Syndicate content

Housing Finance across Countries: New Data and Analysis

Thorsten Beck's picture

Housing finance is a hot topic across the developed and developing world, though for different reasons. With some developed economies just coming out of a housing slump and others still in the middle of it (including my current host country, the Netherlands), often caused by easy and excessive access to mortgage credit before the crisis, households in many developing countries suffer rather from a dearth of long-term financing options. To illustrate this discrepancy, total mortgage debt outstanding in the Netherlands is equivalent to 83% of GDP, whereas it amounts to less than one percent of GDP across many low- and lower-middle-income countries in Asia and Africa. What explains these differences? Are underdeveloped housing finance systems just a symptom of the general shallowness of financial systems across developing countries?  Or are there country factors and policies that specifically explain underdeveloped mortgage markets?

In a recent paper with Anton Badev, Ligia Vado and Simon Walley, we try to answer some of these questions with new data on mortgage depth and penetration. Specifically, drawing on a painstaking exercise of putting together country-level information on the depth of mortgage finance systems across countries and over time and using the recent data on the use of housing finance in the Global Findex database, we explore factors explaining the large cross-country variation in housing finance across the world

One first striking observation is that housing finance seems to be a luxury good, as illustrated in Figure 1. Mortgage depth and housing loan penetration increase with countries’ income level in a convex manner, i.e. slow increases with income across low- and middle-income countries and rapid increases with income across high-income countries.

Figure 1: Mortgage Depth and Penetration across Income Groups

 Mortgage Depth and Penetration across Income Groups

What explains cross-country variation in mortgage market development?

Running simple cross-sectional and panel regressions of mortgage depth and penetration on different country characters shows that policies associated with financial system development are also associated with mortgage market development, including price stability and the efficiency of contractual and information frameworks. We find that the development of the insurance sector and the stock market, sources of long-term funding, is strongly associated with mortgage market development.  On the other hand, there is no clear evidence that government interventions such as subsidies, government guarantees or tax policies are helpful to develop the formal mortgage market, although these results are based on data mostly from high-income countries, given data restrictions.  It is important to note that these findings do not imply any causality.

Benchmarking mortgage markets

When we use socio-economic characteristics to benchmark mortgage markets, we find a wide variation in over- and under-shooting of mortgage markets relative to their predicted levels, not just across countries but also within countries. This variation is not necessarily associated with income level, but does vary with certain policy areas.  This benchmarking exercise can also shows the development of bubbles, with countries such as Ireland and Spain clearly showing an overheating in the mortgage market in the years leading up to the crisis (Figure 2).

Figure 2: Actual and predicted mortgage depth in Ireland over time

 Actual and predicted mortgage depth in Ireland over time

Looking forward

This paper is only a very first step in the exploration of cross-country variation in mortgage markets. There are several venues for further research. First, future data collection work should focus on additional important dimensions of the mortgage market, including maturity structure, loan-to-value ratios, range of financing products, loan currency and structure of mortgage providers.  Similarly, contrasting different funding mechanisms with more detailed data will be important. Related to this, information on regulatory and taxation policies related to mortgage markets would be useful, including the deductibility of interest payment, legal or regulatory limits on loan-value ratios or other contract terms, stamp duties or taxes and other rules. Second, a more in-depth exploration of policies that can foster mortgage market development is warranted. This implies collection of more detailed data on specific policies affecting the development of mortgage markets, but also exploiting specific policy changes to address the identification challenge.

Comments

Submitted by B. Yerram Raju on

Valuation risks cry for mitigation in housing and realty sector at least in so far as India is concerned.

The realty sector is the second biggest employer after agriculture in India. Twelfth Five Year Plan has on its huge investments in infrastructure giving the much needed push for the country’s growth to reverse the recent negativity in the next five years and in its wake accelerate a spurt in realty sector. Increasing urbanization, the huge opportunity in hospitality industry, accelerated investments in education and health sectors are going to be the drivers for the growth in real estate sector. Construction sector contributes 30-35 percent of the GDP and has as much potential to push growth or retard. There are enough numbers to support these drivers in several surveys of researchers, Census of India 2011 and the Business Analysts’ Reports that are all available at the click of the mouse. Government incentives do not fall short either:
• Housing finances feasible with the housing loan limit step up to US $52080 for priority sector lending.
• US$ 625 million allocated for the Rural Housing Fund to provide homes to economically weaker sections.
• FDI up to 100 per cent allowed with government permission for developing townships and settlements.
• FDI up to 100 per cent in hotel and tourism sector through automatic route.

