Construction amnesty: Caution is advised

In the midst of the COVID-19 outbreak, PM Imran Khan announced an amnesty-style package for real estate construction last week, what has now been given an official industry status. While many ask: how is the PM thinking about the real estate industry when we are fighting a global pandemic with detrimental impact on growth, employment and poverty, the PM argues that is exactly why. He has also been careful to call it construction, rather than real estate. True, construction is a labor-intensive industry which can create thousands of new jobs (especially for daily wagers) and it contributes about 2 percent to the GDP. Perhaps, to the economic team, construction is an achievable low-hanging fruit right now, but the package raises more questions than it answers.

To review, the package offers the following: one, there will be no questions asked on the source of income for those who are investing in construction. This essentially allows developers, builders and investors to whiten black and grey money without any government oversight. This is contingent on the investment going into actual construction, rather than just trading, though if there is a time stipulation to how soon the construction needs to start, we don’t know about that yet. This also raises a lot of critical questions about Pakistan’s commitment on the FATF front since real estate has been flagged by the plenary as a major source of illicit funds from crimes including “corruption, drug trafficking, fraud, tax evasion, smuggling, human trafficking and organized crime”.

Two, there will be no capital gains tax (CGT) collected on the sale of built properties. Three, the current tax regime will be replaced by a fixed tax regime which will be on a per sq ft. basis. Other components of the package include the setting up of a Construction Industry Development Board, no withholding taxes will be collected on building materials (other than cement and steel) while sales tax will be reduced in coordination with the provinces, Punjab and Khyber-Pakhtunkhwa to two percent. Furthermore, developers will be exempt from 90 percent of all taxes if they were to invest in Naya Pakistan Housing Program (NPHP).

This will certainly spur a lot of investment in the construction sector but whether it would lead to actual low cost housing which will be affordable for low-middle classes (mind you: nearly 70% of the current housing demand is in the low-middle segment, while the supply is mostly for the high-income households). First, these incentives will definitely increase the demand of land. Higher demand will hike up prices substantially and this will be a problem, especially if we are talking about affordability since land is 90 percent of total cost of housing. Secondly, at a time when demand across industries particularly manufacturing is depressed, there will be a lot of productive businesses which would find it more lucrative to invest in construction.

The package essentially considers the supply side of the problem. But even if supply is increased, is there demand for it? By demand, we mean, the ability of potential home buyers to actually purchase the properties that will be made available in the market. To spur demand of housing, we would need to create a mortgage market, while housing prices would have to be made affordable. A Rs30 billion subsidy has been allocated but it is unclear in what shape would it be disbursed, and for how many houses (what time period) would it be covered. It does not seem to be enough (more analysis on this later).

Since there is a tax advantage to construct properties under NPHP, a lot developers might avail it. But, the current NPHP projects announced by Federal Government Employees Housing Authority (FGEHA) are hardly affordable. The prices for these supposedly “affordable” housing range from Rs3.7 million to Rs11 million across different pay scales of federal employees. The cheapest property here is for Rs3.7 million covering only 2000 flats under the project.

This also happens to be the only block of housing which is eligible for a mortgage under House Building Finance Company (HBFC) Ghar Pakistan scheme where properties eligible for the loan must cost under Rs4.5 million. The rest of the 10,000 planned flats under FGEHA are not affordable by any measure and are not eligible for the HBFC mortgage either. Meanwhile, consider when land prices go up considerably as the race to buy ensues, how will developers offer affordable prices? Cost of construction itself will also go up as demand grows and both cement and steel—which form major components of construction costs—are still liable for WHT (more calculations on this later as well).

The point is: yes this will spur construction, and may create jobs for the poor. But a lot of money will flow into the sector—which will create problems for Pakistan given it will be unexplained—and we might end up creating a lot of housing for which there will be no demand, resulting in ghettos. One must question: does this package solve a problem or create several more?