Supply creates its own demand. To be fair, this quote that is known world-over as Say’s law are actually words written by John Maynard Keynes in 1936 to explain in simpler terms what French Economist John Baptiste Say said in 1803. Keynes went on to argue against it, much like, a more recent rebuttal that comes from American Economist Paul Krugman who in a NYT piece argued: “not only doesn’t supply create its own demand; experience since 2008 suggests, if anything, that the reverse is largely true – specifically, that inadequate demand destroys supply.” We can argue over this or we can get to our point faster. Last week’s construction policy announcement begs the following: will the policy increase supply of housing, and will that, in turn, trigger demand? Short answer: Not on its own.
Here’s the long answer. Suppose the no-questions-asked rule, together with the relaxed fixed tax regime as well as the tax reduction (90% slash) for investments made in Naya Pakistan Housing Program (NPHP) are all able to persuade builders, developers and investors to buy land and begin construction. However despite subsidy (Rs30 billion), and tax breaks, it seems the asking price may only be affordable for a small group of households who already have supply in the market. Perhaps, in the long-run, a consistent supply of housing could bring down prices, (oh but, in the long-run we are all dead! - another of Keynes’ key messages to the world), the projects right now will neither be low-income, nor fit the criteria set by NPHP itself (for the purpose of this discussion, let’s only talk about NPHP and not any other construction ventures).
The question is: though latent demand for housing is there, will NPHP projects be affordable enough to sell? The pet project close to PM Imran Khan’s heart was all set to increase the housing supply by 5 million, to meet the yawning gap in housing of an estimated 10 million across Pakistan, during the PTI tenure. The project as we all know hit a lot of snags but right before COVID-19 had jolted the country, it was starting to move slowly in a positive direction.
The government announced a subsidy and had a groundbreaking on six projects (about 20,000 flats), five of which were under Federal Government Employees Housing Authority (FGEHA). These are about 10,000 flats across Islamabad, Rawalpindi and Lahore being offered to federal government employees across the Basic Pay Scale (BPS) range of 1-22. One-third of this housing is for the lowest income employees on the BPS scale of 1-9, while one-fourth of these flats are middle income employees in the BPS range of 10-17 (see table).
One could argue that these projects have been shoved under the NPHP banner when in fact these are typical FGEHA planned projects. But that would be deviating from the more important point. If these are part of NPHP, the tentative prices can be considered as benchmark for what is to come (or a jumping off point) and we can use these to determine whether we can establish affordability.
According to the SBP, low-income housing is defined as a property priced below Rs3 million. None of the flats in the FGEHA scheme meet this criteria. But let’s ignore that for a little bit. Here are four scenarios which can be explored.
Scenario 1: What if there is no mortgage, and the pay-off needs to be made in 3-years? We are assuming here that the current work being done by regulators to bring approval times from 12-18 months down to 30 days will ensure projects are not delayed. The table clearly shows that the lowest income employees will have to make a monthly payment of 4 to 7 times of their average monthly salary. This is not feasible. True, these employees enjoy allowances which this analysis has not accounted for but a comparison can be made with house rent allowance. One metric of affordability is that mortgage should not exceed what folks are paying in rent. The differential here is significant.
Scenario 2: How long will it take for allottees to pay-off the loan if they paid Rs20,000 per month as installment. Recall that under the NPHP, allottees can opt for one of the three installment plans where applicants pay a monthly Rs5,000 to Rs10,000 in the lowest category; Rs10,001 to Rs15,000 in the middle category and between Rs15,001 to Rs20,000 in the highest category. If we pick the upper limit of the highest installment and compare them to the payable amount after 10 percent down-payment, the lowest income employees will be paying these off in 14 to 22 years. This could maybe work if the government was running a TOKI-like program (Turkey’s government backed housing agency that mass provides social housing) where beneficiaries pay an equal amount every month to a government-owned organization for the duration of the pay-off. Surely, builders and developers would not want to wait this long to recover their payment. For the TOKI-like model to work, the government will have to pay upfront to the builders all of the housing cost to complete the projects. Again, this feels infeasible.