What is most disturbing, however, is the spate of Court verdicts, public acrimony and declining stock prices of real estate sector threatening the upcoming properties in Chennai and Panvel: Hiranandini faces liquidation proceedings in a suit decreed on favour of Tata Capital; Raheja fined and penalized for defaulting its buyers in Delhi; Adarsh Housing Complex fraud facing the CBI probe; Campacola Compound 36 storied structure facing demolition in the wake of its blatant violation of the FSA norms; many more in the courts waiting for verdicts. This sector is invariably referred to as the black hole of the economy and the creator of the black money aided and abetted by the men in power and politics. There were suicides and murders and some are recorded and some recorded could not be traced to the offenders!

Advanced economies like the US are fast changing the rules of the game: mortgage rules are being altered; guarantees are being redefined; credit rating agencies are ordained by law to be more transparent and valuers to fall in line. Governance is redefined with Volker’s Rule.

Banks that got into the sector post liberalization have piled up no less than INR 16000croresas at the end of March 2013. Many rue that behind all this is the culpability of the valuation of the real estate and housing in retail, holding a huge risk for the envisaged growth of the sector. Enterprise Risk Management is totally absent in the sector. It is perhaps difficult to expect the valuers as a syndrome of virtue in an ocean of vice. But the time has come for thinking about the ethical practices in valuation of various types of properties including the intellectual property that asserts more as a right represented sometimes by brand or a logo. The intangible assets also are being sought to be valued.

It should not be forgotten that the raison de ‘etre for the global recession rested in faulty credit ratings and valuation of properties that led to subprime lending and its consequences. Indian economy could not decouple from the effects of global economic recession.

Where does the remedy lie?

Values vary in nature and type within and across the sector and across the users: land; buildings, appurtenances; location – geographic, seismological, environmental, developmental; structural – engineering, design and component standards; housing; commercial complexes; hospitality industry; education and health sector etc. The types can be actual value, attributed or imputed value; Inherent value; apparent value; market value; registered value; admissible value; sale value; insurable value; declared value; market value and so on and some of these overlap.

Banks, Courts, investors, insurance companies, estate buyers; home buyers, leaseholders etc broadly constitute the user groups. Some demands from these groups conflict or converge. Therefore, the purpose for which valuation is sought determines the risk dimensions. One may ask: when the user needs are met how does it matter which way they choose to adopt?

In the emerging economic environment interlinked with global opportunities, standards dictate the future and systems and procedures define their presence. Data attributes define the analytics; but if the data is either not available or available in unreliable status it would be difficult to track and trace a default and this carries huge risk.

Lately the Indian Banks Association (IBA) in association with the Institute of Valuers has developed a Hand Book on Valuation Standards for Banks and the forms of reporting by the valuers when an indent goes to them. These are still to be approved by the Banks’ Boards for adoption. The recent International Conference on ‘Global economy, Risk management in the field of International Valuation’ resolved to fight for their justifiable place in the regulatory regime of the SEBI that recently released draft regulations for the Real Estate Investment Trusts (REIT) as the Companies Act 2013 already recognized the chartered engineer valuers on par with the Chartered Accountants and Cost Accountants. It also resolved to develop standards in valuation and develop a code of ethics. While these are welcome initiatives, valuation risks require a deeper risk mitigation mechanism.

Complexities in Businesses demand effective risk management of the enterprises and Enterprise Risk management centering on risk culture, risk identification, risk mitigation measures, and good governance accompanied by effective monitoring and evaluation of risk practices through risk audit holds the key for ensuring healthy growth of the sector. In Realty valuations play truant and therefore valuation risks’ assessment and management is extremely important component of Enterprise Risk Management.

