Building up on yesterday’s discussion on savings and investment, some readers may be surprised to note that less than a third of country’s savings find its way in to financial sector. The rest, according to a recent central bank staff notes (SBP staff note 01/16), is used in real estate or other form of capital formation by informal ways (See also: BR Research column: Census and the savings rate).
According to the note’s author, Amjad Ali, savings kept in any form of formal financial instruments declined sharply to 22 percent of total national savings during 2000-05. While that period was marked by very low interest rates, incidentally that was also a period of real estate boom in the country.
Interestingly, according to a dated estimate by PIDE economists (Research Report No. 127; 1981), nearly 22 percent of remittances are invested in real estate. The latest estimates aren’t available, but it would not be surprising if real estate has attracted a higher share of remittance inflows.
Little wonder then that real estate prices have been flirting with the skies as investors make hay, while the lesser mortals, the ones who need a roof of their own, are left on the sidelines. Some rebut this view, pointing to the recent surge in housing and commercial projects. But think again! Housing backlog alone is about 9 million, and annual addition in the existing backlog is around 300,000 units, according to a recent research by Prime Institute.
Prime’s just released report, titled ‘Real Estate Market in Pakistan: Growing Beyond Regulations’ highlights how “hardly 2,000 to 2,500 real estate projects are currently in the pipeline all across Pakistan while in India, 50,000 projects underway only in the main cities”. The report identifies a host of impediments in the development of Pakistan’s real estate industry.
These include: (a) over taxation; (b) difficulties in land acquisition, lack of clear property titles and delays in registration; (c) inadequate zoning and bye laws restrictions in the country; and (d) a lack of favourable mortgage financing in the country.
Prime’s report also points out the absence of regulatory regime for real estate developers. “Building control authorities, which exist at provincial levels, significantly fall short of being comprehensive regulators. While they are only concerned with buildings, issues such as sale deed, ensuring utilities provision, overseeing maintenance, regulation of valuation; defaulted developers and so forth are not dealt with. A real estate regulator on the other hand is expected to do everything,” the report said.
“In the absence of such a regulatory authority, there are no proper records available which should ideally not only contain the property records but also history of structural changes. India came up with a developer regulatory regime in 2011-12. In Dubai, there is the Real Estate Regulatory Authority (RERA). Pakistan needs a real estate regulator to lower the cost and time of doing business and bring professionalism in the market,” it added.
Hoping to bridge the real estate gap, the Securities Exchange Commission of Pakistan (SECP) had launched a set of Real Estate Investment Trust (REIT) regulations in 2008 (revised in 2015). However, these regulations did not help in sectoral development. In last seven years, only one REIT scheme has been launched.
A host of micro, macro and structural problems are behind the lacklustre response in REIT.
The relatively micro issues can be resolved easily, if the SECP, and the federal and provincial governments put their mind to it. These include for instance, the CGT on transfer of REIT property to REIT trustee, prior approvals from SECP which takes its own sweet time for approving deals in Karachi while sitting in Islamabad. Then there other relatively micro issues in REIT policy surrounding around the allowed time period for construction under REIT, or conflict of interest issues whereby a REIT management company is supposed to be an investment manager, a business manager, and an investor.
The relatively bigger issues that will take more than simply a change in policy revolve around lack of mortgage finance, lack of clean property titles, and delays in judicial proceedings that negatively impacts mortgage financing. Recall that growth in mortgage finance is critical to buttress the growth in REITs since mortgage finance helps trigger consumer/investor demand for real estate projects, whereas REITs’ raison d’être is to allow developers to raise financing and do projects beyond their financial capacity without going to the banks.
A central problem, however, is the informal reserve of value that real estate has become. While the sale and purchase of real estate properties are usually carried out on market rates, the reported value – the value on which the transaction is taxed at – usually ranges between one-tenth and one-fifth of the market value. This doesn’t only help real estate investors and genuine buyers avoid taxes, but it also helps whiten the ill gotten monies, as and when required.
Currently, many developers do different projects under different companies. And the reason why developers are shy of formalizing under the umbrella of REIT is because their buyers do not want to register their transactions as per market value since that would put them under taxman’s radar. There are those who argue that if the taxman stops harassing people and if the government lowers the rate of transaction taxes on real estate properties, the government would get the same amount of revenues and people would start registering their properties on market value.
Then again, while many of those who are supposed to fix the system are the ones who park their ill-gotten monies in real estate, many of those from the private sector who are criticizing the public leaders for parking their monies in Panama have also been hiding their ill-gotten monies in the real estate Panamas scattered across the lengths and breaths of this country. With records of real estate properties gradually becoming digitized, perhaps it would take home-grown Real Estate Leaks to root out Pakistan’s very own Panama.
