Role of Banks in Real Estate Financing in Saudi Arabia - Research Paper Example

? Role of Banks in Real E Financing in Saudi Arabia Outline Role of Banks in Real E Financing in Saudi Arabia Thesis: Banks have been playing an important role in financing real estate sector in Saudi Arabia increasing the current boom in the sector, lending banks and the real estate owners profit from this arrangement which may be affected by economic and political factors bringing up some challenges which can adversely affect the profitability to the two partners. I. Introduction A. Argument B. Thesis II. The real Estate Sector A. Argument B. China C. United Arab Emirates D. Brazil E. Other Countries III. Trends in Real Estate in Kingdom of Saudi Arabia A. History of Real Estate in Saudi Arabia B. Increasing demand for housing C. The rising urban population IV. Key Real Estate Movers in Saudi Arabia A. Saudi Arabian Government: The Real Estate Development Fund B. Transport V. Role of Banks in Real Estate Financing in Saudi Arabia A. Interest Rates i. Increased government revenues ii. Real Estate Development Fund iii. Saudi Arabia Central Bank base rate B. Islamic Banking i. Islamic Banking on Mortgage ii. Islamic Banking on Interest Rates iii. Islamic Banking in Saudi Arabia iv. Islamic Banking Growth Rate v. Islamic Banking and the Unemployed VI. Current Real Estate Financing Trends A. The Real Estate Boom B. Loan borrowing growth VII. Role of Banks in financing real estate in Saudi Arabia in future A. Saudi Arabia Regulatory Framework B. Home Ownership Percentage C. Other Funding Sources D. The New Mortgage Law E. Impact of the New Mortgage Law VIII. Conclusion A. Overview B. Remarks Role of Banks in Real Estate Financing in Saudi Arabia Real estate is one of the fastest growing sectors in the Kingdom of Saudi Arabia today. Many companies and individuals are constantly looking for opportunities to build their own homes or buildings to lease to others. The real estate boom in the Kingdom of Saudi Arabia has attracted banks to fund the projects in this sector. Banks financing real estate create a win-win scenario for the owners as well as the banks. There are other financiers in real estate including the Saudi Arabia Government. The terms and conditions for the banks and other real estate financiers vary depending on the project and location. Banks have been playing an important role in financing real estate sector in Saudi Arabia increasing the current boom in the sector, lending banks and the real estate owners profit from this arrangement which may be affected by economic and political factors bringing up some challenges which can adversely affect the profitability to the two partners. The real Estate Sector The real estate sector is one of the fastest growing in the world if not the fastest. It is the only sector in the world that has defied the norm currently. Despite recession and economic slow down in most of the countries in the world, the real estate sector continues to grow at a remarkable pace. This has led to increased prices for both developed properties and undeveloped land. Some of the top hotspot markets for real estate in the world today are: China: The most populous country in the world has been getting high demand for housing. Hong Kong, one of the fastest growing in China, has a population of about seven million people and the population is growing at about 1.2 percent per year. Demand for housing has been going through the roof and contractors are unable to work with the high demand. This has pushed the price of housing in Hong Kong to an unimaginable pricing. Three bed roomed apartments have reached an all time high price of close to five million dollars. The housing sector grew by approximately 23 percent in last year and the same trend is expected to continue. United Arab Emirates: This country has been able to attract real estate investors successfully even after the housing crisis a few years ago. The hotspots in United Arab Emirates are Dubai and Abu Dhabi. Dubai is one of the fastest growing cities in the world. The real estate sector has been growing a lot in this city pushing the prices even higher. The housing prices increased by twenty percent in the last year. A three bed roomed apartment in a relatively exclusive area in Dubai has gotten to just under a million dollars. Brazil: is another country where the real estate has been growing a lot in the recent years. In Rio de Janeiro, the prices for a standard three bed roomed apartment has risen to about two million dollars in some exclusive estates. Other countries that have made it to the top real estate destinations include Turkey, Colombia, Russia, Austria, Taiwan and mainland China (Forbes.com, 2013). Other counties like Saudi Arabia are also trying a lot in the real estate. For example, the country stared the