The broad concerns today are not just the traditional risk areas: There are certain risks peculiar to the enterprise itself – product risks, valuation risks, pricing risks, concentration risks, accompanying credit, market and operational risks; etc. But there are risks waiting outside our corridors to enter: capital markets, risks that might arise from multiple regulators (RBI,SEBI, IRDA, PFRA, MOF) – one solace is that there is an oversight of the impact of multiple regulators currently in vogue- a Financial Super Regulatory Board within the overarching power of the Ministry of Finance, GoI.

However, the realty sector has no single regulator or a regulatory board providing an oversight of the sector. Multiple regulators have sometimes conflicting interests and provide leeway for the real estate to brazenly violate any and all regulations. Number of laws encircles the realty sector and each law has its own regulator.

Complexity of business breeds an element of chaos and uncertainty as the organization is in a constant state of metamorphosis. While the organizations are dynamic the risks get distributed: Organizations have distributed operations complicated by a web of global supplier, agent, business partner, and client relationships. Traditional brick and mortar business is a thing of the past: physical buildings and conventional employees no longer define the organization. An interconnected mesh of relationships and transactions redefine business boundaries. Complexity grows as interconnected relationships, processes, and systems nest themselves in intricacy, such as deep, multi-layered supply chains. The challenge with extended enterprise relationships is that change is exponential. Not only is the organization dealing with constant change in its own operations, each individual relationship is dealing with change and continues downstream. This brings risk exposure to the organization that sits in the shoes of its extended relationships.

The intersection of distributed and dynamic business brings disruption. Change combined with complexity in distributed operations/relationships means the organization is easily disrupted in the context of GRC. The explosion of data and transactions has brought on the era of “Big Data.” Organizations manage high volumes of structured and unstructured data across multiple systems, processes, and relationships as they attempt to unravel the entire picture of risk in the context of performance. Velocity, variety, and volume of data are overwhelming – disrupting the organization and slowing it down at a time when it needs to be agile.

Data analytics have a scope to come to the rescue but the sector is not prepared it for it moves on kneejerk reactions than data on all the verticals both within and across the country and globe. The sector has to invest in systems; research and data warehousing.
Cash Flow Risks:

There can be some ‘deadweight costs’. To illustrate, if a company expects operating cash flow of INR200 million for the year and instead reports a loss of INR50 million, a cash shortfall of this size can be far more costly to the firm than just the missing INR250 million. First of all, to the extent it affects the market’s expectation of future cash flows and earnings, such a shortfall will generally be associated with a reduction in firm value of much more than INR250 million—a reduction that reflects the market’s expectation of lower growth. And even if operating cash flow rebounds quickly, there could be other, longer-lasting effects.

For example, assume the company has a number of strategic investment opportunities that require immediate funding. Unless the firm has considerable excess cash or unused debt capacity, it may be faced with the tough choice of cutting back on planned investments or raising equity in difficult circumstances and on expensive terms. If the cost of issuing equity is high enough, management may have little choice but to cut investment. And unlike the adjustment of market expectations in response to what proves to be a temporary cash shortfall, the loss in value from the firm having to pass up positive-NPV projects represents a permanent reduction in value.

Some companies gainfully and strategically move to risk transfer markets. A company has real estate investments in Hyderabad, Bangalore, North East and infrastructure – road construction projects in Haryana and Rajasthan. The market is Hyderabad is in a flux due to political risks and in Bangalore, it is stuck due to saturation of investments in the real estate sector. North East has State funded projects and has the risk of delayed payments, whereas the projects in Haryana and Rajasthan are moving at fast pace. Deployment of resources strategically to the projects in Haryana and Rajasthan makes lot of sense for the firm presuming that it can transfer the risks. But the projects in Hyderabad and Bangalore are in mid-way and have commitments to the clientele for delivery at specific intervals. Financial risks have to be weighed against the other risks the firm carries before risk transfer markets are explored. The firm’s valuations would depend upon the extent to which the reputation risk is managed effectively.

