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COOPERATIVE HOUSING: LEARNING FROM INTERNATIONAL EXPERIENCE

AROUND THE WORLD

In my previous blog, I referred to Prime Minister’s 100 days agenda relating to construction of 5.00 million houses in five years as one of the factors that will lead to set future trends in real estate sector of the country. Now after surpassing 100 days of the present government and recent development of other significant events, directly associated with housing sector, one just cannot find himself in a comfortable position to invest in the sector.  The announcement for the constitution of “Naya Pakistan Housing Authority” as a first step, towards the long term commitment of the present government, has yet to spread its wings to show its direction. The anti-encroachment drive, restrictions applied on construction of high rise apartment buildings (now allowed), higher interest rates, unstable currency and reduction in development expenditure, all lead to overall economic recession along with correction of real estate sector. Furthermore, the creation of a separate Directorate of Immovable Properties by Federal Board of Revenue (FBR) to curb taxation issues of the sector has yet to make its impact on the sector as well.

Country’s Economic managers, after having evaluated five months performance of the present government, are now looking towards the upcoming budget proposals of the new government, which are likely to start from February this year. This will perhaps clarify the future trends and bring stability in the market for the upcoming financial year. Till such time the market is in a wait & see mode.

However, after listening Prime Minister’s 100 days agenda performance speech, wherein he focused on livestock and organic hen farming, which unfortunately became a laughing stock, I wonder why the true concept of Cooperatives has not been considered by the government, despite focusing local body empowerment and community based management system (CBMS) in the country. Although the history of Pakistani Cooperatives is not so good enough, yet the hidden potential of the cooperative sector, towards sustainable economic development, can bring the desired results by adopting accountability and good governance measures.

cooperatives

“Cooperatives in Pakistan” is a debatable issue. The topic is full of merits and demerits and one can identify the reason for its minimum contribution in the Gross Domestic Product (GDP). Quite interestingly, as against current contribution of 7%, Iran has set a target of 25% contribution of Cooperatives towards its GDP by 2021. There are 160,000 registered cooperatives in Iran operating in 120 fields, including agriculture, services, housing, transportation and production, etc.  This is one aspect of understanding the importance of cooperatives for sustainable economic growth. Similarly the housing cooperatives, especially international cooperatives play a significant role in reducing their respective housing issues to a greater extent. Pakistan can also take advantage from their experiences in tackling this issue.

homeless

ICA Housing, a sectoral organization of the International Co-operative Alliance, with more than 30 member countries worldwide, including Pakistan, was established to promote the development of cooperative housing in various developing countries around the world. The objective of the organization was to facilitate developing countries in solving problems of providing shelter to homeless individuals.

The best way of learning from the international experience is to organize seminars and conferences on this vital issue. There has to be a clear demarcation of the grey areas and the apprehension regarding cooperatives as a “wolf in a sheep’s clothing “must be addressed accordingly.

REAL ESTATE BUBBLE: DO WE NEED SOME CORRECTION

 

Colorado-Housing-Bubble

Real estate bubble or housing bubble refers to a situation where the real estate prices increase artificially, irrespective of demand and supply mechanism, till such time when the artificial incremental growth fails to sustain any more. Once this level is achieved the bubble bursts and the prices start falling down to their realistic values. Unlike stock market, the period of real estate bubble is more lengthy and unpredictable.  The effects of real estate bubble are felt by a common investor when it is close to burst.

Now the question arises as to how the prices increase artificially over and above the average growth rate? In this regard the economists are of the view that there are many factors attributable to such situations. Normally when the economy is growing, people have sufficient disposable income to invest in real estate. Low interest rates results in strong credit growth, particularly house financing. This leads to high speculation and invasion of investors in the market, leaving behind the genuine buyer. When the investors dominate the market, the speculative forces entangled the market and the prices start increasing artificially. Furthermore, irrespective of economic growth momentum, the global shift of investment from stock and bullion markets to real estate sector also contributes towards formation of bubble through creation of artificial boom in the market.