construction of the building that will be the highest in the world, Kingdom Tower in Jeddah. Trends in Real Estate in Kingdom of Saudi Arabia The Real estate sector is currently one of the fastest growing in the Kingdom of Saudi Arabia. Growth in the sector is almost ten percent per year especially in the last half decade. Rapid growth of the sector in Saudi Arabia started in the early 1970s. There was a population explosion in the country pushing the need for housing to the roof tops. At that time, most people in the country were cautious on how to approach real estate because of the strict Sharia law in Saudi Arabia. This made the real estate sector to lag compared to other countries. Saudi Arabia’s Islamic architecture and heritage meant a lot to most people and wanted to maintain it. However, the population was growing too fast and the urban centers were growing at an alarming rate making it necessary to re-strategize and provide housing, offices and industries to cater for the rising demand (Levine, 2004). The need for housing was considered by the Saudi government by establishing the Real Estate Development Fund. The main objective of this institution was to make it easy for the Saudi people to own homes by giving them interest free loans. This created a lot of interest in buying homes for most Saudi’s. After all, who would not take advantage of interest free loans? The Real Estate development fund realized that the need for commercial buildings and industries was also increasing. Funding with interest free loans was expanded to include commercial and industrial use (Elsheshtawy, 2008). In the recent decades, the urban population has been increasing rapidly. Most people are moving to urban centers for jobs awhile the youth are going for the purpose of learning in colleges and universities. Urbanization in Saudi Arabia is increasing at an unprecedented rate increasing demand for housing exponentially. House prices rose by over a ten percent between 2010 and 2011 while prices for undeveloped land rose by about 175% in the same period. Cities like Riyadh and Jeddah have been growing in excess of four percent per annum creating an even higher demand for housing, commercial and industrial property. The same trend is experienced in other large cities across Saudi Arabia (Oxford business school, 2007). Key Real Estate Movers in Saudi Arabia Saudi Arabian government has been encouraging the Saudis to own property. It is the role model in the sector building residential housing for civil servants and establishment of mega projects across the Kingdom. The government has spent billions of dollars for establishment of real estate schemes for the civil servants and soldiers. In addition, the Real Estate development Fund has increased funding for real estate year after year. This institution set aside one trillion Saudi Riyal for real estate in the year 2011. The Real Estate Development Fund has been writing off loans for those who are unable to pay and increases the limits for the new loan applicants. The organization has also played an important role in impacting demand and supply for the real estate sector in Saudi Arabia. Transportation Transportation in Saudi Arabia is being improved across the country. There are a number of projects that have been started and others have been proposed. As of 2011, the government started to build two ports, twenty six new railway lines and six airports at a cost of about one hundred and fifty billion Riyals. The Kingdom believes that investment in infrastructure should play an important role in real estate development. Workers and raw materials can be transported faster to regions where construction is taking place. Spending budget on infrastructure is increased every year. The current 2013 budget on transportation for example is 19% higher compared to last year. Improvement in infrastructure in the Kingdom of Saudi Arabia definitely affects the real estate sector positively (Business Monitor International, 2013). Role of Banks in Real Estate Financing in Saudi Arabia Interest Rates Banks are by far the biggest influencers of the real estate growth in the Kingdom of Saudi Arabia. Banks offer low or no interest rates to real estate developers and owners. Low interest rates on borrowing in the Kingdom of Saudi Arabia are affected earnings by the government from oil exports has been increasing. Oil accounts for more than 80% of government earnings as the table below shows. Government earning increase makes it possible for the government to influence the real estate sector through the Real Estate Development fund. In fact, the Real Estate Development Fund in the Kingdom of Saudi Arabia has played a pivotal role in real estate. This agency has been offering an approximately twelve thousand home loans every year. In last year, the agency write-off about ten