Infosys, Wipro, TCS, and a few other likes have been allotted prime land at nominal costs by the State Governments with the promise of huge employment opportunities in their locale. These properties unhesitatingly marked these properties to the market in their capex that led to bloated balance sheets and enhanced share values on the stock exchange in no time. Risk transfer markets function differently for different sectors.

The valuations risks are linked to the drivers of real estate: Consumption, investment, tax benefits, migrant remittances and speculation.

The five different categories in my view have a different perspective on valuations. People wanting to consume a house relate it to rentals; investment motive relates to returns from other assets; tax issues are known; migrants may look at borrowing costs abroad and returns on their remittances and finally the speculators, their valuation is entirely on different parameters. Lease markets look for different sets of valuations. While the property valuations may be looking northwards, rental markets may be looking southwards. This could happen due to a variety of factors and the environment but it is the financing agency that gets the shock in non-payment of installments. In most cases the lender does not get the insurance for the full value of the loan. While the bank may grant a loan of Rs. 50mn, the insurance valuer of the same property may value only the insurable portion that may come to just Rs.20mn. In the event of recourse to the asset, the lender may actually be able to realize only Rs.1crore from the insurance and the forced sale may fetch under distress circumstances another 50lakh INR or even less. The balance may have to be written off. The valuation that determined the Rs.50mn loan would eventually come to serious questioning.

Figuratively, the valuation risks can be charted as follows:

Building valuation is relatively easy to arrive at as the specifications can be verified and the quality of construction can also be checked reasonably. Materials used in construction will have a bearing on valuation, though high depreciation is applied for such materials such as high quality elegant marbles, granites, branded windows, costly and elegant glass panels, costly sanitary wares etc. If the old buildings are to be valued, the cost of current construction should be considered as replacement cost and the depreciated value is to be applied.

Cost of the facilities has to be calculated and added to the total value, though such cost is highly depreciated substantially. Such facilities enhance the esteem value. Facilities such as swimming pool, club house, gym, community hall, games room, CCTV, Intercom, WIFI, Lifts, Generators, Garbage Chute, parking area, Security, Administration Office etc. are the factors that determine additional fancy valuation.

Factory and stock valuations are entirely a different ballgame. Depending on the nature of the enterprise, the valuations are arrived at.

As the technological advancements are visible these days, obsolescence is the main factor in valuation of such facilities.

Fall in demand may be due to shift of location’s characteristics. announcement of the area falling under seismic zone, unauthorized occupation of slum dwellers nearby, reputation loss of the builder due to the exposure of poor quality construction elsewhere.

Natural calamity such as Tsunami has affected the value of the property which is in the coastal area.
Any announcement of zone classification restrictions by the authorities will also affect the value of the property.

Acquisition notice issued for general purpose such as road expansion, new airport expansion, will reduce the value of the property substantially.

Infrastructure development such as maintaining Good Park with a facility for morning walkers, opening of mall, good restaurants, hospitals, decent super markets in the vicinity, will enhance the value of the property.
A few live examples, which resulted in the change of valuation of properties would be in order:
1. Value of properties across the coastal line reduced substantially after tsunami.
2. Around the year 2000, Gachibowli, a village suburb on the periphery of Hyderabad but part of the then announced financial city, suddenly got inflated values when the ICICI Bank bought an acre of land at INR. 14lakhs against the then prevailing market rate of just around INR one lakh. There was no looking back on the land rates in the area thereafter. Value of properties near I-T corridors increased multi fold in chennai (OMR). From a mere INR 0.5mn per acre in 2005, the value in that area increased to INR 2.5mn per acre immediately after the announcement in 2005. It further increased to INR 10mn per acre after the allotment of land to i-t majors in 2006 and the value increased further to INR 50mn per acre after the office space was occupied in 2009 and now there is no land available even for INR 100mn acre.
3. Office space in OMR skyrocketed and the monthly rental value went up to INR 50 per sft, but the same got reduced to INR. 20 per sft., on its slowdown in USA.
4. The announcement of new airport in Chennai has resulted in reduction of value in the areas affected by the expansion as people feared less compensation by the government on acquisition
5. Better infrastructure facilities in tier ii cities resulted in increase in valuation of properties in such tier ii cities
6. Easy and affordable finance by housing finance companies such as LIC housing, Canfin homes, HDFC has given better purchasing power in the hands of middle class to own their houses.
7. Younger generation engineers with computer background were given jobs by it majors in a big way for offshore development due to outsourcing from US, has resulted in many of the youngsters going for owning properties with the financial assistance by banks and housing finance companies. This rush resulted in the increase in rate per sft. Of flats in major cities.
Ill-gotten money of corrupt politicians, bureaucrats and unaccounted money of businessmen have been invested in real estate, resulted in mush room growth of construction activities with no proper approvals. The innocent buyers of such properties have to face the severe action by the authorities such as demolition, which has resulted in losing the base value of such properties.

