'Government must heavily penalise property hoarders' an interview with Mohammad Hasan Bakshi, Chairman ABAD

Housing is a top agenda for the PTI government and under the flagship Naya Pakistan Housing Plan (NPHP), PM Imran Khan wants to facilitate the construction of 5 million affordable houses across the country. To put that in context, the existing shortage of housing in Pakistan is estimated to be 10-12 million units with the gap widening as the supply is catering to only a small section of the population, particularly in the high-income category. In fact, nearly 80 percent of the shortage is in the low and middle income segment. BR Research met veteran builder & developer Mohammad Hasan Bakshi who is the current Chairman of Association of Builders and Developers of Pakistan (ABAD) to discuss the same. In the first of this two-part interview, we discuss the regulatory and legislative challenges in the housing sector and what interventions are necessary to document the real estate and housing sector as well as optimize its growth. Here are edited transcripts:
BR Research: Builders tell us that growth in the housing sector in Karachi has become stagnant. Talk to us about that.
Mohammad Hasan Bakshi: Karachi accounts for more than 70 percent of regulated construction activity in the country, which means that when activity slows down in Karachi, the entire country suffers. There are multiple reasons for stagnancy. At the federal level, FBR has frequently changed the valuation table and tax regime. In the past two years, Chairman FBR and Finance Minister have been saying that there is a lot of untaxed money being dumped in real estate which has to be curtailed. This has turned the sentiments negative, which has led to lesser investments.
The city is also recovering from a ban on construction of high rise building. The Supreme Court under Justice Saqib Nisar banned construction of high rise building after a report from Water Commission that said there was a shortage of clean drinking water in the city and buildings were causing further shortages. That is a false perception because buildings do not consume water; humans do. To control water shortages, we have to improve water management system by controlling leakages, theft and also addressing migration issues resulting in population explosion. Consumption naturally grows in a particular area whenever we move from horizontal to vertical construction, since there are a higher number of residents in apartment building, than in bungalows. If the same population was to shift in horizontal housing, they would be consuming much more quantity of water per person
Moreover, construction is a productive activity. There are at least 72 allied industries associated to the housing and construction sector providing direct employment to over 1.5 million skilled and unskilled labour. Justice Nisar realised this, and the ban was eventually lifted. During that time, many ship breaking yards, steel re-rolling mills, block making units, concrete batching plants etc. came to an abrupt halt.
Six days after the ban was lifted, there was another order in a separate petition by Honourable Justice Gulzar. This order is being misinterpreted by Sindh Building Control Authority (SBCA) to date. Currently SBCA have stopped processing and approval of building plans on almost all categories of plots. According to order, court has put a ban on further conversion of plots for commercial purposes but the regulator has decided to stop processing and approval of all projects. We are back to square one. The decline in transactions we are witnessing today has never been seen in history before.
BRR: That may have affected supply recently but a major reason why housing shortage exists is that the current supply is simply not affordable for the average consumer. Real estate has been commodified. There is a lot of trading in plots but it never gets converted to housing. Would you agree?
MHB: We have to first distinguish between the two separate real estate activities. One is trading and investments in plots where untaxed money is being dumped. Second is construction. This is where a plot is bought by a builder or developer who constructs a building and delivers it to customers. This generates economic activity.
In the first category, plots are hoarded for years and sold off when the return is good and the plot has gained enough value. Plot hoarding/trading causes the prices of land to shoot up and eventually consumers bear the brunt of it as they have to pay a much higher price for housing units. From our perspective, these plot traders and hoarders should be heavily penalised, and the activity of construction should be encouraged which is helping run 72 industries and providing skilled and unskilled employment to millions.
BRR: How can the government penalise and discourage plot hoarding?
MHB: Government should heavily tax transfer and holding of open plots, and if the owner/buyer utilises it in construction activity within two years, then that amount should be adjusted against their approval charges and tax liability. One has to keep in mind that it takes around two years for the issuance of construction permits. Another way would be to make the filer status compulsory for buying an open plot over 120 sq. yards. That will discourage the investors to invest in open plots and they will be inclined to invest in under construction or built up properties.
BRR: What is the distribution of real estate activity in plot trading and construction? How much is each?
MHB: Around the world, only construction is considered a profitable business because there is value-addition; trading of plot is not. Unfortunately, in Pakistan, plot trading is extremely profitable and hence the activity is much higher here. This trend needs to be reversed. Investment in construction needs to become much more attractive.
BRR: How can construction be made profitable so more investment pours into it?
MHB: We have to think about why this is not profitable. Suppose a builder buys a plot, gets approvals, and constructs a project on it. After selling the completed project, his capital and profit together is not enough to buy another plot of the same size in the same vicinity. He has to go for a smaller size of plot or bring in more partners because by the time he delivers the project which takes five years, the plot value has multiplied. In construction, business land is a raw material which needs to be made available on regular basis at reasonable rates.
Another issue here is the long approval time of two years or more. This has to be brought down to two months which is a global average. The problem with long approval times is the builder already knows that he cannot start a new project before two years. So he is reluctant to sell his existing stock at competitive rates. Buyers have no choice but to pay more since the demand is many times greater than the supply. Demand and supply gap hence rises, and the only solution is increasing the supply which can be achieved by reducing the number of no objective certificates (NOCs) required for issuance of construction permits and overall approval times.
