The real estate sector for any economy, especially for an emerging economy, is a crucial driver for economic growth. Pakistan’s real estate sector has forward and backward linkages with over 40 ancillary industries from steel, cement, and bricklaying to cables.
Roughly 30-35% of the country’s employment is directly or indirectly affiliated with the construction sector. One estimate indicates that an increase of 100,000 in housing units in one year contributes to approximately two percent of Pakistan’s total GDP.
As such, the construction sector in Pakistan has played an essential role in providing jobs and facilitating the revival of the economy. In 2016, due to the IMF and FATF pressure, the PML-N government undertook several measures to regulate the industry and bring it into the formal sector.
They also increased tax significantly to increase government tax receipts, which depressed the real estate market and ancillary industries for close to four years.
So what did the PTI government do right?
So what did the PTI government do right? Well, several things. First, given the number of industries involved and employment during the Coronavirus pandemic PM Imran Khan set up a construction package, and the sector was amongst the first given permission to open up during the lockdown of the country in April 2020 onwards. The construction sector was given the status of being an industry.
The sector was given several tax advantages, including a tax amnesty scheme (due to expire June 2021), and interest rates (technically SBP) were brought down. In July 2020, the SBP mandated banks to lend 5 percent of their loan portfolio for financing housing and construction by December 31, 2021.
Moreover, most importantly, the government recognized that a vigorous and dynamic mortgage market had to exist for the housing market to develop, which required above everything else robust foreclosure laws.
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Why so few houses in Pakistan?
Why so few houses in Pakistan? Only 32 million houses have been built in Pakistan since 1947, of which 39 percent are urban. This is against the pent-up demand of annual housing of around 700,000, out of which only 50 percent is met every year.
Overall it is estimated that there is a shortage of approximately 10m residential units in the country. The country suffers from several issues when it comes to developing the property market.
Hindrances include improper land titling, which is often very obscure and unclear, illegal property development by societies that do not have necessary approvals from government bodies, shoddy regulation by authorities, and a lack of clarity around foreclosure laws from the courts, which has deterred banks from giving loans to borrowers keen to get on the housing ladder.
This lack of a mortgage market has been one of the most significant challenges governments face to provide low-cost housing. In Pakistan, housing is mainly bought outright on cash, and hence the country has a meager percentage of homeownership given the size of the country.
Small numbers of the predominantly affluent middle class and the rich have been able to build or buy their houses. Ansaar Management Company, which provides affordable housing for low-income people, estimates that only one percent of housing units developed annually cater to 68 percent of Pakistan’s total population (people who earn a monthly income of Rs 30,000).
On the other hand, almost 56 percent of housing units target 12 percent of the population, comprising individuals with a monthly income of Rs 100,000 and above. To make matters even worse, as the country is becoming increasingly urbanized, land value in the major cities has shot up and is increasingly out of reach for the average buyer.
Housing finance in Pakistan is particularly low; the World Bank reports that the country has South Asia’s lowest at 0.25 percent mortgage finance to GDP ratio, with a 3.4 percent regional average; around 3 percent in Bangladesh and 11 percent in India. The SBP estimates that the house price to income ratio is 20:1 in Pakistan (compared to a global average of 5:1).
The mortgage market has never been able to develop due to ineffective foreclosure laws in Pakistan. Courts have generally awarded stay orders that can last for decades (the average
case is around 8-10 years), making banks extremely reluctant to get involved in mortgages.
Courts have generally sided with house occupants despite them not making mortgage payments on their loans to banks. It has ultimately meant that banks became highly hesitant to give out mortgage loans.
Foreclosure laws When the PTI government came into power with its promise to deliver 5 million houses in 5 years under various schemes, including the Naya Pakistan Housing Program (NPHP), it realized very quickly that one of the biggest obstacles to its delivery was the lack of solid foreclosure laws, which allowed banks to sell the mortgaged property when the borrower defaults.
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This section was declared ultra vires to the constitution by the Supreme Court of Pakistan in a December 2013 decision. The court stated at the time that the Ordinance did not give borrowers adequate remedies or ‘right to a fair trial.’
The SBP amended the law, and in 2015, a bill was drafted and submitted to the National Assembly, the Financial Institutions (Recovery of Finances) (Amendment) Bill. The bill updated several sections of the 2001 bill, but most importantly, it added three further subsections to Section 15.
The Financial Institutions (Recovery of Finances) Amendment Act was signed into law in August 2016. However, it was once again taken to court. Last year, March 2020, a five-member bench of the Lahore High Court issued a 103- page judgment that decided that the 2016 law allows banks to auction the mortgaged property of loan defaulters without obtaining a court order first – is constitutional.
Alongside this historical court decision for the mortgage market, there was in the background, hectic work between government, SBP, and Banks on explaining the importance and workings of foreclosure law.
They also made further revisions, which the National Assembly approved the law ‘An ordinance to provide for the efficient recovery of mortgage-backed securities by financial institutions’ (Ordinance No. IX of 2019).
Given one of the significant hurdles perceived by banks had been their inability to pursue non-judicial foreclosures. Under section 3 of this Ordinance, it allows banks to recover their mortgage principal or interest without needing recourse to a court or tribunal for intermediary facilitation.
The section states that any legal right (including those created through the mortgage) relating to a property, created in favor of a ‘secured creditor’ (any financial institution), can be enforced ‘without the intervention of any court or tribunal.’
This could be done 60 days after the banks issue a notice requiring the defaulter to pay their secured debt or installments. The law also enables the banks to approach the state to ask it for help to take possession of properties to recover their dues. The state authority will need to take the necessary measures to ensure compliance with such a request.
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Most importantly, it also declares that no actions undertaken by the state authorities in compliance with this law can be questioned ‘in any court of law or before any authority.’ Section 14 states that civil courts will have no jurisdiction over any matters pursued under this Ordinance.
Section 15 states that the Ordinance overrides any other law inconsistent with its legal provisions. Legal action cannot start against a creditor for any of its activities taken in good faith under the Ordinance.
Under the new law, borrowers may challenge the action relating to the sale or possession of their property by the bank only if they submit 75 percent of the payable amount to the court.
A small caveat is that this requirement only applies to the borrower; however, any other aggrieved person affected by the bank’s action can appeal without submitting the 75 percent deposit.
Additionally, section 9, law states that the court can only stop the sale of the mortgaged property if: There is no mortgage agreement in place, the mortgage has been paid back, the borrower, or any other person raising this appeal, has deposited the outstanding mortgaged money to the court.
The government’s Naya Pakistan Housing Program (NPHP) aims to provide subsidized mortgage financing to low-income groups (5% for five marla houses and 7% for ten marla houses over 10-20 years).
Crucial for this was for banks to feel comfortable lending to low-income groups where income uncertainty exists (therefore potentially higher defaults for the banks), and land is often in areas where the title may be unclear. In November 2020, the SBP announced relaxations to incentivize banks to lend for low-income housing.
Banks were encouraged to use alternative methods to identify income sources and the creditworthiness of borrowers and exempted them from requirements of using ‘verifiable income’ in calculating the debt to burden ratio (DBR).
To increase mortgage lending, banks have also been exempted from the provision of following the DBR and the Internal risk rating system for low-cost housing finance until September 30, 2022. It is clear with this strong thrust by the government on the different interlocking aspects of the housing market – the next two years will see a substantial uptick in the number of people on the property ladder.