thousand loans to fund more twelve thousand loans in the year 2012. The funding amounted to about 1.3 billion dollars in 2012. At the same time, the King allocated 66 billion dollars for housing in the year 2012. To facilitate real estate construction, the King also provided more than 800 million dollars to construct a cement plant. The King thought that it would be a good idea to have ready cement for construction of real estate faster (ITP Publishing, 2013). More people get funding and the institution is able to write off loans that have not been paid. This creates competition with commercial banks which have to reduce their lending rates to their respective clients. In fact, the government through the Real Estate Development fund is the major competitor to the commercial banks. The central Bank of the Kingdom of Saudi Arabia charge commercial banks low base interest rates. Even with their mark-up, the interest rates remain low to the customers. Low interest rates have encouraged many people in the Kingdom of Saudi Arabia to borrow money for real estate. Interest rates have been maintained at 2% since 1990 and the highest they have ever gone was 7% and the lowest 1.5%. The loan book has been growing steadily and is expected to increase with about 13% in 2013. Loans borrowed for real estate have already risen to about Riyals 41 billion for consumers. In the year 2012, the National Commercial Bank of Saudi Arabia claimed that the residential loans to consumers were at 60 billion Riyals. This was a great increase from the previous year in which residential loans were at 29 billion Riyals. The rate of borrowing within those two years doubled and the rate is expected to continue in the coming years (World property channel networks, 2013). Islamic Banking Islamic banking in Saudi Arabia has a great influence on mortgages as well. Islamic banking is based on the principles of the Quran in which it is believed that interest rates should not be charged on loans. It is claimed that money on its own cannot generate money or interest rates. Instead, an investment should be made in order to generate money. Basing on this fact, Islamic banking differs from the convectional way of banking which focuses more on lending and not investment. The investment made should be that all the parties involved share both the risks and the profits. In addition, Islamic banking is based on moral and social responsibility that the poor should be assisted to be more or less equal to others (Ariff and Iqbal, 2011). Saudi’s can access real estate loans at no interest rates. A convectional mortgage using Islamic banking system is one in which the property owner and the bank get into a shared property according to the contribution of each. Once the property is complete, the owner of the property has to pay some rent to the bank. Rent paid to the bank is used as a contribution towards regaining the property from the bank or buying out the share of the bank. In this case, the share proportion of the property owner increases as that of the bank decreases. The property is transferred to the owner once the amount agreed upon is paid in full (Hassan and Lewis, 2007). Islamic banking in Saudi Arabia is the largest among the Islamic countries. According to Islamic Research and Training institute which is a subsidiary of the Islamic Development Bank based in Jeddah, the market share of Islamic banking in Saudi Arabia reached 209 billion dollars in the year 2011, which was equivalent to 49% of the total banking market share. Saudi Arabia accounts for more than seven percent of the total Islamic Banking market share in the world. The market share is expected to increase with the recent regulatory changes in real estate banking in the Kingdom of Saudi Arabia. Islamic banking in Saudi Arabia has become popular over the last decade with growth at 20% per year. In the year 2010, Islamic banking grew at a whopping 25%. Popularity in Islamic banking is due to the approach on lending. It focuses on investing together while sharing risks and profits among the parties involved. Most people are encouraged by the risk sharing factor as they do not have a lot to lose in a worst case scenario outcome. The Arab Banking regulatory agency expects the trend to continue that way for the next few decades. It may be the main method of banking in Islamic countries in the years to come. Union of Arab banks (2013) has been proposing common regulation on Islamic banking across the countries where the service is available. Bankers and regulators from the Middle East and North Africa region met recently to push for this common objective. Islamic banking and its approach to real estate ownership and mortgage is the reason why real estate is growing a high rate in the Kingdom of Saudi Arabia. Any person who meets the necessary requirements can approach