -21.8 16.6 10.1 8.5Real GDP growth rate, % 0.1 7.7 5.3 5.6 3.2 2.0 4.2 0.2 3.8 4.2 4.4Non-oil private sector real GDP growth rate, % 4.1 3.9 5.3 5.8 6.1 5.5 4.6 2.7 3.7 4.2 4.5Government real GDP growth rate, % 2.9 3.1 3.1 4.0 3.1 3.0 3.7 5.2 5.9 5.3 4.7Oil sector real GDP growth rate, % -7.5 17.2 6.7 6.2 -0.8 -3.6 4.2 -7.6 2.1 3.5 4.0Inflation, YoY % change 0.2 0.6 0.3 0.7 2.2 4.1 9.9 5.1 5.3 5.1 4.8GDP per capita (USD) 8,774 9,744 11,111 13,640 15,041 15,868 19,200 14,687 16,039 17,279 18,286

BUDGETARY INDICATORSTotal government revenue (SR bn) 213.0 293.0 392.3 564.3 673.7 642.8 1,101.0 509.8 735.0 769.0 798.3Total government expenditure (SR bn) 233.5 257.0 285.2 346.5 393.3 466.2 520.1 596.4 626.5 676.0 718.0Deficit/surplus (SR bn) -20.5 36.0 107.1 217.9 280.4 176.6 580.9 -86.6 108.50 93.0 80.3Budget balance, % of GDP -2.9 4.5 11.4 18.4 21.0 12.2 32.5 -6.2 6.7 5.2 4.1Domestic debt (SR bn) 558.0 660.0 610.6 459.6 364.6 266.8 235.0 225.1 167.0 145.0 137Domestic debt as % GDP 78.9 82.0 65.0 38.9 27.3 18.5 13.4 16.1 10.2 8.1 7.0

FOREIGN TRADE INDICATORSTotal export revenues (USD bn) 72.3 93.0 125.7 180.4 210.9 233.1 313.4 192.2 236.3 249.9 268.5Oil export revenues (USD bn) 63.6 82.0 110.4 161.6 188.2 205.3 281.0 163.1 203.2 212.4 227.3Total imports (USD bn) 29.6 38.3 43.5 53.8 63.0 81.5 100.6 86.4 87.0 97.4 112.0Current account balance (USD bn) 11.9 23.3 49.3 90.0 98.9 93.3 132.3 22.8 69.6 63.1 58.8Current account as % of GDP 6.3 10.8 19.7 28.5 27.8 24.3 27.8 6.1 16.0 13.2 11.3

EXCHANGE RATE (=USD1)Saudi riyal 3.75 3.75 3.75 3.75 3.75 3.75 3.75 3.75 3.75 3.75 3.75

BANKING INDICATORSBank claims on private sector, year-end % change 10.0 11.0 37.4 38.9 9.2 21.4 27.1 -0.04 6.6 9.1 11.1Total private credit, year-end % change 12.4 11.3 37.0 38.9 9.8 20.6 27.9 -0.6 7.3 8.8 10.2Total bank credit, year-end % change 12.3 17.2 34.5 36.2 9.8 19.7 25.2 -1.1 8.4 8.6 9.5Broad money M3, YoY % change 14.7 6.9 18.8 11.6 19.3 19.6 17.6 10.7 5.0 9.7 10.4SAMA net foreign assets (USD bn) 41.9 59.5 86.4 150.3 221.1 300.9 437.9 405.3 440.41 470.8 499.1Repurchase Rate (year-end) 2.00 1.75 2.50 4.75 5.20 5.50 2.50 2.00 2.00 2.00 2.50

