Real estate bubble

July 21, 2016


The writer is author of Putting Pakistan Right: Standpoints on the War on Terror, Energy, Transit Corridors &Economic Development.
The writer is author of Putting Pakistan Right: Standpoints on the War on Terror, Energy, Transit Corridors &Economic Development.

THE question in many people’s minds over the Eid holidays was what was going to happen to property prices going forward. The preceding week, an important amendment had been made in the income tax rules whereby property valuations, for purposes of tax, would be determined not by the provincial governments but by valuers appointed by the State Bank of Pakistan.

Values would be determined at market prices instead of the historically low documented prices that appear in transfer deeds and registration documents.

What this means is that at the time of a transaction, the seller would have to approach a nominated valuer and get the property price assessed. The transaction would then get recorded in the register at no less than this assessed price.

That property prices are undervalued — in some areas hugely while in others only marginally — is an open secret. This has created a colossal black economy and where undocumented wealth, often from dubious sources, finds a tax haven. The money so invested does not productively contribute to any economic activity. It creates an artificial bubble in prices and fuels speculation.

Bona fide projects offering above market returns were having trouble attracting investors when so much ‘funny money’ was being made in real estate speculation over these last four or so years. So it was with all this in mind that in May this year I had submitted a recommendation for the Federal Budget 2016-17 — a one liner that read “please get money out of property and channelised towards more productive economic endeavours”.

Where potential buyers will take their money is anybody’s guess.

Now the new rules are looking to address this and gradually bring this money into the tax net. That this was going to negatively affect property prices was a foregone conclusion. The question in everybody’s mind was: By how much?

That answer would appear to depend on two things: one, the sincerity of purpose with which the government now follows through with implementing the mechanism. In other words, how watertight and incorruptible it makes the process. Two, the price erosion on each property will be in direct proportion to the extent to which it has been undervalued in the register.

Finally, how and over what time period would this erosion play out? Just as during times of a speculative boom, an expectation of higher future prices sees buyers scurrying to make a quick gain before dumping it on the next buyer, in a prelude to a slump the opposite happens.

To begin with, many potential buyers would not have the full amount equivalent in ‘white money’ with which to pay the property’s market price. On top of that, since many buyers were in it for speculative gain only, and not for any genuine need, and now all of a sudden that this no longer seems possible, many of them would evaporate. That would mean fewer buyers.

Where potential buyers will now take their money is anybody’s guess. My hunch is they would look towards other avenues of speculative investment of which there aren’t very many. But they should not be of any concern in our calculations. Instead, the big opportunity is that if the rules are implemented as they are intended, then all investment that is currently held in property assets becomes documented, in other words ‘white money’, and from here it can move and find other avenues of productive investment in other parts of the economy.

That is a good thing, although the process is likely to be a long-drawn one as sellers would be in no hurry to sell in a declining market, except those who perhaps need the cash urgently or had inves­ted borrowed money. In this way it may be at least another 12 mon­ths before the market arrives at a new eq­uil­i­b­rium.

Meantime, is there anything more the government can do? Here’s an idea:

A disproportionate amount of Pakistan’s wealth is held in real estate assets. Progressive economies need new business start-ups, growing emerging businesses and commercialisation of innovative ideas. The State Bank has an opportunity to now spur the development of alternate asset classes such as venture capital funds, private equity and investment funds.

Additionally, information memorandums containing business and project investment opportunities, on which some prior due diligence has been conducted by the State Bank or its nominated agency, can be showcased to institutional and individual investors.

Even a capital gains tax waiver may be offered as an inducement. With some imagination, money can be induced out of property and channelised towards productive economic endeavours that would deepen capital markets, spur economic growth and result in job creation.

The writer is author of Putting Pakistan Right: Standpoints on the War on Terror, Energy, Transit Corridors &Economic Development.

Published in Dawn, July 21st, 2016