Land Titles: Most land registries are disorganized and non-transparent in their dealings. The landed properties are most times locked up in legal disputes. Fixing ownership is many a time nightmare. The purchase price of land actually costs a fraction of the developed land for the intended purpose. The intermediary costs hide like a bikini suit. A significant number of plots may not have clear title where the possession is 90 percent ownership. Aggregation has its serious risks as most of the land is held by individuals/families. If any legal issue involved in the title of the property and if there is a possibility of any defect in the title, that will have an impact on the valuation.

Caveat Emptor rules. For example, in Hyderabad and Secunderabad and in most places in Telangana districts the erstwhile Nizam has passed on properties to his harem at free will and the title in several cases is not properly recorded. Still, land transactions did take place. It is not enough if one goes through the encumbrance certificate for the last 13 years as most purchasers do but the legal notices served on the title that get published in several prominent local dailies both in English and vernacular. Such notices are carefully scanned and documented by a software company and available at nominal price to the intending purchaser. The buyer can ask the seller to get vacation of this notice before the transaction could materialize.

Regulatory complexities invariably end up in higher transaction costs. The regulations vary across States, cities and different types of local bodies. Land ceiling Act has its grinding teeth. The newly enacted Land Acquisition Act 2013 empowers the State for resuming land for public purposes or misclassified purposes earlier getting reclassified for such enablement. This Act poses new risks and challenges for the realtor. INR Stamp duty and capital gains tax add their own costs that have to be reckoned properly in valuations. Urban Land Ceiling legislation in some States has not been repealed and this adds to the costs for clearances.

Agricultural lands are outside real estate definition as they yield corps, which has a separate value other than just land. Similarly, mines are also excluded as they have additional value in the form of deposit of minerals and ores.

Hospitals are part of the facilities of health care but have a separate real estate value with equipment permanently attached, such as oxygen pipe lines, super specialty operation theatre and state of the art emergency and casualty wards.

SEZ land cannot be freely transferable. If the land is not used for the purpose, then that land has to be returned to the authorities as the allotment was made at concessional rate
Posh area has fancy value as the owner pays extra for pride ownership.

Low income group area will not have any big appreciation as there are certain restrictions with respect to ownership. Most of them are allotments by the authorities at a concessional rate or free allotments.
Apart from that, there is an apprehension that the quality of construction is poor and the general maintenance of the complex is far below normal.

Guideline value is the benchmark value for the purpose of stamp duty by the government to restrict black money in Real Estate. The Income Tax Authorities take guideline value for capital gains purpose, if the value shown in the transaction is less than the guideline value. Further to that, penalty proceedings will also be initiated against the assessee.

Infrastructure growth can be anticipated on the announcement of a new bus terminal nearby or metro rail station to be located nearby, closer to proposed IT corridors etc.,

Authorities might have stated certain areas as purely residential wherein conversion to commercial, which will fetch more value is not possible. This factor will have the bearing on land value.

Development Control Rules of the authorities may specify conditions for more FSI such as road width, set back space, height of the building, plot coverage etc., Eg., Land with more frontage in a road width more than 60 feet in city like Chennai, will be eligible for more than 2.75 FSI whereas lesser size land will have maximum FSI of only 1.5 times of the land area.

