Discourse Vol 3, Issue 3
The Real Estate Price Quandary: Issues and Way forward
Publication Year : 2022

As argued in PIDE Reform Agenda for Accelerated and Sustained  Growth  (2021),  the  pricing  system   in   the  real estate   market  of  Pakistan   is   not  efficient.  The  availability of  information   related  to  the  price  and  characteristics  of a   property  is   either  insufficient  or  vague.  As  a   result,  the price  system   in  the  real  estate   market  does   not  perform its functions of coordination and efficient allocation of resources  in the  economy.

One  of  the  factors  contributing  to  the  inefficiency  in  the real  estate   market  is   the  information   asymmetry   created by  the  existence  of  different   property   rates  defined   by different  entities. Currently, at least three property  rates are operational  in the market and that  includes:

■  The  Federal    Board   of   Revenue   (FBR)    immovable property evaluation.

■  The District Collector (DC) rate.

■  The market rate.

The existence of multiple rates in the real estate market is due to the revenue considerations of the agencies. Although the actual transaction  happens at the market rate, the recorded price varies as  per the  need and suitability of buyers and sellers.

Due to  these factors,  the  price system  of the  real  estate market is not producing the desired signals. Resultantly, efficient allocation  of resources within  the  sector as well as across  sectors  is  not  happening. The real  estate sector is heavily over-invested  and the  real  estate  is  out  of reach to the lower-middle and middle class.

The inefficiencies  created  by  multiple  rates  are far  more damaging  than  the  revenue generated  from  the  market. Main distortions created  by multiple pricing include:

■  Increased transaction cost

■  Information asymmetries

■  Distorted  pricing system

■  Increased chances of fraudulent transaction

■  A source of whitening  black money

■  Realized tax yield much lower than the potential.

There are four types of taxes/duties applicable to real estate transactions:

The Provincial Government  collects stamp duty and capital  value tax. The  Federal  Government  collects the capital gain tax and withholding tax.

1. District Collector (DC) Rate

Provincial governments use the District Collector (DC) rate to calculate the stamp duty and Capital Value Tax (CVT). Section

27-A of the Stamp Act (1899)  states that the duty on the immovable property shall be charged according to the value of the property,  and for the  valuation  of the  property  DC

notified value table/rate shall be used.

The district  collector announces the valuation  of properties based on the characteristics of properties that include location   (district,   tehsil),   type  (urban,   rural),   and  nature (the classification of land) of the property. The practice of applying the DC  rate  at the  time  of mutation  was formally adopted during the  1980s with the following  objectives:

To make the sector more efficient. To maximize the tax revenue.

To control  price fall.

Afterward, the stamp duty and CVT, which fall  under the provincial jurisdictions, are calculated based on DC rates at the time of mutation.

Initially, the Federal Government also adopted DC  rates to calculate  both  capital  gain and withholding taxes.  However, in Income Tax Ordinance 2001, the power to determine the property  price was given to the commissioner. The Income Tax Rules  2002 also prescribed the mechanism for the commissioner to determine the fair market price.

Currently,  provinces  charge stamp  duty  at  a  rate  of 3% for  rural  immovable  property  and  1% for  urban properties  evaluated  at  DC  rates.  While  the  capital value tax rate  is  2% for the  urban  property evaluated the DC rate.

2. The Federal Bureau of Revenue Valuation of Immovable

Property

Issues  in the adoption  of the  DC  rate for  charging  taxes emerged in the mid-1990s when the DC rates were far below the market rates.  Moreover, the revision of the DC rates was not carried out periodically. Resultantly, the real estate sector became a favorite sector to park black money.

To tackle the valuation gap between the DC  rate and market rate, the FBR started the practice of issuing the valuation of immovable property for different cities of Pakistan  in 2016. These valuation  tables  are meant to be at par with the market rate, and the FBR has revised these tables  two times,  i.e.,  in 2019  and 2022,  so far. Now the  capital  gain tax and withholding  tax on the sale  of immovable property  are calculated  based on FBR immovable property tables in localities where the tables are notified, while for all other localities, the DC rate is still applicable.

However, the market rate often varies from  both the FBR valuation and the DC rate. The market rate (the actual rate at which transactions are happening  in the real estate market) is roughly 5 to 10 times higher than the DC rate and 2 to 4 times higher than the FBR rate.

3. Comparing Different Rates

To  highlight the  difference  in  these  rates,  and show the anomalies  in the  objective  for which DC  rate  and the FBR were introduced, we performed a small  exercise. We selected two properties from Rawalpindi city (Satellite Town) and compared the market rates of these properties with the DC rate and the FBR valuation.[2]

There exists  a   huge  gap  between  the  valuation  of  these properties  at  different  rates.  This valuation  gap  leads  to  a  tax  gap  as  well.  The tables  below  show  the  magnitude  of  the valuation  and the tax gap.

4. Multiple Listing: A Panacea

To overcome the problem  of information asymmetry in general  and to ensure the availability of price-related  information in  particular, one of the possible solutions is  the introduction of multiple listing services  in the real  estate sector. The introduction of multiple listing services would also enable the real estate market to get rid of the obsolete official pricing mechanisms that include the DC rates and the FBR valuation tables. The price information available or given in the listing service can be used for recording the transaction and for calculating tax liabilities.

The key points to keep in mind while designing these services are:

i. the fair market price is revealed during the auction

ii.  there is fair bidding without rigging

iii. who will regulate the services and who can participate

iv. How do the listing services get integrated with the mutation process

[2]  These properties are listed for sale at zameen.com, and we used asked price as the market rate. The calculation of the FBR valuation and the DC rates are based on the values given in respective tables.