The recent United States housing bubble of 2008 coupled with the downward economic trend, greatly affected the US economy. The bubble that shaped out in 2005-2006 was controlled and corrected by economic managers through interest rate adjustments which brought down the real estate prices to its reasonable value in 2012.

bubble support

The real estate artificial prices in US, which were at its peak in 2005-2006, took almost seven years to come down to its reasonable levels. Furthermore it is quite interesting to note that this bubble must have also taken some considerable time to reach its peak in 2005-2006, so we can say that the life cycle and the effects of these bubbles may spread over decades.

It is however imperative here to mention that it is not like that the bubble cannot be predicted. There are many early warning indicators which clearly predict the creation of bubble. Although there are many other indicators like low interest rates and leverage, high living expenses against low salary level and increasing role of investors in the market, etc. , yet I have examined one of the most common indicators, i.e., the gross annual rental yield indicator.

A gross rental yield is calculated as follow:

Gross Rental yield =    (Annual Rental Income / Cost of Property)  X 100

In Pakistan, the standard average annual rental yield on residential properties is 3% to 4%. As such the property prices when compared to their rental value clearly reflect the excess fat.   An analysis of the property prices of Pakistan’s major cities, in comparison to their rental values, reveals that the real estate bubble is in the offing.

Luckily with the change in government and an expected tight monetary policy, the interest rates will likely to be increased again in near future. Resultantly the real estate market is definitely going to be affected appropriately enough to get its excess fat evaporated.

100DA

Construction of 5 million houses, as per 100 days agenda of the new government, will also play its role in rationalizing the market. However the details, in this regard is yet to be unveiled, as such, once the same is presented, a much more  clear picture will emerge, which will set the trend accordingly.

Let our fingers crossed that the real estate market of Pakistan will respond rationally and positively in the near future to get it self corrected from artificial effects.

 

 

FINANCE BILL 2018: REFORMS & THE AMNESTY

Taxes

The Finance Bill, like any other bill, is a legislative proposal, which becomes a full fledge Act or law, once it is passed from both the houses of Parliament along with assent given to it by the President. The Finance bill is a part of the budget memorandum, presented annually in the National Assembly. Every year through Finance Bill, the government initiates various amendment proposals in different direct and indirect tax laws for levy of new taxes, modification or continuation of existing tax structure. Once these proposals are approved from both the houses of parliaments and formally signed by the President, they become part of the law and enforced accordingly.

This year, as part of economic reforms package, which included tax reforms and amnesty scheme; following four ordinances were promulgated by the President which need to be understood alongside the current Finance Bill 2018:

  1. The Foreign Assets (Declaration and Repatriation) Ordinance, 2018;
  2. The Protection of Economic Reforms (Amendment) Ordinance, 2018;
  3. Voluntary Declaration of Domestic Assets Ordinance, 2018; and
  4. Income Tax (Amendment) Ordinance, 2018.

Tax-Amnesty

The Foreign Assets (Declaration and Repatriation) Ordinance, 2018 requires every Pakistani citizen, wherever he/she may be, to declare his/her foreign assets latest by June 2018 and pay the tax on the market value of those assets. In case of immovable assets outside Pakistan, the tax rate is 3% of the fair value of the property.

A new provision has been made in the Protection of Economic Reforms Act, 1992 (PERA) by virtue of which the exemption from taxes on foreign currency account and the immunity previously available to all the foreign currency account holders in Pakistan from enquiries by tax authorities with respect to the source of the capital has now been confined to tax filers only. As such now no non filer will be entitled to open foreign currency accounts in Pakistan.