Formal funding mechanisms are scarce and most depend upon high cost informal costs that carry huge risks – one, in identifying these costs and two, in assimilating them into the cost structure for appropriate valuation. In fact, it is no exaggeration that there would be no real estate transaction without hidden costs being incurred by the buyer. This would mean that the recorded price is lower than the actual price. The financing institutions accommodate the hidden costs through equipments and internal structures when retail buyer seeks the loan. REITs are a significant capital and liquidity source for real estate industry globally and are making their entry, thanks to the SEBI’s recent draft proposal discussed earlier.

Corporate Governance issues boil down basically to the following:

Supervisory Board has to combat the challenge of high transaction costs, high informal funding costs leading to tax avoidance and large use of cash. Payments and settlement systems have not been integrated with the financial entities. Businesses need restructuring to enhance tax efficiency.
Complex regulatory regime coupled with unclear land titles would lead to power games. Political risks make the organizations less transparent than required.

Well qualified independent Directors on Boards as required under the new Companies Act 2013 for which the rules are being released with reasonable speed are rare to come by.

The Boards rarely know the information they have to seek from the CEOs and there are compromises on information sharing.

All these translate to depressed valuations and poor ratings that would end up in the spiral of increasing interest rates from the financing institutions on the debt component.

Bond markets have not yet matured enough to get into by the evolving realty sector.
When the realtor operates in debt markets and informal credit markets, the costs are going to be huge and they would be passed on to the buyer. Thus the pass-though mechanisms have some collusive retail financing permissiveness. Insurance costs are not properly structured with the result several risks in the property like poor construction quality, poor infrastructure, waste management, and embedded infrastructure of inferior nature devolve on the ultimate buyer. These many a time escape the valuations upfront.

Risk Mitigation Measures
1. Risk culture needs to spread across all verticals in the sector by assiduously and consciously practicing it. Risk mitigation would start with an inclination to identify risks and actually identifying thereafter. The next step is educating the entire staff and administration as to where the risks are originating and fixing responsibilities and timelines to reduce or eliminate all together these risks. Therefore, fundamentally it devolves on sharing information across the organization.
2. We need a separate Regulator for the Realty sector that should be consisting of chartered engineers, experienced insurers and experienced financiers to put in place realistic regulations with implementation rigor.
3. Best practice manual for a variety of products where in the procedures and processes have to be clearly spelt out and the Builders’ Associations have to take on the responsibility.
4. Transparency in transfer pricing mechanisms.
5. Payment and settlement systems to integrate with the sector.
6. Defined products and processes matter most.
7. Corporate governance has to improve. McKinsey’s Global Institute in its latest study on the subject indicates that directors spend more time on strategy than any other area. 12 percent only is spent on risk management. The Study mentions that companies and boards are becoming more complacent about risks as the 2008 debacle becomes distant memory.
Corporate social responsibility assumes importance to enhance green field investments in real estate maintenance.
8. User association responsibilities to upfront the valuation mechanisms.
9. Each Realtor shall have mechanisms to oversee good governance, risk and compliance with clear cut responsibility for the Chief Risk Officer who shall be put in place mandatorily and who should be responsible to the Board.
10. Builders’ Associations should engineer specific studies to highlight how much of a percentage growth in the sector contributes to the growth in manufacturing and more particularly the SME sector as a building has over hundred MSMEs as vendors. The Corporate Social Responsibility of the sector can be moulded to enhance value to the vendor organizations in meeting the emerging standards in the components.

It is the systems and standard operating manuals, effective governance practices and the detailed risk management that hold the key for the healthy growth of the sector and the economy as well in its wake. The Institution of Valuers at its recent Mysore Conference (23-24 November, 2013) resolved to fight for their justifiable space in the realty sector on interactive platforms of the Government, Institutes of Cost Accountants, Institute of Chartered Accountants and Institute of Company Secretaries and Centre for Corporate Governance. They would like to disseminate knowledge on valuations and their varying dimensions. They are keen on setting up knowledge platforms driven by business ethics. One should only wish them good luck.

Add new comment