Tuesday, November 6, 2007

Saudi Real Estate: An Investment Theme or a Speculative Mania?

JEDDAH, 10 January 2005 — Land is property subject to private ownership and control is the foundation of our modern society. It means that some have the right to prevent others from living; for the right to own implies the right exclusively to occupy.
All of us need land, on one extreme, in some parts of the Arab world, people live in cemetery simply because they cannot afford rent; on the other the very few have more property than the whole population of an African country. Ownership of land has been a source of debate and a cause of violence.
Our society has become materialistic in character to the extent we treat nature, as merely another type of profitable venture.
A wave of optimism is spreading around the country, people believe that they are seeing the dawn of a new era in the real estate market that will bring unimaginable riches and prosperity to all. This overconfidence will have dangerous consequences on our economy.
For the record, no asset class or business has done well in the very long term. If we examine GDP, it is basically the cash flow that can be obtained from the value of our country’ assets; history has taught us that long term expected return of say 5 percent p.a. is simply a dream, otherwise the world’s GNP would not be at $30 trillion, but at well over $75,000 trillion. It is a proven fact that superior returns from long term investing are only temporary. If we examine the growth in real earnings of the top 500 US companies (S&P 500) between 1950 and 2002, it was only 1.6 percent per annum. As has repeatedly been the case throughout history, wealth and accumulated savings (investments) were destroyed through natural disasters — earthquakes, floods, droughts, fire, or wars, expropriations, hyperinflation, depression and fraud.
The recent run up of real estate prices is being fueled by artificially low short-term interest rates and the huge increase in consumers loans. However, we must not forget that as soon as interest rates rise, the rally in real estate prices will come to abrupt end.
Any market that is rising because of an increase in bank’s credit (loan) ought to be viewed with great caution. In the past 3 years, there has been an extraordinary expansion of installment, real estate and stock market-related credits, besides consumer credits. This is reflected in the astronomical revenues as reported by the Saudi banks for the year 2004.
There is a shift in money flows that has been taking place away from productive investments and into speculative assets. Given the regional wars and violence, there is a noticeable deterioration of business and social conditions, investors who have bought shares and real estate have increased tremendously for lack of alternatives.
Real estate used to have stable prices. People bought homes in order to live in them, and investors purchased commercial buildings for their yield (rental income) and not with the view of achieving huge capital gains. The market was dominated by end-users and not by people with nothing to do with real estate who participated solely to profit from rising or falling prices. A unique feature of Saudi real estate was the total absence of leverage (borrowing). However, this has unfortunately changed, as of Dec. 31, 2004, total debt of consumers and corporate entities exceeded SR350 billion.
The surge in real estate prices in Makkah and Madinah could be best described as speculative excesses. The market has been in an uptrend since the early 1990s, a speculative mania has set in, and worse yet, investors are perceiving that the rising price trend is permanent.
Most Saudis, individuals and corporate alike, do not realize that they have to borrow-to-buy, so accepted that Saudi economy is becoming debt-based. The introduction of home-financing, called “mortgage” is serving a vital role in supplying additional fiat money to our economy due to the large sums involved. Thus, mortgages are not so much a means whereby Saudis can become homeowners, but a mechanism for supplying additional money to our economy. This new financing scheme will cause further run up in real estate prices and a lower purchasing power of our currency.
The money to buy houses outright through a mortgage, does not exist; this money is created by the local banks to specifically for the purpose of the house purchase, which then contributes to the total money supply.
The world mortgage means “death trap”. In the old times, mortgages were used as a method to borrow money, and pledging your house as a collateral. This pure form of “usury” was practiced by the goldsmiths very much similar to today’s banking methods who are supplying money, hoping for a large profit, and may be confiscating the property in case of borrower’s default. The danger to our society that many families will jump at mortgage financing to fulfill their dream of owning a home, little they realize the future consequences. Their ability to save and the amount of their disposable income both suffer progressive decline.
People are impressed by the rising value of their property. But they only obtain this value if they sell up and move out of housing. Their children generation will face an even greater task in buying a house. With the increase in mortgages for each generation, even less capital is left to subsequent generations, which makes their mortgages even higher, which means that even less is passed down to the next generation.

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