BRR: Lack of foreclosure laws and clarity of titles are often cited as major reasons why banks don't go into housing finance. Which is the bigger problem?
MHB: Banks are hesitant in financing primarily because of lacunas in foreclosure laws. They have to wait 5-7 years for recovery as cases get stuck in courts. As for titles, majority of property titles within the city limits are clear. In the outskirts, there are problems.
The solution of titles lies with the provincial governments. They can create an independent authority or department to whom all land owning agencies must report. Any purchaser of property can go and get the title of the land he is in process of purchasing checked and verified from this agency within a given timeline. After confirmation of clearance of title from the land owning agency, the authority must allow the transaction to go through. After this, no title dispute or litigation should be entertained this generally results in project delays. The government must provide legal cover through legislation to avoid long litigation in courts. This model is successfully being run in Turkey. Multiple ownership on single property is created by the Board of Revenue officials for their ulterior motives in connivance with influential people. This is a primary reason why FDI is not coming in the housing and construction industry in Pakistan. Secondly, I have requested the Honourable Chief Justice of Pakistan through a letter to set up a special bench at provincial and federal levels to dispose the cases related to land and construction within a fixed period of 30 days. The long delays in court and stays hurt the allottees. The court system is being misused by people who want to buy time. Judges must be prohibited by the Chief Justices to grant stay orders or adjournments.
BRR: Nobody in Pakistan really knows what the existing housing demand-supply gap is. Most numbers quoted by government or international organisations use the population growth rate to estimate the shortage which is between 10-12 million units. Since you are supplying housing, do you have an estimate of what demand might be?
MHB: In a city like Karachi, there is a shortage of 2-2.5 million housing units which includes sub-standard housing. We estimated this by using the number of electricity and gas meters installed in Karachi. Karachi's population is around over 25 million, although the official estimates based on Census 2019 are less. Each utility of electric and gas has two million metered connections. If there are six individuals living in a household unit having one meter on average, it means 12 million people have proper housing. This numbers may include some Katchi Abadis that are regularised and have metered electricity and gas connections. The rest of the 13 million population does not have proper housing. So based on six individual per house that makes a shortage of 2.2 million houses. Every year this number is increasing due to a short supply of housing units.
BRR: What was the impact of ban on non-filers to purchase of property? And could one argue that this has been a good deterrent for black money being funneled into real estate?
MHB: That was one of the reasons for the slowdown in construction activity in the country. The government plans on removing this ban which I believe would ease out the market a little bit. As I see it, the ban on non-filers was counterproductive. When an individual purchases an under construction or built up property, whether filer or non-filer, he is contributing to the production of many industries as well as creating jobs. Moreover, when he transfers the property, he shares all his data and information of transactions with the relevant authorities in addition to the payment of multiple provincial and federal taxes.
This makes it easier to collect data of high net worth individuals, and all FBR has to do is send him a notice inquiring about his source of investments. But on the other hand, if we are restricting all non-filers to purchase built up property, and then indirectly we are encouraging saving in dollars. If one buys property in the UK, after completing the transaction, the tax authorities send a notice asking about sources of investments for that transaction, but do not put bans. They encourage people to make investments because that is good for the economy.
BRR: What was the wisdom behind introducing FBR valuation, and why are they still lower than market values. It seems to be the legal way to misrepresent and under-document property transactions.
MHB: ABAD is of the view point that there should be no FBR valuation table. This is not the job of FBR. In fact, it has created a confusion and distortion in the market. ABAD has proposed FBR to charge one percent tax on the actual transaction value. In fact, this tax should be phased out within five years from 1 percent to 0.75 percent, 0.5 percent, 0.25 percent and 0 percent because FBR cannot legally collect taxes on property transaction. Income tax can only be levied on the income generated. After the 18th amendment, tax on property has become a provincial subject and only the province can collect tax on it.
There are other discrepancies. If a property is transferred to a Real Estate Investment Trust (REIT), the FBR is charging zero percent advance income tax, whereas all else which include SMEs and individuals are being charged 2-4 percent by FBR. That is discrimination. As for capital gains tax (CGT), it is payable if the property is resold within three years. Builders construct building on their plots and sell through transfer of title which takes at least 5 years; therefore, the construction industry is not liable to pay CGT.
The FBR needs to be going after property hoarders and traders instead. It should have a database of those individuals who have a huge number of plots in their names and are continuously flipping properties. Most of these individuals are front men for others and do not have a tax history. FBR must look into the sources of investments, tax history, bank accounts and conduct audit of a few cases to ascertain and unearth the actual beneficiary of such activities. The benami property law can be an important tool here.
The FBR has all the required information but are unable to take decisive action. These front men are buying properties on their own name on behalf of bureaucrats, politicians, and retired officers, but no one in the government has the courage to unearth the actual beneficiaries.
I think, these people who are being represented by front men are not more than five percent of the population. These are the people who are tormenting Pakistan's economy. It is time that the government takes action against them. This is a big challenge which Chairman FBR needs to address without further delay. I offer him my complete support.