Saudi Arabia is facing a huge housing challenge with the country's population reaching 27.14 million, even as the authorities ponder over a  mortgage law, which could give a boost to the housing sector.   

Much of the housing problem is rooted in the country's fast-changing demography. The number of houses simply can't keep up with the population growth. In total, the country has a deficit of two million housing units, a figure that's rising by some 150,000 a year, according to independent economist Saud Jleadan.  

Industry experts including private Saudi-based mortgage lender Real Estate Financing Co (Refco) and US consultancy Clayton Holdings estimate that just 30 per cent of Saudis now own their home. That's down from more than half 20 years ago according to some estimates and a striking symbol of the uneven distribution of wealth in the world's biggest oil exporter.

In a report issued in late July, state-owned National Commercial Bank said that rapid population growth and the huge number of young Saudis, two-thirds of whom are under 30, are "exerting enormous pressure on the country's infrastructure, while creating social and economic imbalances".

The housing challenge, says John Sfakianakis, chief economist at Banque Saudi Fransi, is "undeniable."    

The crisis would not exist if Saudi Arabia had better developed mortgage and secondary real estate markets. Banks do extend loans to wealthy Saudis. Indeed, contrary to popular belief, commercial banks even charge interest, while Islamic banks get around the Islamic sharia ban on interest by charging a set fee or agreed profit margin on a loan.   

Crucially, though, Riyadh is yet to pass legislation to regulate mortgage lending, and in particular what should happen if a borrower defaults. That leaves banks reluctant to lend more widely and forces average Saudis to rely on the state-run Real Estate Development Fund (REDF), which offers sharia-compliant, interest-free loans.

But REDF can only do so much. In 2008, barely 8 percent of Saudis who built new homes relied on the body, according to a spokesman. Critics say the government underfunds the agency, while the spokesman said a "substantial rate of default" hurts efforts to loan more money.   

The secondary market for residential property in Saudi is small; anyone in the market for a house often builds their own. But REDF does not lend money to build until a would-be mortgagee owns land to build on. The organisation does not lend money to buy land.

With both finance and land so tight, and demand growing fast, it's little wonder that housing is in such crisis.

Mortgage lending makes up just 1 percent of gross domestic product in the kingdom according to Deutsche Bank. That compares with "well over 50 percent in most developed countries, and approximately 6 per cent in Kuwait and 7 per cent in the UAE."    

Only just over a quarter of the 165 billion riyals ($44 billion) spent on construction in Saudi Arabia in 2009 went to residential units according to the National Commercial Bank report. "Residential expenditure has been declining steadily over the past five years." 

The obvious solution -- a comprehensive mortgage law -- has been under discussion for the past decade without ever materializing.   

It may not always look like it from the outside, but Saudi society is modernising. Driven by reformist ruler King Abdullah, the famously conservative kingdom has begun to tweak some of its laws. Housing was said to be a priority.

A draft bill seen by Reuters in February would give lenders the right to foreclose on properties in default, while lenders would enjoy the added security of reporting debtors through a central authority, rather than through a notary public as is currently the case.

Domestic and foreign banks have prepared ahead of a hoped for boom: an annual mortgage market worth up to $20 billion. Deutsche Bank launched a Sharia-compliant mortgage joint venture with Saudi-based investors.

The finance ministry's Public Investment Fund took a 20 percent stake in private mortgage lender Refco, which was set up more than a decade ago by a group of Saudi real estate agents in anticipation of a mortgage law, and now plans to start offering home loans in 2010 and list in 2012.

Hope for a breakthrough seemed to be realized in May, when the secretary-general of the council of ministers, a congregation of government ministers whose meetings are chaired by the king, said the bill was about to enter its "final phase".
 But he quickly recanted and later denied having made the statement at all.

Four months later, Saudis are still waiting. "Despite the heightened anticipation, there are no clear signs that the law will gain final approval this year," said Samba Financial Group in a recent report. "Those who have seen the law say it lacks details about implementation mechanisms, among other areas."         

Industry sources told Reuters that the delay is based in part on the reluctance by authorities to accept the idea -- common around the world but less acceptable in Islamic law -- that defaulters could be evicted from their property. But landlords in Saudi can already evict renters if they miss a payment, and regularly do. Why should eviction be so different when it comes to mortgage payers?    

Abdulaziz Al-Dukheil, a deputy finance minister in the 1970s and currently head of the Consulting Center for Finance and Investment, a financial, economic and management consultancy, told Reuters that government officials regularly give large parcels of land to VIPs and senior officials. The new owners then sell the land to speculators who in turn sell it on to property developers, he said.

Industry sources say the circle of land owners carefully limits the amount of land that comes onto the market. Combine that with the big influx of foreign workers over the past few years and the rental market is a good place to make a lot of money.

Credit Suisse said in July that average residential rental yields in Riyadh and Jeddah are a healthy 8 percent and 10 percent respectively. It also helps that Saudi clerics agreed about 30 years ago that capital gains on land should not be subject to tax. "We don't have a fair and transparent mechanism for land allocation," said Abdulaziz Al-Gasim, who heads a local law firm.

"Not levying taxes on land has encouraged people to speculate, especially (when) the state spends money to equip it."    

Saud Al-Gusaiyer, director general of real estate developer Dar al-Arkan, blames the government's decision in the early 1970s to condition REDF housing loans on owning land. The result: land has become more valuable than houses. Gusaiyer estimates that land prices rose 40 times on average between 1973 and the mid 1980s, and 80 times in the main urban areas.

In the last 6 months of 2009 alone land prices increased by 30 percent. "Land owners repeat the same statement when you talk to them about selling  'I will wait'," Gusaiyer said.

Gasim estimates that the cost of land now accounts for 60 percent of the total cost of a typical home in Saudi Arabia. Even if it is eventually passed, the mortgage law is unlikely to solve the housing deficit completely. "The core of the housing problem lies in affordability," said Sfakianakis.

"The mortgage law will not create the sort of supply that will help fill the housing deficit for mid- and low-income Saudis if other problems are not dealt with."    

Chief among those problems are low public sector salaries and high land prices. Official statistics show the average monthly salary of a Saudi public sector employee -- the 3 million or so people that Sfakianakis said are driving demand for new houses -- is no more than 5,200 riyals ($1,390).   

The Consulting Center for Finance and Investment's Dukheil estimated that four out of five Saudis earn between just 2,500 and 8,500 riyals per month. "People who earn less than 10,000 riyals per month, and they are millions, cannot find a home," he said. Not when the price for a quarter acre block in an average Riyadh suburb is 1.5 million riyals ($400,000). - Reuters