SAVING & INVESTMENT INDICATORSGross fixed capital formation, % of GDP 18.1 18.4 16.7 16.5 17.5 20.5 19.5 24.7 23.9 24.8 26.5Non-oil government investments, % of GDP 2.6 2.9 3.2 4.6 4.4 5.8 6.2 8.6 8.7 8.6 8.4Non-oil private investments, % of GDP 13.8 12.9 11.6 10.0 9.7 10.1 9.6 12.0 11.0 10.9 10.7Gross domestic savings, % of GDP 37.1 41.8 45.9 51.3 50.1 48.5 52.8 37.1 41.8 42.3 40.9Government savings, % of GDP -0.9 6.0 14.0 23.6 26.2 20.5 40.7 6.6 12.1 16.5 17.8Private savings, % of GDP 38.0 35.8 31.9 27.7 23.9 28.0 12.1 30.5 27.6 23.5 24.3

DEMOGRAPHIC INDICATORSPopulation (in millions) 21.5 22.0 22.5 23.1 23.7 24.2 24.8 25.4 27.1 27.7 28.4Non-Saudi 5.8 6.0 6.1 6.3 23.7 6.6 6.7 6.8 8.4 8.6 8.9Unemployment rate (%) Saudi 9.7 10.4 11.0 11.5 12.0 11.0 9.8 10.5 10.0 10.7 10.9Non-Saudi 0.8 0.8 0.8 0.8 0.8 0.4 0.4 0.3 0.4 0.4 0.3

OIL INDICATORSArgus Sour Crude Index (ASCI) 59.4 66.4 93.8 60.4 76.0 79.4 82.1Average oil price (WTI) (USD/barrel) 26.3 31.3 41.3 56.6 66.1 72.3 100.2 62.1 79.5 82.5 85Average Saudi oil price (USD/barrel) 23.4 26.8 34.5 49.5 60.5 68.1 93.4 61.4 77.0 79.0 81Crude oil production (million bpd) 7.09 8.41 8.90 9.35 9.21 8.82 9.20 8.18 8.19 8.48 8.75

STOCK MARKET INDICATORS Jan. 2011 Feb. 2011Tadawul Stock Index (TASI) (period-end) 2,518.1 4,437.6 8,206.6 16,712.6 7,933.3 11,038.7 4,803.0 6,121.8 6,620.8 6,358.03 5,941.63

Source: Saudi Arabian Monetary Agency, other Saudi Arabian government authorities, Banque Saudi Fransi forecasts

17

SAUDI ARABIA

ECONOMICS

March 2011

Disclosure appendix

Analyst certification

The analyst(s), who is primarily responsible for this report, certifies that the opinion(s) on the subject security(ies) or issuer(s) and any other views or forecasts expressed herein accurately reflect their personal views and that no part of their compensation, was, is or will be directly related to the specific recommendations or views contained in this research report.

This report is designed for, and should only be utilised by, institutional investors. Furthermore, Banque Saudi Fransi believes an investor

,s decision to make an investment should depend on individual circumstances such as the investor

,s existing holdings

and other considerations.

Additional disclosures

1 - This report is dated as at 20 March 2011.

2 - All market data included in this report are dated as at close 19 March 2011, unless otherwise indicated in this report.

3 - Banque Saudi Fransi has procedures to identify and manage any potential conflicts of interest that arise in connection with its Research business. A Chinese Wall is in place between the Investment Banking and Research businesses to ensure that any confidential and/or price-sensitive information is handled in an appropriate manner.

DisclaimerThis report is prepared for information only. Where the information contained in this report is obtained from outside sources, Banque Saudi Fransi believes that information to be reliable. However, Banque Saudi Fransi does not guarantee its completeness or accuracy. The opinions expressed are subject to change without notice and Banque Saudi Fransi expressly disclaims any and all liability for the information contained in this report.

The report only contains general information. It should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe to any investment. The specific investment objectives, personal situation and particular needs of any person have not been taken into consideration. Accordingly, you should not rely on the report as investment advice. Neither Banque Saudi Fransi nor any of its affiliates, their directors, officers and employees will be liable or have any responsibility of any kind for any loss or damage that may be incurred as a result of the information contained in this report.

Designed by Corporate Communications Dept. / Banque Saudi Fransi