a bank and get funding for his home or commercial venture. Funding can last as little as one year and can extend to three decades or more depending on the property, the amount of money the customer can raise and the terms and conditions greed upon. The Saudi Arabian government is actively involved in Islamic banking increasing products in the banking sector such as real estate loans (Albawali, 2006) Though Islamic Banking has an impact on real estate, a number of people have been left behind. People who are not employed may not be able to afford real estate funding. Real Estate funding requires that someone proves that they are able to make the required rent payment per month. The Saudi Arabian King has been chipping in such scenarios by offering land and funding for real estate to some people in some places across the kingdom. At the same time, the regulations governing the real estate sector and financial sector are being changed to make it possible for all Saudi’s to be able to own homes in the next decades. Current Real Estate Financing Trends The real estate sector is experiencing a boom in the Kingdom of Saudi Arabia. Property and land prices have increased exponentially and borrowing from banks to purchase land and property has been on the increase as well. This is pushed by the high demand for housing in especially cities. People investing in the real estate in the Kingdom of Saudi Arabia are mostly dependent on loans from banks. Therefore, financing from banks to real estates has been increasing (Blumberg Capital, 2013). Growth in loans increased in August 2013 by fifteen percent compared to August 2012. At the same time, the mortgage borrowing has been increasing at between 15 and 20% per annum in the Kingdom of Saudi Arabia. The lending grew at more than 80% in the year 2012 compared to 2011. 18% of the total lending was for real estate and home ownership. The percentage had grown from just 8% four years earlier. The sector is expected to growth further in the same way and so will loans from banks (Hancock, 2013). Role of Banks in financing real estate in Saudi Arabia in future With the changing regulatory framework in the Kingdom of Saudi Arabia will definitely change the role of banks in financing real estate. The regulation will impact the real estate positively as it is going to encourage more people to venture in real estate. Saudis and non-Saudis alike are encouraged by the Kingdom of Saudi Arabia government to take home loans and property loans. The real estate sector in Saudi Arabia is expected to grow at a constant five to ten percent per annum in the next decade. The figure could even be higher as the number of urban dwelling people has been increasing exponentially in the Kingdom (International Monetary Fund, 2013). Currently, just about 37% of the population has home ownership in Saudi Arabia. The Saudi government has set a target of 80 percent home ownership by the year 2014. As such, lending from banks is going to increase as no people would be able to venture into real estate without funding from the banks. Lending from Saudi Arabia banks have been growing at approximately ten percent per year. The rate will increase to more than ten percent in the next decade and much higher in the decade after. The national Bank of Saudi Arabia has already started setting aside more money for home loans. The additional funds are meant to increase house purchases and land acquisitions across the Kingdom. These transactions have been increasing dramatically in the last few years and it seems that the National Commercial Bank of Saudi Arabia is already taking action. The bank could play an important role in fostering the change needed and expected in the real estate sector in the Kingdom of Saudi Arabia (National Commercial Bank, 2013). Contrary to what most people may think, there are no other real estate funding institutions other than the real estate development fund and commercial banks and credit banks. Home loans and property funding in the Kingdom of Saudi Arabia is restricted to these institutions currently. However, the new mortgage law that was recently approved promises to change the real estate sector in the Kingdom of Saudi Arabia. The new law will increase lending to real estate and home owners. At the same time, there will institutions that will be allowed to resell mortgages. Foreign companies will be allowed to participate in the real estate sector in the Kingdom of Saudi Arabia for the first time. All they are required to do is raise two hundred million Riyals equivalent. They will then be issued with a license to operate as mortgage providers in the Kingdom of Saudi Arabia (Fattah, 2012). However, the new mortgage law comes with strict regulations to the foreign lenders and providers. Saudi Arabia is very strict when it comes to Sharia law. As such, Islamic