Voluntary Declaration of Domestic Assets Ordinance, 2018 requires every Pakistani citizen, wherever he/she may be, to declare his/her undeclared domestic assets latest by June 2018 and pay the tax as per valuation criteria defined. A tax rate of 2% and 5% has been fixed for declared value of foreign currency and all other assets respectively. The basis of valuation of all immovable properties shall be as follows:

  1. Open Plots and land       :        Cost of acquisition or FBR rates, whichever is higher
  2. Super Structure               :        Rs. 400 per square feet of covered area
  3. Apartments and flats :   Cost of acquisition or Provincial stamp duty rates whichever is higher

 

The amendments in the Income Tax Ordinance 2001 through Income Tax (Amendment) Ordinance, 2018 were made to make Income tax ordinance compatible with the provisions of other ordinances promulgated as part of Economic Reforms Package. Besides basic amendment in “the year of income tax chargeable to tax” u/s 111(2) and increasing the maximum exemption limit form Rs.400,000/- to Rs.1,200,000/- no specific changes pertaining to real estate sector were made in this ordinance. The provisions of the Income Tax (Amendment) Ordinance, 2018 were however made part of the Finance Bill-2018 and all the remaining three ordinances are going to be passed from the National Assembly simultaneously.

Tax1        

The area wise value of properties determined by the Deputy Commissioner for the purpose of calculating stamp duty is commonly referred to as DC rates. Since long these rates have also been used as acceptable value of properties for taxation purposes as well. However the fact remains that the fair value, the transaction value and the DC rate of immovable properties differ significantly. The wide gap between these values compelled the Federal Board of Revenue (FBR) in 2016 to come up with a new set of rates for assessing the value of immovable properties. These new values of immovable properties, called the FBR rates, being higher than the DC rates were consequently used in lieu of DC rates for taxation purposes. Despite implementation of more stringent valuation standards, the menace of under-declaration of the actual transaction value remained unresolved. As such, replacement of existing valuation system with a new system is proposed whereby the immovable properties are recommended to be valued on the basis of transactional values rather than their standard values (DC/FBR rates).

In this connection a post of Director General of Immovable Properties is likely to be created under section 230-F of the Income Tax Ordinance 2001, duly empowered to appoint valuation expert to assess the fair market value of the properties and to initiate proceedings, within six months from the date of all such transaction where there are reasons to believe that the consideration for transfer is under stated to avoid tax. However the proceedings shall only be initiated if the fair market value of the property exceeds by more than 50% of the declared consideration. In case the transaction is proved as such, the government shall have the right to acquire the property by making payment of consideration to the seller through FBR. This will help reduce the under valuation trend to a greater extent.

A new section 227-C has also been under consideration by virtue of which nobody can purchase any vehicle or property, exceeding Rs.4.00 million and above, unless he is filer. This may however need to be examined in the light of the fundamental right of every citizen for acquisition of assets.

It is however imperative here to mention that since the immovable properties is a provincial subject as such despite having been officially discussed neither the new rate mechanism nor the provision of section 230-F and 227-C is included in the finance bill-2018. However one thing is very much clear that the government is eyeing on tapping the huge amount of invisible un-taxed funds, spread all over the real estate sector.

 

Real Estate Investment Trusts- An OVERVIEW

REIT

The conceptual framework of Real Estate Investment Trust that was initially legislated by the US Congress in 1960 was finally recognized and adopted by Pakistan in 2008 when the Securities and Exchange Commission of Pakistan formally presented the Real Estate Investment Trust Regulations, 2008 on 31st January 2008 which was subsequently replaced by Real Estate Investment Trust Regulations, 2015 on 16th April, 2015.

The REIT, as defined by Wikipedia, “is a company that owns, and in most cases operates, income-producing real estate.” The motive behind creation of REITs was to create a mechanism, based on mutual funds, whereby the benefits associated with real estate and stock based investments were combined in such a way that helps create an opportunity, especially for small investors to access income producing real estate which was previously confined to wealthy individuals and large financial intermediaries only.

