Structural issues behind real estate leasing, mortgage

The World Bank’s board of directors previously approved three projects for financing in Pakistan worth $435 million as the country faces a severe housing shortage.

According to the World Bank, “the housing shortage in Pakistan is estimated at 10 million units, with about 40% in urban areas”.

A critical aspect is the scarcity of housing finance, with a mortgage finance to GDP ratio of only 0.25%. It is one of the lowest in South Asia compared to Bangladesh (3%) and India (11%).

A large amount of property cannot be rented, which means that the relevant building control authority does not recognize this.

Many suburban and semi-rural areas have a disproportionate share of low-cost rental housing, which planning authorities do not recognize, meaning they cannot be rented either. However, due to lower rates and rents, many residents live in these areas.

In the case of urban areas, many properties cannot be rented because they do not have a certificate of completion. This reduces the possibility of renting a property.

“Pakistan is primarily a cash market; a mortgage market has never been developed largely due to lax foreclosure laws and high interest rates,” said Ammar Habib Khan, Chief Risk Officer of Karandaaz Pakistan. “These factors make it unaffordable for mortgages.”

The other option than renting a property is to mortgage it. Recently, the SBP increased the interest rate from 9.75% to 12.25% and then to 13.75%.

With interest rates in double digits or near double digits, mortgages are simply unaffordable. The central bank of Pakistan’s inflation target is 8-9%.

It will be a moonshot if the long-term interest rate reverses and the snail walks to 9.75%. But the 9-10% mortgage is unaffordable.

Another aspect is the rental yield. As Profit postulates, the average rental yield in urban residential areas is 3%. This implies that prices are rising faster than the cost of living.

Renting is cheaper than getting a home loan. A record amount of money is floating around in real estate files, driving up prices for undervalued land.

Buying something expensive and then seeing the price drop does not mean the owner will sell it because the real estate market is a cash market. Of course, the market bounces back even if it takes a decade.

Mortgages are also long-term investments, typically lasting 15 to 20 years. If a bank or NBFC provides this long-term loan, they will also require long-term liabilities, such as bonds or some other form of collateral.

It is always difficult to get this from banks or NBFCs, and if it does eventually happen, it will be on strict and tough terms. This is also not a suitable option.

“NBFC has a funding problem. We don’t have a secondary market deep enough to raise funds, so it’s difficult for NBFCs to raise debt, which can then be loaned out as mortgages,” Ammar Habib Khan said.

“All NBFCs struggle with the asset-liability mismatch. Debts they can raise have a maturity of less than a year while mortgages have a maturity of more than a year.

By comparison, India has a huge NBFC market that offers millions of low-income mortgages funded by long-term liabilities. Therefore, banks are less effective in this area.

India’s NBFCs, which accounted for 23% of the market in fiscal 2019, overtook the country’s state-owned banks, which still make up the majority of the country’s credit system.

Due to pressures on asset quality and higher capital requirements, banks’ ability to lend has been constrained. With better distribution channels for rural and semi-urban retail customers underserved by banks, NBFCs have benefited from more robust growth opportunities.

Unlike India, Pakistani banks act as low-cost deposit takers, i.e. they deposit the funds with the government. A bank doesn’t even have to consider mortgages when such a system is in place.

Plus, why would anyone take the hard route when the government is providing free money and IOUs? It is unhealthy to think of taking out a mortgage when the banks don’t even allow opening an account without a pay slip.

Moreover, on the contrary, Indian banks and NBFCs have developed effective credit scoring models that help in granting low-income mortgages to the lower middle class, who are in the informal sector and unbanked.

This is a structural problem, and it can only be made effective by discouraging rent seeking and monetary economics. There is cautious optimism.

The author is an expert in political economy, cities and governance, and works as an associate researcher at the Center for Social and Political Research

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Published in The Express Tribune, May 30e2022.

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