guidelines have to be followed accordingly. They lenders are required to follow Sharia law in which they should not charge interest rates on loans but focus more on investment. In this case, the lenders would be expected to get into joint partnerships with the borrowers to share risks and profits as specified by the Sharia law of Islamic banking. In addition, prices of real estate should be fair in accordance to the guidelines provided by the Saudi Arabian Monetary Agency (SAMA) as per the beliefs and customs of Islam. Failure to adhere to this regulation will lead to severe penalties and could even lead to revocation of the license issued to the mortgage provider. Despite the strict laws, the new mortgage law promises to open Saudi Arabia Real Estate sector to the world (Ammari and Sunar, 2012). Currently, most people do not own homes in Saudi Arabia because of the high cost of housing, land and strict borrowing regulations. Around fifty percent of people in the Kingdom of Saudi Arabia live in rental houses because of these restrictions. The new mortgage law is expected to change all this by making it possible for the Saudis’ that rent to afford their own houses. Mortgaging in Saudi Arabia will greatly change the lives of the low medium societal class who have no option but to lease homes and property at the moment. The number of people without their own homes is likely to reduce with the implementation of this law, which has been waited upon for a long time. The Saudi government aims at having all people own their own homes by the year 2030 (Hanwale, 2011). Conclusion Real estate sector in the Kingdom of Saudi Arabia has been changing a lot in the last few decades. Banks have played a pivotal role in financing the real state sector. As the sector grows, so do the borrowing. The Real Estate Sector in the kingdom has had a lot of challenges which are to be bypassed with the introduction and implementation of the new Mortgage law. This law will allow foreign lenders to participate in real estate in Saudi Arabia. Banks role in the growth of the industry is also expected to increase. The current commitment by the government promises lots of opportunities in the real estate sector in the Kingdom of Saudi Arabia for local and foreign companies and businessmen. Only time will dictate what happens to the real estate sector in the future in the Kingdom of Saudi Arabia References Albawali, S. (2006). Banking system in Islamic countries: Saudi Arabia and Egypt. ProQuest. Ammari, S and Sunar, T. (2012). Saudi Arabia Reforms Real Estate Mortgage Law. Blakes. Ariff, M and Iqbal, M. (2011). The Foundations of Islamic Banking: Theory, Practice and Education. Cheltenham: Edwared Elger Publishing Company. Blumberg Capital. 2013). Saudi real estate market poised for strong growth. Retrieved from http://blumbergcapitalpartners.com/BCP-news/saudi-real-estate-market-poised-for-strong-growth/ Business Monitor International (2013). Saudi Arabia Infrastructure Report - Q1 2010. Saudi Arabian Infrastructure Report. 1, 1-83. Elsheshtawy, Y (2008). The Evolving Arab City: Tradition, Modernity and Urban Development. London: Routledge. Fattah, Z. (2012). Saudi Mortgage Law Opens Kingdom to Home Lending Surge. Business week, 1(1), 1-15. Finkelsten, A. (2012). Saudi Residential Financing Nears $1.6 Billion. Retrieved from http://www.worldpropertychannel.com/middle-east-africa-residential-news/saudi-real-estate-market-national-commercial-bank-saudi-arabian-monetary-agency-sama-saudi-economic-review-6253.php Hancock, M. (2013). Report: Saudi Arabia - Banking - An enviable position. The Banker. Hanwale, K. (2011). Saudi Arabia's real estate market awaits mortgage law. Saudi Economic Survey. Hassan, J and Lewis, M. (2007). Handbook of Islamic Banking. Cheltenham: Edwared Elger Publishing Company International Monetary Fund. (2013). Kingdom's banks see good opportunity in home financing. McClatchy - Tribune Business News. ITP Publishing. (2013). Saudi's Real Estate Development Fund agrees funding of $1.3bn for new homes. Retrieved from http://arabianindustry.com/construction/news/2013/jul/4/saudis-real-estate-development-fund-agrees-funding-of-13bn-for-new-homes-4364451/#.Um1O4ycc1kg Levine, M. (2004). International Real Estate: A Comparative Approach. Dearborn: Dearborn Real Estate. National Commercial Bank. (2013. Saudi Arabia: NATIONAL COMMERCIAL BANK became the maiden bank to implement Real Estate Additional Loan Program. MENA Report. Oxford business Group. (2007). The report: Emerging Saudi Arabia 2007. Oxford: Oxford Business Group. The hottest real estate markets on earth. Retrieved from http://www.forbes.com/pictures/eglg45fkdef/no-10-colombia-26/ Union of Arab Banks. (2013). Islamic Banking Trends - the Future of Arab Banking. Retrieved from http://www.uabarablaws.org/islamic-banking-trends/ Read More