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Monday, July 15, 2024

How would new real estate taxation impact prices & stock market returns?

Effective tax rates on actual rental income would also rise as the land owner will pay a higher applicable tax rate on actual rental income or 20% tax on deemed rental income.

The incumbent government unveiled its maiden federal budget for the fiscal year 2022-23 in order to stabilize economic growth and control the increasing inflation. In the new budget, the government has also proposed hiking taxes on immovable properties.

To clarify, individuals who have more than one immovable property worth more than Rs. 25 million in Pakistan, a 5 percent of fair market value will be assumed as its income. In this regard, Azfer Naseem, an expert on retail investment, explained in an interesting Twitter thread how would the recent changes in real estate taxation impact real estate prices and stock market returns?

According to Azfer Naseem, people invest in real estate for profits and to park their black money. To park any black money, people now need a substantial amount of white money, since the Federal Board of Revenue (FBR) has substantially increased property valuation during the last few years. With the introduction of taxation on deemed rental income, the holding cost of real estate has increased substantially.

Read more: FBR collects Rs 5.4 trillion in taxes

Moreover, effective tax rates on actual rental income would also rise as the land owner will pay a higher applicable tax rate on actual rental income or 20% tax on deemed rental income. Globally, such kinds of taxes lead to a reduction in speculative trading in plots and an increase in construction activity. Moreover, higher advance tax on transfers, especially for non-filers, will also increase transaction costs.

Both the above factors combined will reduce the attractiveness of real estate as a parking place for white and black profits (savings) as people cannot hide black money without putting up white money.

This will result in a decrease in the flow of fresh funds in the real estate market and will disturb the demand-supply balance and dampen prices. Weak price performance, higher holding costs in the form of taxation on deemed rental income, and higher friction in the form of higher taxes on transfers will put a halt to the upward spiral of real estate prices.

Stock market to become more attractive

With high real estate prices, weak capital gains, higher holding costs, and higher transaction costs the relative attractiveness of the stock market (low valuation, positive holding period cashflows i.e dividends, and far more frictionless transfer) would improve. As a result, the stock market would start attracting white money as part of savings used in real estate transactions.

Also, people will have a lower incentive to keep black money so they will reduce leakages eg by reducing their cash in hands reported in tax returns after selling property (this is usually created when people not having black money use their white money to buy real estate).

Read more: Banks enable investment in stock market

They will also have more incentive to declare slightly more in white profits for example by properly reporting inventory balances etc. Regarding the files that don’t incur transfer costs, DHA City and Bahria prices are benchmarked with prices in DHA and other city areas, so a slow down in the overall real estate market, and a reduction in prices of the main city real estate will dampen this market too.