A US REIT Company is required to have at least 75% of its total assets in real estate and 75% of its gross income should come directly from real estate activities like rental income, interest on mortgage financing and sale of real estate. The REIT is also required to distribute a minimum of 90% of its annual taxable income to its shareholders in the shape of dividends. A minimum of 100 shareholders are required for a REIT, provided no more than 50% of its shares held by five or fewer individuals.

Consequent upon its legislation by US congress, the first US REIT was created in 1961 and the Americans responded to this form of investment in a positive manner. Today the US REIT Industry shows an equity market capitalization of more than $ 1 Trillion, representing $ 3 trillion in gross real estate assets .The success of REITs can also be gauged from the fact that an estimated 80 million Americans own REITs (invested in REITs) through their retirement and other investment funds. Generally, investment in REITs is for dividend rather than for growth/capital gains. Some REITs in US pay the dividend on monthly basis to attract passive income seekers. The all REITs average annual return in US is 9.72 % (2017: 9.27%).

In Pakistan a REIT Management company (RMC) falls under the category of Non-Banking Finance Company and requires a license to this effect from SECP. So far only one REIT is listed on the Karachi Stock Exchange which is claimed to be the first listed REIT in south Asia.

As against US REITs which are broadly classified into Equity REITs and Mortgage REITs, here in Pakistan the REITs are divided into two types i.e., development REITs schemes for construction of properties and the rental REITs schemes for renting out completed properties. Under the revised REIT regulations 2015, the Paid-up capital requirement for RMC has been reduced from Rs.200 million to Rs.50 million and the minimum stake of RMC in a RET has also been reduced from 20% to 5%. Besides allowing a performance fee for REIT managers, a new concept of strategic investor has also been introduced who is entitled to a 20% stake in the REIT scheme. So far as the matter regarding dividends is concerned, it was left at the discretion of the RMC to device dividend policy in the best interest of the unit holders.

riet-banner

As per information available on Dolmen City REIT official web site:

Dolmen City REIT is Pakistan’s first REIT scheme. It is a Closed-ended, Listed, Rated, Perpetual,Shariah-compliant, Rental REIT scheme which offers investors to become Unit holders of two component of the Dolmen City project, Dolmen Mall Clifton and The Harbor Front. The properties will generate rental income that will be distributed by the REIT Scheme among unit holders in the shape of dividends. Any possible appreciation in the value of the property will be an added benefit. Dolmen Mall Clifton has a total built-up area of approximately 1 million square feet spread over three levels. Anchored by Hyperstar and Debenhams, Dolmen Mall Clifton has a strong mix of local and international brands including Mango, Next, Nike, Nine West, Timberland and Charles & Keith. With 130 retail outlets, a multi-level department store, and a food court that accommodates 1,200 customers, Dolmen Mall Clifton is the largest shopping mall in Pakistan, currently operating over 90% occupancy rate. The Harbour Front is an office complex home to leading local and multinational corporations of the country. The complex offers prime office space across seventeen floors, spread over 270,000 square feet. The building is currently 100% occupied with the current tenant portfolio comprising of companies including Engro, Phillip Morris Mitsubishi and Procter & Gamble, among others.

  • NAV (March 2018)                      PKR 18.44 per units
  • Dividend Yield
  •    Quarter Ended (Mar. 2018)                          3.00%
  •    Annualized (2018)                                        12.00%
  •  Unit Price (Current on PSX)   PKR 12.99

Despite all these impressive and healthy numbers of a single RMC, what significant contributions can we expect from REITs to solve the ever increasing housing shortage in Pakistan?

PAKISTAN HOUSING SECTOR A DO MORE APPROACH

Key chain

The Real Estate Sector is broadly divided into three segments i.e., residential, commercial and industrial real estate. It covers the activity of buying and selling of properties falling under these segments. Accordingly, the residential real estate segment covers the activity of buying and selling of properties in the shape of residential land and constructed built up properties. The analysts and the investors gauge the growth and performance of the sector differently by using different parameters. The analyst focus on the macro parameters like demographics, economy, interest rate and government policies etc. Whereas an investor focuses on micro parameters like location, speculative news, comparative prices, prospective growth activities and personal interests etc.

