CHALLENGES ABOUND

SAAD ANWAR HASHMI
(feedback@pgeconomist.com)

July 2 - 8, 20
12

The real estate market includes both commercial and residential properties across Pakistan. In recent times, we have witnessed an increase in construction of housing projects. There is a significant shortfall in the supply of commercial and residential properties. It is estimated that Pakistan has a shortfall of nine million housing units while demand is increasing. Pakistan, with population majorly made of lower and middle classes, has huge demand of low cost housing projects. Since mega construction projects in construction are targeted towards high income brackets, those requiring low cost housing encroach land and build homes promoting illegal land allotments through land mafias. It is estimated that 70 per cent of the population either live in slums or rural areas whereas only 30 per cent of the population are those who are homeowners with registered addresses with local utility companies.

The challenge faced by the construction industry is primarily the mediums through which such projects are financed. Builders are hired by potential investors for projects, where cash flows are linked with payment of installments upon purchase. Construction companies and builders are paid by the investors through achieving targets or milestones. If the payment is delayed due to quality or not achieving a certain milestone by the targeted date, builders often find themselves in liquidity issues which cause further delays and increase the cost of the projects forcing budgetary estimates to be revised. Any discord over payments further results in grinding halt due to cash flow issues. Even if a builder reaches default, the assets under charge cannot be sold since equipment is required at all times forcing restructuring of loans. Due to the risk and uncertainty involved, builders requiring bank financing are not extended credit. Few banks have defined policies not to take any exposure in the real estate market whereas others view the industry as risky. Any financing where the enforceability of the collateral is under question, is generally avoided by banks.

Another challenge faced in the real estate market is shortage of willing investors. Investors are increasingly cautious with the pace with which construction takes place for both commercial and residential properties where the risk includes delays in finishing the projects under which the project is never completed and investments are lost. Property decisions are primarily made on word of mouth. Part of the remittances is directed towards new projects, which is viewed as a positive sign. With new housing and commercial projects underway, investors find such opportunities as a hedge against inflation despite the risks with cost overruns and delays.

An easy barometer to view the demand for construction is to analyze the growth in sale of cement. The cement sales have grown to 21.64 million tons by May 2012, as against 19.97 million tons in the same period last year, which mainly accounts for both price and demand impact. The price of cement averaging between Rs430 and Rs450 per bag continues to be volatile. Despite the fact that the government has reduced the federal excise duty (FED) charged on cement from Rs700 per metric ton to Rs500 per metric ton in the budget for current fiscal year, the same impact is not transferred to the buyers with reduction in price. Cement manufacturers pinpoint the economy, rise in the price of fuel, curtailment of gas and electricity along with rise in cost of raw materials, thereby justifying an increase in price operating at 65 to 75 per cent capacity. The builders believe that the price of cement is a result of cartelization. With the government announcing many programs under public sector development programme, the price of cement will further increase unless such increases are justified considering cement plants are operating at 100 per cent capacity.

According to the association of builders and developers (Abad), the budgetary estimates along with the tolerance come under question with factors such as increase in the price of cement along with cost of paint, finishing, tiles, wood and electrical wiring. Builders have also been affected with the constant devaluation in exchange rate, which increases the cost of imports for steel and construction equipment. Despite challenges with costs, rise in demand results in frequent change in estimates.

With businesses locating in urban cities and lack of development expenditure in rural areas, there is a shift of population from rural to urban centres seeking employment opportunities, which puts a burden on the resources including water, gas and energy. Many live in groups sharing rent in rundown localities largely undocumented. The government does not take any action against such encroachments to avoid public protest resulting in law and order issues.

With each bank focusing on quality of security and capacity of repayment, bank financing for mortgages is extended to individuals with healthy income and who can afford to pay the mortgage net of expenses. The scrutiny of an application for a home loan is more stringent keeping into account asset quality. Commercial banks primarily extend such credit to those residing in urban areas whereas specialized financial institutions e.g. house building finance company limited and Tameer Micro Finance focus on extending rural credit.

Despite the given challenges, the real estate market is expected to be prosperous. With increased competition with commercial and housing projects, investors have a wide choice to own or rent a property. Real estate investments through real estate investment trust (REIT) may also be viewed as an investment for portfolio diversification.