Scenario 3: We know that the House Building Finance Corporation (HBFC) is getting refinancing from the Pakistan Mortgage Refinance Company (PMRC) which is getting funding line from the World Bank. HBFC is offering a 12 percent fixed rate mortgage (FRM) along a 20-year tenor for houses costing under Rs4.5 million (this ceiling has been raised from Rs3million last year). This is an attractive product, albeit with limited funding. Unfortunately, only 2000 of the total FGEHA flats would even qualify for this (See Chaklala Heights, Row 4). The mortgage payment of Rs37,000 against a house rent allowance of Rs2,200 is pretty high. It is also 1.7 times the average BPS. Let’s introduce another concept of affordability here which says, that if a mortgage payment (or rent) exceeds 30 percent of the monthly income, the house is not affordable. Accounting for that, in order to make this monthly mortgage payment, the employees should earn at least Rs 80,000. Their current BPS is about Rs21,000. If allowances is doubling the basic pay, this product might just be affordable (but for employees earning at the higher end).
Scenario 4: Now under the construction policy, mortgages will be offered at 6 percent. We could calculate how many mortgages Rs30 billion will cover at this rate (more on that later). First, mortgage payment for the cheapest flat here (See Chaklala Heights, Row 4) is about Rs24,000 (if tenor is 20 years) and Rs28,000 (if tenor is 15 years)—both higher than the upper limit of the NPHP installment plan. These are also more than 100 percent of the basic salaries. Since these don’t include the allowances, the other way to look at it is to calculate how much should these folks be earning to meet the 30 percent criteria? Column M gives those numbers. Let’s pick Lifestyle Residency for the lowest income employees (row 3). They need to be earnings a little over Rs100,000 to afford this product since the mortgage payment is between Rs32,000 and Rs 38,000.
This analysis can be used to deduce a few preliminary points. It is pretty clear that these housing prices at the mortgage FRM of 6 percent are not going to be affordable, unless we are supplying these homes to the upper-middle income groups –this is not where the demand is. Column M gives a pretty good idea of what people should be earning to afford NPHP housing.
Even if the government can negotiate better deals with builders, maybe get into cross-subsidy models or other ways to drive down prices (though think about what happens to land price when demand goes up!), there are other issues. One: will banks be open to providing mortgages, an asset class they have historically stayed away from even in times of economic prosperity? With macro instability, default rates always go up. Banks will not want to take on this burden at all. Will the government step in as a guarantor or a third-party equity owner; who will take the risk?
Two: banks will further stay away because of the lack of clear foreclosure laws. Three, it is clear that COVID-19 will not disappear in the next few months and countries will be intermittently locking down and opening up urban hubs as they do. This means consumers will be saving money for essentials and rainy days, a lot of them will fear losing their jobs and not want to have cash stuck on housing construction. Even if they were looking at housing from an investment point of view, job uncertainty is another factor which would keep banks away. Then, yet another concern is credit worthiness and how to measure it. If the homes are provided to middle to low-middle income households, income sources are not always cut and dry. Concerns about land title clarity and collateral registry are also potent risk factors dissuading banks. Many of these lands will be in the outskirts and semi-urban locations where titles are unclear, especially in the case of private owned land. Sindh and Punjab have been working on documenting and digitizing land records but the exercise is not complete. The Secured Transactions Registry has been created by the Securities & Exchange Commission of Pakistan (SECP) under the law which would register immovable assets against which credit can be given by banks. Sources say the registry is in its very initial stages of execution awaiting appointment of a registrar.
Then there are questions on subsidy. Rs30 billion will not cover a lot of flats, and what happens once this government goes out leaving behind millions of mortgages that require subsidy cover? The funds have to come from somewhere and for a sustainable period of time.
The only thing clear right now is that PM Imran Khan is biting more than he can chew. Creating thousands of jobs in construction is a novel idea that needs a lot of work. Some of that work is being done, but you only have to head to Pakistan Institute Development Economics (PIDE)’s latest webinar on the subject to gauge just how deep rooted the problems are, and how many questions remain unanswered.
As a country, we can talk about electric cars, but even over 3 decades later of the slogan being coined, “roti, kapra, makaan” remains the most relevant and present of all our aspirations. What does that say about us?