House icon

The term housing refers to houses and buildings for people to live in. It also includes the process of planning or provision of accommodation by government or any other authority.

The real estate demand in Pakistan remained fluctuating since long. This has resulted in escalating the housing requirements in the country as well. Pakistan Housing Finance Project Report, a document of the World Bank, reveals that as of today, the estimated housing shortfall in Pakistan is approximately up to 10 Million units. The demand for housing increases by 400,000 to 700,000 units annually, whereas currently only 100,000 to 350,000 units are being fed into the system annually. This means that the backlog of 10 million units is increasing by 3.5% annually. As such, in order to cope with the situation, we need to inject 0.9 to 1.1 million units annually for a 20 years plan, failing which the real estate sector of the country will certainly be entangled in a crises, like the one we are facing today, in the shape of load shedding.

Factors like increase in urban migration, population growth, high cost of living and low saving rates have contributed a lot towards escalating the shortfall in housing sector. Besides this the most important factor towards slow growth of housing sector in Pakistan is access to home loans. According to State Bank of Pakistan’s Housing Finance Review, “the mortgage to GDP ratio in Pakistan stood at 0.5 percent as on December 31, 2016”. Quite interestingly in the most developed countries, such as in Denmark or the Netherlands, mortgage loans exceed 100% of GDP. USA is having more than 67%. In India it is around 7%. Even Bangladesh is having mortgage loans of 1% to her GDP. The trend can be gauged from the fact that the average age for first-time home buyers in the U.S. and Australia is 33 and 32 respectively and this has remained unchanged for the last 20 years in Australia alone. In Pakistan, unless people get access to home loans, the problem will aggravate, day by day.

The major reason of urbanization in Pakistan is the job placement of young individuals in urban areas. Even after retirement people prefer to settle in the urban areas, rather than going back to their native towns & villages. If people are provided with an opportunity of home loans, obviously the demand will increase automatically, inducing the developers to supply accordingly. As it is very well said that construction is the mother of many industries and impetus for labour force, as such this increase in demand and supply will generate economic activity on self-propelled basis.

As part of housing finance reforms in Pakistan and in line with India’s Real Estate Regulation Act (RERA), a bill to establish a Real Estate Regulatory Authority for regulation and promotion of the real estate sector in Pakistan has also been introduced in the Senate on 21.08.2017. According to the bill, no real estate project will be presented in the market for sale without prior registration with the envisioned regulatory authority. Registration of any individual working in the real estate sector with the authority will also be mandatory. However after the bill was presented in the upper house of the parliament, it was forwarded to the concerned committee. The Ministry of Capital Administration and Development Division (CADD) sought feedback from CDA over the bill and after examining the provisions of the bill, CDA pointed out several clauses that, it claims, are contradictory to the CDA Ordinance as well as other rules and regulations of the civic body.

Furthermore the State Bank of Pakistan introduced a regulatory framework in 2006 to encourage banks/development finance institutions (DFIs) to increase their investment into the housing and construction sector but generally the banks are reluctant to long term financing like housing finance, owning to long term engagement of funds besides low rate of recovery and high rate of classified provisioning.

Despite understanding the reluctance of Banks and Financial Institutions to wards housing finance, the World bank has come up with the project of developing a housing finance plan to help Pakistan meets its growing demand for residential units whereby the World Bank will provide funds to the tune of $.140 million for low-income housing projects that will reach banks through Pakistan Mortgage Refinance Company (PMRC). A shareholders’ agreement, in this regard has been signed on Saturday the 14th April 2018 in which the government holds a 49% stake, while private sector banks hold the remaining majority share in the PMRC.  It is imperative here to mention that another objective of the World Bank’s line of credit is to enable women to increase their house ownership, as presently only 2% of the women folks own houses in the country.

Although a much is being done in the real estate and housing sector yet we need to DO MORE…